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Wednesday, March 31, 2021
FEDS 2021-022: Fundamental Arbitrage under the Microscope: Evidence from Detailed Hedge Fund Transaction Data
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Tuesday, March 30, 2021
Monday, March 29, 2021
Chicago School Economists Got it Wrong. Strong Antitrust Policy Boosts the Economy.
There’s a reason people talk about the current American era as the New Gilded Age. A giant gap between haves and have-nots, mammoth corporations throwing their weight around, financial firms (hedge funds this time around) calling the shots, politicians captured by the rich – it’s all back with a vengeance. Instead of Standard Oil, we have goliaths like Google, Amazon, and Facebook allowed to grow so powerful they threaten not only consumers and competitors, but the entire economy -- and even democracy itself. Current antitrust policy, however, is not up to the task of restoring balance between big business and everybody else.
The University of Utah’s Mark Glick, who teaches law and economics, antitrust law, and industrial organization, joins the Institute for New Economic Thinking to talk about the history of antitrust thinking and its sharp turn towards the interest of big business in the 1980s. He explains the importance of reinvigorating antitrust policy, examines proposals to do so, and sheds light on why it matters to the wellbeing and prosperity of the country.
Lynn Parramore: Let’s go back to the beginning of antitrust policy in the United States. The Sherman Act passed in 1890, targeting monopolies and anti-competitive behavior. Why did the U.S. do this sixty years before any other country had a major antitrust statute?
Mark Glick: In the late 19th century, the rise of big business in the U.S. fostered enormous opposition from farmers, labor, and small business. The emerging big businesses were aggressively forming cartels and trusts, and the abuses of the trusts fostered a significant public outcry that prompted Senator John Sherman to introduce the Sherman Act into Congress 1888.
By this time, the political power of big business and these other classes that were impacted by the trusts in Congress was about equal. Representatives of big business in Congress opposed the Sherman bill because they claimed it trampled on their freedom of contract, the right to enter into contracts with other firms as they wished. On the other side, the farmers, laborers, and small businesses wanted free competition, which meant a limit on the power of big business.
Congress debated the bill for 18 months with no resolution. Finally, within a week, in April 1890, a redrafted bill emerged from the judiciary committee. The final floor vote on the bill was unanimous (one dissenter in the Senate). The explanation for this sudden, newfound unanimity was that the bill was ambiguous – each side could read into what they wanted. The bill stated that “every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade . . . is declared illegal.” Those on the side of big business hoped that “restraints of trade” meant “unreasonable restraints of trade,” which suited them because they didn’t think most restraints of trade were unreasonable at all. But representatives of farmers, labor, and small business interpreted “every” to mean “every restraint of trade,” which made them think that the power of big business would be significantly curtailed.
LP: What happened after the Sherman Act was passed? How did this ambiguity get resolved?
MG: In the U.S., political power is divided between the three branches of government. In the late 19th and early 20th centuries, big business held substantial political influence in the executive branch, and that’s where an antitrust case by the government must begin. The big business-oriented presidencies meant that after the passage of the Sherman Act, the Harrison, Cleveland, and McKinley administrations brought few antitrust cases against business. Instead, the Sherman Act was primarily used against labor to limit strike activity. It’s interesting that the only person ever to go to jail as a result of antitrust enforcement in these decades was Eugene Debs, a labor leader and socialist party member.
In the meantime, a few cases against business mainly involving railroad agreements reached the Supreme Court. During this period, even though the Supreme Court embraced laissez-faire and substantive due process (a doctrine that limited business regulation because it allegedly violated the “liberty” interests protected by the 14th Amendment), Judge Rufus Peckham in Trans-Missouri Freight held that “every” restraint of trade means “every restraint of trade.” This was a view supportive of the non-big business groups. But by 1911, in the Standard Oil case, a new majority on the Court held that only “unreasonable restraints of trade,” not “every” restraint of trade violated the Sherman Act. This has remained the rule since. So on antitrust, big business got the potential to argue a profitable restraint was “reasonable.”
LP: In his latest book, “Liberty from All Masters,” Barry Lynn argues that the Wilson Administration represents the golden years of antitrust in America. Wilson’s vision for the country, known as the “New Freedom” platform, included taking strong antitrust actions against the big corporations that were dominating the country's economy. Should antitrust today try to mimic Wilson’s New Freedom?
MG: Setting aside that Wilson was openly racist and antilabor, his administration did pass the Clayton Act, which dealt with issues like business mergers, and the FTC Act, which concerned unfair competition.
But Wilson was not the populist Lynn claims. Wilson thought big business had been progressive and in the public interest. The Clayton Act and FTC Acts were in line with the political interests of big business and were supported by the National Civil Federation, the leading lobbying group for big business at the time. Big business wanted specific anti-competitive conduct spelled out (the Clayton Act) and a commission that could immunize business strategies in advance (the FTC Act). This is what Wilson delivered. Wilson also opposed a solid labor exemption from the Clayton Act and Sherman Act and as a result, federal judges issued hundreds of anti-labor Sherman Act injunctions in the 1920s. It definitely wasn’t a golden age of antitrust for labor.
Nonetheless, the passage of these antitrust laws was an advance. The Clayton Act addressed merger control (but contained loopholes repaired after World War II) and gave state attorneys general and private parties standing to bring cases. The Federal Trade Commission (FTC) also evolved into an effective antitrust enforcement agency.
LP: Where should progressives today look for a model for better antitrust enforcement? And why is it so important?
MG: The model for antitrust policy should be Roosevelt’s New Deal policy consensus, which lasted from approximately 1933 to the middle 1970s. Strong antitrust policy was a key part of the New Deal policy consensus. However, antitrust was embedded in an ensemble of policies, which included the suppression and regulation of finance, support for unions and organized labor, government investment in infrastructure and innovation, a social safety net, and Keynesian macroeconomic policy. Each of these policy changes occurred to different degrees and with different timing. Later, Johnson’s Great Society Program would add racial justice to the policy mix (the original New Deal made concessions to southern democrats to secure passage).
It often goes unrecognized how effective New Deal policy was for the American economy. As Northwestern economist Robert Gordon has shown, productivity soared in the 1930s and 1940s as high wages encouraged electrification and adoption of other innovations. Leading scholars of innovation find that the decades of the 1930s and 1940s produced more basic innovations than any other American decades before or after.
The New Deal consensus extended until the crisis of the late 1970s. The mixed economy produced higher GDP growth, higher labor productivity, lower unemployment, lower income inequality, and higher investment than the decades before or after. An integral part of this success was strict antitrust enforcement. The paradigm cases for antitrust enforcement during the New Deal consensus were United States v. Socony-Vacuum Oil Co. and United States v. Philadelphia National Bank. Socony Vacuum established a broad per se rule for horizontal conspiracies, and Philadelphia National Bank created a presumption of illegality for mergers that resulted in concentrated markets. Beyond this, the Supreme Court made it clear that the goal of antitrust enforcement included protecting political democracy from undue influence by big business.
LP: If robust antitrust policy is critical both to the economy and to democracy itself, what caused the about-face during the Reagan Administration?
MG: In the 1980s, neoliberal policies began to replace the New Deal policy consensus. Proponents of the neoliberal ideology pushed to have finance deregulated, unions were decimated, and top tax brackets were reduced. These policies aimed to, and succeeded at, raising the incomes of the wealthy mainly through the financial sector. But they were presented as universally beneficial because they were said to make the economy more efficient.
A school of economic thought known as the Chicago School promoted a framework for weakening antitrust based on the claim that business strategies once thought to harm competition actually increased “efficiencies.” The central theme was that antitrust should be guided by something called the “consumer welfare standard.”
The label was deceptive: it appears to mean that the point of the standard is to improve the situation of consumers. The idea, so they claimed, was to evaluate business conduct and mergers by whether they increased overall efficiency. But in the fine print, they meant something else: not economic efficiency as taught to economics graduate students, but "consumer surplus,” stripped of the problems and caveats. This was simply introductory textbook economics: it's the gap between what you would be willing to pay for something like a TV and what you actually bought it for. The problem is that this standard just takes the existing distribution of income as given. What you are willing to pay for something depends on how much money you have. It's not some absolute standard of welfare, and you can't measure it without making heroic assumptions. All this was hidden from view and the consumer welfare standard took over the antitrust world in the U.S. and abroad.
LP: Why did the consumer welfare standard become so popular?
MG: Consumer welfare has always been a misrepresentation of economics promoted by proponents like the conservative jurist Robert Bork and Chicago School economists.
It’s not a measure of efficiency. While undergraduate textbooks in economics sometimes confuse this issue, in graduate-level economics and in the specialized field of welfare economics, it’s clear that efficiency means what economists call “Pareto efficiency.” Pareto efficiency takes the initial distribution of resources and goods for granted. Then, efficiency is enhanced when no one is made worse off and somebody's situation is improved. Pareto efficiency doesn’t apply to antitrust, though. Antitrust involves litigation where there are winners and losers. An outcome can’t be Pareto efficient if there is a loser. In fact, Article III, Section 2 of the Constitution does not allow legal cases to proceed if there is no “case or controversy” -- meaning a potential winner and loser. The Chicago School has been muddling the whole issue.
Consumer welfare just isn’t meaningful economics. It’s branding for limiting antitrust to scrutiny of product price, product quality, and innovation. But antitrust enforcement in the New Deal consensus also pursued goals of limiting concentration, keeping entry open, protecting small business, and political democracy. Today, antitrust should be used to protect workers and the economy when it can. For example, the Department of Justice (DOJ) has allowed thousands of bank mergers to occur, closing its eyes to problems such as greater instability from financial interconnection and too big to fail concerns. Antitrust is part of a policy regime and there is no reason for agencies to ignore obvious economic or political concerns from mergers.
Bottom line: there is no economic science involved in the consumer welfare standard. It was always merely a marketing device to advance the neoliberal agenda in antitrust. For all the talk and concern about efficiencies in the last few decades, what has actually resulted is an economy with lower investment, lower productivity, lower employment, and greater inequality than under the New Deal consensus. Plus, it is now widely acknowledged that the American economy is much more concentrated today, with numerous markets in which only a handful or fewer competitors still exist. The Chicago School has been proven wrong.
LP: As antitrust policy changed in the 1980s and 1990s, how were people impacted?
MG: The Chicago School influence changed antitrust for the worse in numerous ways. One of the most insidious has been the shifts in the evidentiary burden in antitrust cases on plaintiffs. This has led to weak enforcement and much greater market concentration.
Let me just give you a few examples of this phenomenon. You may have read that the big tech companies have made an unprecedented number of acquisitions in recent years. Microsoft, Google, Apple, Amazon, and Facebook each have made hundreds of purchases of other companies in their respective industries. The antitrust agencies have not investigated, let alone challenged, with minor exceptions, any of these mergers. The reason, in part, concerns Justice Lewis Powell, who, prior to accepting Nixon’s nomination to the Supreme Court, wrote the famous call-to-arms for American big business known as the “Powell memo.” Justice Powell made the evidentiary burden to a plaintiff challenging a potential competition merger unreachable in United States v. Marine Bancorporation in 1974.
Under the logic of Marine Bancorporation, if Google purchases a start-up that could siphon off its search business in the future, the DOJ or the FTC would have to prove that the target would have entered the general search market in the future (absent the merger) and that it would have deconcentrated the market. This is absurd! No plaintiff could prove this.
The Robinson-Patman Act was enacted in 1936 to outlaw price discrimination, preventing distributors from charging different prices to various retailers. Unfortunately, plaintiffs in Robinson-Patman cases also began to face an equally extravagant burden in the 1980s and 1990s. In the 1948 Supreme Court case of FTC v. Morton Salt, Co., a plaintiff that was a victim of price discrimination only had to show injury to itself. Since the 1980s, the federal courts have slowly increased the burden requiring proof of injury to competition as a whole, a standard that is virtually impossible to meet. In the circuits that have done this, there have been no successful plaintiffs I’m aware of.
LP: The New Brandeis movement has emerged to focus on strengthening antitrust policy, taking its cues from Justice Louis Brandeis, who served on the Supreme Court between 1916 and 1939. These insurgent scholars, activists, lawyers, and economists believe that the antitrust laws aren’t supposed to just deal with consumer welfare, but also to make sure we have competitive markets and see that large private entities don’t amass too much power, and, by doing so, threaten democracy. Do you agree with proposals by the New Brandeisian antitrust scholars like Tim Wu (author of “The Curse of Bigness: Antitrust in the New Gilded Age” and economic advisor to President Biden) and Columbia University legal scholar Lina Khan (recently nominated by Biden to the FTC)?
MG: As I understand it, the centerpiece of the New Brandeisian proposals (along with agency transparency) is to return to structural presumptions in antitrust similar to those that existed in the New Deal consensus. Many others have also made this suggestion, and I agree with this approach.
When mergers increase market concentration, we know that competition has been harmed even if to a small extent. Since this is the case, it makes sense to ask the merging parties to establish that the merger will provide benefits to the economy. The merging parties should be forced to document how the merger will increase product quality and lower price. In addition, the parties should explain how the merger will impact labor, how will it increase innovation, how will entry be impacted. Don’t ask the government to prove the negative. Merging parties have all the information for such an analysis, and they have access to an army of paid consultants. Similarly, if a monopolist engages in strategies such as below-cost pricing, refusals to deal, or other vertical restraints, the burden should be on the monopolist to show the challenged practice is pro-competitive. Vertical restraints should not be treated as per se legal.
I also agree with Lina Khan and others that the antitrust agencies have to be more forward-looking and preemptive. Amazon, for example, or any platform should not also be allowed to compete in a separate market on the platform. If Amazon runs the platform where most N95 masks are sold, it should not be in the N95 mask business on its own platform. This is a clear conflict of interest and no competitive benefit is likely to result from it down the road.
I would add that it’s also very important for progressive economists to aid the neoBrandeisians. While there are some progressive economists in the antitrust field, they are a tiny minority. For too long, progressive economists have been shying away from the whole subject of antitrust. There should be a call to arms by progressive economists to support the neoBrandeisian enterprise.
LP: Do you have any concerns with the New Brandeisian program? What kind of antitrust framework best serves the needs of the American people?
MG: I think what is lacking is a vision of where we want to see the economy go. In other words, what should the world look like under an optimal antitrust regime? In litigation we would call this the “but for” world.
Often, it sounds like the New Brandeisian goal is some version of perfect competition or competition with small firms. This is not where we need to go. We need instead to reconstruct and update the New Deal consensus, which worked so well for the economy and helped keep a political balance between big business and everyone else.
As economist William Lazonick puts it, we need firms as value-creating enterprises which engage in collective, cumulative learning with a dedicated, unionized employee skill base. We need to regulate finance like we once did. We also need to resurrect the developmental state dedicated to funding basic research and advanced infrastructure, and a political system that is not dominated by big business. Competition must play a critical role in this kind of regime as it did in the New Deal consensus.
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Friday, March 26, 2021
Austerity Raises Covid Deaths
Introduction
We are living in the age of consequences. The outbreak of SARS-CoV-2 uncovered our societies’ pre-existing structural weaknesses — which were the result of a pervasive political indifference to inequality, combined with decades of cuts to the most basic social protections and to wages, leaving large segments of our populations tragically vulnerable to the arrival of this virus (Marmot et al. 2020a, 2020b; Woolhandler et al. 2021).
Of course, the macroeconomic consequences of four decades of neoliberal management of the OECD economies were already there for all to see (Storm 2017): declining long-term growth (aka ‘secular stagnation’), suffocated by rising inequalities in income and wealth and by an obsessive-compulsive fiscal austerity by governments, but barely kept alive by rising (private and public) indebtedness and quasi-permanent asset-price bubbles (‘financialization’).
The neoliberal model suffered a first near-death experience in 2008, in the form of the Global Financial Crisis of 2008 and the ensuing not so Great Recession. It rather miraculously survived, helped by massive (taxpayer) support of governments and central banks and more by luck than skill. But in the process, it further toxified, as austerity deepened, and this fuelled the growth of (mostly right-wing) populism, destabilizing erstwhile stable democracies, notably Britain (‘Brexit’) and the U.S. (‘Trump’).
Hence, when, in early 2020, we let the corona-virus enter our societies through the front door, the virus rapidly found a deadly path through pre-existing socio-economic inequalities and vulnerabilities, with individuals and families at the bottom of the social and economic scale, who were missing out already long before the health emergency, suffering proportionally more, losing their health, jobs, lives, food security and educational opportunities. As daily infections rose and death counts mounted, most governments fitfully responded by imposing social distancing, mask-wearing, and lockdowns and by introducing spending measures to cushion the economic blow from the health emergency.
The scale of the intervention is unprecedented. Fiscal measures announced as of September 11, 2020, are estimated to equal $11.7 trillion globally (or close to 12% of global GDP). These measures and the worldwide recession have pushed global public debt to an all-time high of close to 100% of global GDP in 2020 (IMF 2020).
For more than one year we have been living through this health emergency and economic crisis and it is time to look back and take stock. What are the lessons which macroeconomists must learn from the SARS-CoV-2 crisis? I identify four main lessons in a new INET Working Paper. Before outlining these lessons, I will first consider a few stylized facts concerning the impacts of and responses to the COVID-19 crisis, based on empirical evidence for a sample of 22 OECD countries.
Stylized facts
For the world as a whole, cumulative confirmed SARS-CoV-2 mortality amounted to 2,476,526 deaths on February 23rd 2021, which is when the U.S. coronavirus death toll passed the tragic mark of 500,000 fatalities. Out of these 2.48 million confirmed corona-virus deaths worldwide, 1,006,817 deaths, or 43%, occurred in the panel of 22 OECD countries, listed in Figure 1. As is shown in the figure, the relative cumulative mortality impacts of COVID-19 vary greatly between countries – from 0.5 deaths per 100,000 persons in New Zealand to more than 190 deaths per 100,000 persons in Belgium. The U.S. and the U.K. have 149 and 178 deaths per 100,000 persons in their respective populations.
These differential impacts are to some extent due to ‘geography’, as island nations such as Australia, Japan and New Zealand are better able to tighten border checks (including imposing quarantine measures) in order to stem the spread of SARS-CoV-2 than land-locked nations in Europe and North-America, but geography does not explain the observed differences completely. This is illustrated by the relatively high COVID-19 mortality rates in island nations such as Ireland and particularly the U.K. Hence, more important than ‘geography’ have been three other factors: (1) differences in public health competence; (2) variances in structural socio-economic vulnerabilities to SARS-CoV-2; and (3) the presence or absence of fiscal constraints.
The public health response
OECD governments differ considerably in the level of public-health competence with which they have responded to SARS-CoV-2. For instance, according to the Lancet Commission on ‘Public Policy and Health in the Trump Era’, around 200,000 fewer Americans would have died from the coronavirus if the U.S. had treated SARS-CoV-2 with the same level of public health competence that its peer developed nations have demonstrated. As the Lancet Commission concludes:
“Many of the cases and deaths were avoidable. Instead of galvanizing the US populace to fight the pandemic, President Trump publicly dismissed its threat (despite privately acknowledging it), discouraged action as infection spread, and eschewed international cooperation. His refusal to develop a national strategy worsened shortages of personal protective equipment and diagnostic tests. President Trump politicized mask-wearing and school re-openings and convened indoor events attended by thousands, where masks were discouraged and physical distancing was impossible.”
(Woolhandler et al. 2021, p. 711).
The scatterplot of Figure 2 throws more light on the issue. On the horizontal axis, I measure the difference between additional public spending on COVID-19 relief of each country (as a percentage of GDP and up to January 2021) and the unweighted panel-average of additional relief spending for the 22 OECD countries (which is 7.2% of GDP). On the vertical axis, I measure the difference between COVID-19 deaths per 100,000 population in each country and the (unweighted) panel-average COVID-19 mortality rate, which is equal to 86 deaths per 100,000 population.
There exists a statistically significant negative relation between additional public spending and COVID-19 mortality rates. For example, countries such as Germany, Canada, Japan, and New Zealand, which could and did raise spending on COVID-19 relief by more than the average, experienced below-average death rates. Conversely, more fiscally-constrained countries such as France, Italy, Portugal, and Spain, which could not increase additional spending to the same extent, experienced above-average death rates.
Of interest are those countries which are located far off the regression line. One group, including Denmark, Finland, Norway, and South Korea, experienced significantly below-average COVID-19 mortality while incurring below-average additional spending on relief measures. These countries appear to have managed the health emergency comparatively well (so far) in terms of both public health and public finances (focussing on ‘crushing the curve’ rather than ‘flattening the curve’). The same cannot be said for the other group which includes the U.K. and the U.S. Both Anglo-Saxon economies experienced significantly above-average COVID-19 death rates, despite incurring considerable above-average additional relief expenditures. The Johnson government and the Trump administration thus stand out for their expensive mismanagement of the public health emergency – both in terms of lives and taxpayers’ costs (Marmot et al. 2020b; Woolhandler et al. 2021).
Figure 3 underscores this conclusion. I plot the (negative) change in real GDP during 2019-2020 for each of the 22 OECD countries against COVID-19 deaths per 100,000 population in each country. The chart can be read as a rough representation of how well each country has protected the health of its citizens versus the macroeconomic cost of doing so. There is a clear and statistically significant negative correlation between the depth of the recession and the average number of COVID-19 deaths. The U.K., Spain, Italy, Portugal, and France all suffered excess mortality and above-average slumps in real GDP, whereas Denmark, Finland, Norway, and also Germany experienced below-average mortality and below-average recessions. The U.K. is probably the clearest example of how a country can end up in the worst possible outcome due to a half-baked, reactive, and politicized policy response. It follows that there is no inescapable trade-off between ‘saving the economy’ versus ‘saving the people,’ because outcomes depend on the quality and the consistency of public health interventions and of macroeconomic management.
Structural differences in socio-economic vulnerabilities
The disturbing truth is that the excessive COVID-19 deaths in the U.K. and the U.S. occurred despite considerable relief spending, because of deep and long-standing flaws in British and American economic, health, and social policies. These structural flaws were evident, well before SARS-CoV-2 arrived, in stagnating longevity (Woolhandler et al. 2021) — and also in the chronically widening gaps in mortality across social classes, ethnic groups, and geography. The health emergency is reinforcing these long-standing economic and health inequities, often driven by racial disparities in housing, income and wealth, employment, and social and political rights. In the U.S. COVID-19 deaths, hospitalizations and cases have disproportionately affected Black, Latino and Indigenous people, who carry a greater burden of chronic diseases from living in disinvested communities with poor food options and poisoned air quality and have less access to health care. Since the 1980s, the Lancet Commission details, “the disparity between social and economic classes has widened” as unions were crushed, automation and globalization destructed high-paying jobs by fissuring the workplace, and tax while social policies have “increasingly favored the wealthy” (Woolhandler et al. 2021, p. 707) “The suffering and dislocation inflicted by COVID-19,” the Lancet Commission sums up, “has exposed the frailty of the U.S. social and medical order.”
Figure 4 presents evidence on the association between socio-economic inequality and COVID-19 deaths for the panel of 22 OECD countries. On the horizontal axis, I measure the difference between the Gini coefficient of (after-tax-and-transfer) income distribution of each country and the panel-average Gini coefficient. On the vertical axis, I measure the difference between COVID-19 deaths per 100,000 population in each country and the panel-average COVID-19 mortality rate. The U.S. and the U.K. find themselves in the upper-right quadrant of the graph, which means that they have above-average income inequality as well as above-average COVID-19 mortality. Likewise, Spain, Portugal, and Italy are clear cases of above-average inequality and above-average mortality.
Countries including Denmark, Norway, Finland, and also Germany are located in the lower-left quadrant, as they feature below-average income inequality and below-average COVID-19 mortality. Australia, Canada, Japan, and Greece recorded below-average corona-mortality but have above-average income inequality. Belgium is an outlier in Figure 4, having low inequality but the highest COVID-19 mortality; the reason for Belgium’s exceptionalism may lie in the fact that Belgian public health authorities are reporting not only confirmed cases (which are mostly hospital deaths) but also suspected cases (such as deaths in the community, especially in care homes). We must therefore keep in mind that Belgium’s (arguably more realistic) recorded death rate is not strictly comparable to death rates recorded in the other countries in the panel.
Fiscal constraints
Cumulative public relief spending to cushion the negative impacts of the health emergency for households and vulnerable businesses (recorded until January 2021) varies €815 per person in Spain and €5490 per capita in Australia (see Figure 5). Average cumulative relief spending is €2778 for the 22 OECD economies in the panel. On a per-capita basis, Germany and Finland did spend more than 5 times as much on COVID-19 relief than Greece and Spain, and more than 2½ as much as Italy. Differences in per-capita relief spending are not always due to fiscal constraints, as is shown by Denmark, Korea, and New Zealand which all have below-average per-person relief funding in combination with relatively low COVID-19 death rates.
But in countries such as France, Spain, and Italy, where per-capita spending was relatively low and COVID-19 mortality relatively high, the fiscal capacity of government to raise spending to cushion the economic impact of the health emergency was compromised – because these (already highly-indebted) governments had limited access to financial (bond) markets and no national lender-of-last-resort. (This is documented in more detail in the Working Paper).
Figure 6, finally, shows that the level of per-person public COVID relief spending matters for the public health outcome. Figure 6 plots cumulative per capita public relief spending (in euros) against cumulative confirmed COVID-19 deaths (per 100,000 population). The estimated linear relationship has a statistically significant negative slope: the higher the per-person relief, the lower the corona death rate. The U.S. is, again, a worrying outlier, combining the 2nd highest per capita relief spending and the 5th highest COVID-19 death rate.
A closer look at Figure 6 reveals that six more countries – Korea, Finland, Norway, Japan, Australia, and New Zealand – do not fit the negative relation between spending and mortality. Korea, Finland, Norway, and Japan succeeded in containing COVID-19 deaths at low levels of per capita relief spending; Australia and New Zealand managed to protect public health as well, but with much higher levels of public spending (comparable to that of the U.S.) This reinforces the conclusion that the ‘quality’ of the public intervention matters and pro-active and consistent public health responses do contain health impacts at manageable costs.
Lessons for the age of consequences
Now, with vaccines coming on stream, there is talk of getting back to ‘normal’. But the ‘normal’ that existed in February 2020 and before is neither normal nor acceptable. We must build a healthier, more resilient, and therefore more equal society. This will be possible only if macroeconomists learn from their past mistakes and change – from being part of the problem to contributing to the solution. Here follow macro’s main failings in a nutshell.
1. A deadly emphasis on fiscal austerity, consisting of a dogmatic balanced-budget conservatism, used to justify decades of underinvestment in public health infrastructure (including disease prevention and health promotion) and social protection. Austerity weakened economies and governments, increased social and political fragmentation, and, by aggravating economic and health inequalities, made populations significantly more vulnerable to the corona-virus – as has been clinically documented for England by the Marmot Commission (Marmot et al. 2020a, 2020b), and for the U.S. by the Lancet Commission (Woolhandler et al. 2021).
2. A foolish belief that redistributive policies will harm economic growth, which explains the stubborn unwillingness to reverse or reduce the social, economic, and health disparities that have left the underprivileged in society so profoundly unprotected. The belief in this trade-off has had toxic effects, but most ‘serious’ macroeconomists stubbornly uphold it, quite in line with Friedrich Nietzsche’s aphorism that “a bad conscience is easier to cope with than a bad reputation.” In the Working Paper, I show that more unequal economies suffered a deeper recession due to the COVID-19 health emergency and that more egalitarian countries were more ‘efficient,’ in terms of macroeconomic costs, in responding to the emergency. For example, the relatively inegalitarian U.S. suffered 70 COVID-19-deaths more (per 100,000 population) than more egalitarian Germany, while spending almost double the amount of money on COVID-19 relief (percent of GDP) than Germany. This conclusion holds true for public health impacts as well: as shown in Figure 4, SARS-CoV-2 mortality rates are significantly higher in more unequal societies.
3. A Uriah Heepish obsequiousness to the supposedly superior rationality of functionless financial speculators, which is allowing the rentier class to have its cake and eat it. In response to the SARS-CoV-2 health emergency, central banks have doubled down on unconditionally backstopping private financial markets, out of fear for financial instability and lacking any other courses of action. But central banks’ actions to contain financial panics by providing liquidity and backstops have had the perverse effect of turning financial markets into a state of ‘perpetual mania’ (Palma 2020). Central banks are bailing out global finance, while governments are in no position to reform it. The SARS-CoV-2 health emergency has thus accentuated as never before the oppressive power of – what Keynes (1936, p. 376) called – ‘functionless financial investors’ over central bankers, treasury officials, politicians, and the real economy. This rentier capitalism is, quite directly, to blame for the economic stagnation and the widening socioeconomic and health inequalities which increased the deadly vulnerability of large groups in our economies to infection with SARS-CoV-2 (as argued in the Working Paper).
4. A deep-rooted aversion to raising taxes, fuelled by the Reagan-Thatcher-inspired (“there is no such thing as society”) de-legitimization of the state’s role in financing critical social, economic, and health expenditures.
Taxes are indispensable not just for reasons of microeconomic redistribution, but even more strongly to put a curb on the extreme liquidity preference of the functionless investors. Combined with higher real wages (Taylor 2020) and more countervailing power for workers (Stansbury and Summers 2020), this redistribution is needed to revive aggregate demand and to remove the stranglehold of the super-rich and the big corporations on monetary and fiscal policy-making.
Such was the ‘conventional wisdom’ in macroeconomics that, for decades, mainstream macroeconomics acted as “the influential and invaluable ally of those whose exercise of power depends on an acquiescent public” (Galbraith 1973), legitimizing misguided macro policies and neutralizing any suspicion that there might exist feasible alternatives.
To solve this crisis of a corrupted collective imagination, macroeconomics must be reformed – by ditching its ideological blinders which prevent it from understanding that inequality, income distribution and demand matter for growth, in the short and in the long run; that there is no such thing as an inescapable equality-efficiency trade-off; that government spending on health and social protection is not a ‘cost’, but is critical to maintain social stability and to strengthen societal and individual resilience to deadly pathogens; that extreme inequality is economically wasteful, socially destructive and politically dangerous; that our current financial system is cannibalizing our real economy; that instead of letting irrational and greedy functionless financial investors ‘discipline’ governments we must bring the financial system under democratic control and abolish socially wasteful financial speculation; that the extreme liquidity preference of functionless investors is our biggest social and economic problem and has to be quashed; that we must urgently and radically get ‘money’ out of our political systems, because it is a big distortion; that government budgets don’t need to be balanced; and that redistributive taxation is critical, not just to invest in social overhead services that enhance labour productivity, lower the reproduction costs of labour, and thereby increase the rate of profit, but more importantly to re-allocate income and demand, away from speculative finance and toward investment in productive capabilities, social protection, education, public health and other socially useful activities.
References
Galbraith, J.K. 1973. ‘Power and the Useful Economist.’ American Economic Review 63 (1): 1-11.
IMF. 2020. Fiscal Monitor: Policies for the Recovery. October. Washington, DC: IMF.
IMF. 2021. Fiscal Monitor Update: January 2021. Washington, DC: IMF.
Keynes, J.M. 1936. The General Theory of Employment, Interest and Money. London: Macmillan.
Marmot, M. et al. 2020a. Health Equity in England: The Marmot Review Ten Years On. Institute of Health Equity.
Marmot, M. et al. 2020b. Build Back Fairer: The COVID-19 Marmot Review. The Pandemic, Socioeconomic and Health Inequalities in England. Institute of Health Equity.
Palma, J.G. 2020. ‘Finance as perpetual orgy: How the ‘new alchemists’ twisted Kindleberger’s cycle of “manias, panics and crashes” into “manias, panics, and renewed manias”.’ Cambridge Working Paper in Economics 2094. University of Cambridge: Faculty of Economics.
Storm, S. 2017. ‘The new normal: Demand, secular stagnation, and the vanishing middle class.’ International Journal of Political Economy, 46(4), 169-210;
https://www.tandfonline.com/do...
Storm, S. 2018 ‘Financialization and economic development: A debate on the social efficiency of modern finance.’ Development and Change, 49(2), 302–329.
Storm, S. 2021a. ‘Cordon of conformity: why DSGE models are not the future of macroeconomics.’ Institute for New Economic Thinking Working Paper No. 148, https://www.ineteconomics.org/...
Storm, S. 2021b. ‘Lessons for the age of consequences: COVID-19 and the macroeconomy.’ Institute for New Economic Thinking Working Paper 152, New York: Institute for New Economic Thinking.
Stansbury, A. and L.H. Summers. 2020. ‘The declining worker power hypothesis: An explanation for the recent evolution of the American economy.’ NBER Working Paper 27193. Cambridge, MA: National Bureau of Economic Research.
Taylor, L. (with Ö. Ömer). 2020. Macroeconomic Inequality from Reagan to Trump. Market Power, Wage Repression, Asset Price Inflation, and Industrial Decline. Cambridge University Press.
Woolhandler, S. et al. 2021. ‘Public policy and health in the Trump era.’ The Lancet 397 (10275): P705-753, February.
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Thursday, March 25, 2021
Wednesday, March 24, 2021
Tuesday, March 23, 2021
Monday, March 22, 2021
FEDS 2021-020: Global Stablecoins: Monetary Policy Implementation Considerations from the U.S. Perspective
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Saturday, March 20, 2021
FEDS 2021-019: The Ways the Cookie Crumbles: Education and the Margins of Cyclical Adjustment in the Labor Market
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FEDS 2021-018: The Macro Effects of Climate Policy Uncertainty
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New CDC Guidelines to Reopen Schools Could be Dangerous
The scale of disaster visited on the world by the COVID-19 pandemic defies any easy summary. But it is safe to say that the question of keeping schools open is among the most fateful decisions facing public authorities. As the pandemic stretches into its second year, it is now becoming among the most contentious.
In the U.S., after some hesitation, the Biden administration seems to be encouraging rapid opening of schools, despite high levels of community transmission in many places, before robust mitigations are completely in place. Many Republican governors and officials also demand the step, including former President Trump in his recent CPAC address. Languishing under lockdowns and zoom or hybrid classes, many exhausted parents, anxious employers, and bored students seem receptive, though polls show widespread reservations about whether premature reopening might trigger new waves of infections. In recent days, more and more states have moved to mandate full in-person classroom instruction within a few weeks.
Accompanying these decisions are organized efforts to recycle earlier studies of school safety[i] designed to reassure skeptics that reopening schools to full-time instruction is really safe, even as new variants of COVID-19 spread that are more contagious and possibly more dangerous than earlier forms. Even the Center for Disease Control is joining this rush to judgment, suggesting that seating students as little as three feet apart might be an acceptable rule for social distancing.
Bitter experience has taught us a great deal since the beginning of the pandemic. Among the most important lessons we have learned is that it is not, in fact, safe to open schools as the pandemic persists without close adherence to significant and stringent abatement measures.
We begin with the most important point as to how we now better understand the risks that eluded us in prior surges of the virus. In those earlier episodes, many people who in fact had the virus showed few indications that they did, even as they went on to spread it to others. This “asymptomatic” transmission was a genuine novelty that researchers only slowly came to grips with.
Unfortunately, the display of coronavirus symptoms is highly correlated with age, thus the younger the student, the less likely they are to show symptoms, or exhibit what are considered “typical” COVID-19 symptoms. The younger students, therefore, were much less likely to be tested. So they continued participating in the school community even as they spread the disease and even having suffered symptoms and long-term side effects that absent a COVID-19 diagnostic determination, were falsely attributed to other illnesses. As a result, the studies commonly cited as supporting school reopening are deeply flawed; they are based on having only tested students who showed symptoms, rather than applying broad screening tests either universally or with true random samples capable of catching the otherwise undetectable asymptomatic spreaders and infected.
The extent of this bias has now been quantified in several studies in the UK, such as the Office for National Statistics Infection and Household Surveys[ii] and REACT-1 Studies.[iii] These studies randomly sampled large numbers of households within the UK at regular intervals regardless of symptoms. The results are dramatically different from the earlier studies, and even from symptom-based testing from the UK during the same time period; they show that contrary to the conclusions from earlier studies based on biased symptom-only testing protocols, in-person schooling is associated with much higher risk than previously thought. A recent study published by the Center for Disease Control (CDC) from Mississippi confirmed these findings; it showed that case-based reporting of infection in children underestimated infection by between 14-68-fold over May to September 2020 compared with serological surveys.[iv]
With the more recent large-scale random sample testing performed in the UK, Sweden, and the US, we now know the following facts:
1. The secondary COVID-19 attack rate – that is, the rate at which the coronavirus spreads – was actually higher for both elementary and high school students than adults when the schools were open for in-person instruction between April to November in England (ONS Household Infection Survey).[v]
2. Both elementary and high school children were far more likely than adults (2x and 7x, respectively) to be the first case in their households rather than the adults between April-December in England.[vi]
3. The spread of infections among school-age children and in the community closely tracked school openings and closures as well as attendance, with the prevalence of infection being highest in these groups compared to all other age groups while schools were open and tiered restrictions for broader society remained in place. Importantly, particularly with the new variants, growth of the pandemic continued in regions where these variants were prevalent even as other institutions were shut down in the national lockdown in November.[vii] These statistics were mirrored in a recent study on the risk of coronavirus spreading in U.S. schools.[viii]
4. Increases in the prevalence of infection among school-age groups preceded rises of infection in other age groups. This has a vital implication; the new studies suggest that infections among children at school do not just reflect infection rates in the community. Rather, they drive increases in infection within the community through spreading from schools into homes, and from there to the broader community.
5. Claims that teachers do not face serious risks are simply false. The risks of infection turned out to be two times greater for teachers of in-person classes relative to those conducting virtual online classes in Sweden.[ix] The study also found an approximately 40% higher infection risk in England in those in teaching occupations compared to those in non-teaching occupations, even when schools were only partly open (REACT-1 study).[x]
6. Several studies also show an increased risk of infection among parents of primary and secondary school children being taught in-person within schools.[xi]
7. The spread of new, more easily transmitted and more deadly variants underscores the true dimensions of the threat from in-person school instruction. With the new B.1.1.7 variant now surging in many parts of the world, variant cases continued to rise with an R=1.45 (compared to an R of only 0.9 for non-B.1.1.7 variants) even during national lockdown while schools were open. R only dropped below 1 – a critical level for controlling the rate of infection – following complete school closures. The numerous outbreaks linked with B.1.1.7 in school settings across the globe over the past few weeks are of grave concern.
8. Between 12-15% of primary and secondary school children had one or more persisting symptoms 5 weeks after infection, according to an ONS survey that took care to examine all infections, including asymptomatic infections.[xii] Before that study appeared, it had been widely thought that because mortality is low among children exposed to SARS-CoV-2, that children are not impacted. Given we know so little about the long-term implications of “long COVID” syndromes, which at least in adults have been often associated with organ dysfunction, it is important to adopt the precautionary principle, and reckon with long COVID related outcomes in addition to deaths.
9. Recent evidence supports the role of mitigations in reducing the impact of transmission within schools. However, it is clear that multi-layered protections are needed, rather than single or a few measures, as the risk reduction is associated with the number of mitigations in place.[xiii]
The coincidence of the rush to reopen with the spread of the new variants of concern to the CDC and the World Health Organization is particularly unfortunate. The new B.1.1.7 variant is both 50% more communicable, and about 30% more lethal than the earlier strains. It is now the dominant and resurgent strain across Europe and is now endemic across the United States. All through the pandemic, the United States has lagged in testing for the virus. It has trailed not only in sheer volume but also in the form of testing: most tests cannot sort out the new more dangerous variants from older forms of COVID-19. Only so-called “genetic survey” tests can do that reliably and they are used only in a few places.
Data from the relatively few U.S. states that use these viral genome survey tests strongly indicate that the now widely reported declining case numbers mask a dangerous, exponential rise in cases of the newer more contagious variants. These appear even now to be turning around the recent falls in total cases in some areas of the country. We expect that in the next few weeks that phenomenon will show more widely.
Another lingering concern testifying to the persistent impact of outdated science is that so much of schools’ reopening guidance remains aimed at hygienic measures, surface wipe-downs, and plexiglass barriers, all of which are completely ineffective in limiting what we now know is the primary mode of indoor transmission, airborne aerosols.[xv]
The latest CDC guidance suggesting that the risks to students are similar at 6 foot or 3-foot distances and thus that schools can safely reopen with more-or-less normal student seating density and populations in the classrooms completely misses the point. A close analysis of the “3-foot paper[xvi]” the CDC cited shows it to be riddled with errors in protocol, most importantly, that it again relies on data from primarily symptomatic carriers; that it improperly conflates infectious susceptibility with contact rates; and is based on a flawed sampling methodology.
Neither did it measure the actual distancing practices within classrooms, but rather considers guidance at district levels, and only for all schools with attendance greater than 5%. This could mean that schools were wrongly categorized to different distances that were not accurate. Differences in other mitigation measures, class size, or class attendance were also not accounted for. Ultimately, the study is also too small to come to any scientifically supported conclusion, as the results show that the risk of infection among districts with guidance to distance greater than 6 feet could vary from half of those with guidance to distance greater than 3 feet by up to 1.3 times as much.
Most critically, while the authors were correct in saying that there is little difference in risk relative to seating distance, they drew exactly the wrong conclusion from the distance data. Newer science has demonstrated quite definitively that the coronavirus spreads heavily through the air, more so, in fact, than through droplets on surfaces or direct contact. As a direct result, the earlier 6-foot indoor social distancing rule guidance was proven to offer misleadingly false comfort wherever ventilation is poor. A beautifully illustrated and simulated interactive New York Times article highlights “Why Opening Windows Is A Key to Reopening Schools” safely. It’s worth a read, because it also demonstrates clearly why relaxing distancing measures, say to seating students 3 feet apart instead of at a 6-foot distance is not necessarily a good idea.
Contrary to the notion that even 3 feet of distancing is sufficient protection, and 6 feet is overkill, the critical safety issue is that students are all uniformly at risk in poorly ventilated rooms no matter where they are or how they distance. With one infected person in an enclosed and poorly ventilated room, the coronavirus permeates the entire space, putting everyone inside at similar risk regardless of where they sit. The key corrective abatement measure necessary is wholesale improvement in ventilation, filtering, and HVAC systems. Nothing whatsoever in any of the cited studies supports safely moving students closer together.
The Biden administration’s new emergency aid bill contains substantial funding, at last, for states and localities. They could use some of that money to refit ventilation systems in schools and implement rigorous testing programs, and even quickly roll out portable HEPA filter systems. But as of 2020, a GAO study indicated that ventilation and heating systems in slightly under half of the school systems examined required substantial new expenditures to meet code, much less enhanced protection necessary for coronavirus abatement. With substantial federal support only now coming available, properly replacing older ventilation systems with HEPA filters will take time.
And though rapid COVID-19 tests are now available, few public schools can afford the current generation of tests. The simple mathematics of exponential growth and airborne transmission in confined areas means that tests on everybody – students, teachers, and staff, including cafeteria workers and janitors – need to be performed at least twice a week. Testing less often means that the virus cannot be identified fast enough to stop outbreaks from sweeping through schools and that contract tracing and quarantine efforts come too late to be effective. And similar to the VHAC upgrade concern cited above, it will also take time for forthcoming federal aid to flow down to schools and labs to enable frequent and affordable school testing on a national scale. In any case, these tests should not replace robust mitigatory measures within schools, but rather complement a robust, multi-measure mitigation approach.
A reconsideration of the current rush to reopen in-person instruction with less than sufficient mitigations is, therefore, clearly necessary. The understandable hopes for a return to normalcy raised by the stepped-up campaign to vaccinate everyone are premature. The vaccine effort, while gathering momentum, will not reach enough people quickly enough to make opening this Spring safe, without more robust mitigation measures within schools. And the costs of making a rushed mistake based on outdated science will take too long to become obvious.
We understand and sympathize deeply with the pain that the continued delay of reopening causes our colleagues and fellow citizens. But it cannot make sense in the actually existing state of most public schools (or, for that matter, all but the most affluent private schools) to push to reopen without all the critical mitigations, as this will once again potentially lead to educational disruption in the form of school closures and further lockdowns. Better to ensure schools can remain open once they do restart through robust mitigation, ramping up testing, ventilation, and, above all, vaccinations than send new waves of sick students, teachers, and parents to already overstretched hospital and emergency medical facilities in a third resurgence of the coronavirus, and unnecessarily put a generation of students, teachers, and parents at risk of Long COVID side effects.
Reopening most schools now, before most schools lack robust protective measures, and don’t yet have broad ability or finances to conduct frequent surveillance testing to prevent asymptomatic spreaders of the latest, more dangerous coronavirus variants from infecting their community, is thus very unwise.[xvii]
Notes:
[i] Bailey, “Is it Safe to Reopen Schools,” CRPE
[ii] Coronavirus (COVID-19) Infection Survey, UK Statistical bulletins
[iii] Munday, Jarvis, Gimma, Wong, van Zandvoort, “Estimating the impact of reopening schools on the reproduction number of SARS-CoV-2 in England”, CMMID, number.cmmid.github.io
[iv] Hobbs, Drobeniuc, Kittle, Williams, Byers, Satheshkumar, Inagaki, Stephenson, Kim, Patel, Flannery, “Estimated SARS-CoV-2 Seroprevalence Among Persons Aged <18 Years — Mississippi, May–September 2020,” CDC Morbidity and Mortality Weekly Report.
[v] Hyde, “Difference in SARS-CoV-2 attack rate between children and adults may reflect bias,” Clinical Infectious Disease, inacademic.oup.com
[vi] “Children’s Task and Finish Group: update to 4th Nov 2020 paper on children, schools and transmission”
[vii] Gurdasani, Alwan, Greenhalgh, Hyde, Johnson, McKee, et. al., “School reopening without robust COVID-19 mitigation risks accelerating the pandemic,” The Lancet
[viii] Chernozhukov, Victor; Kasahara, Hiroyuki; Schrimpf, Paul. “The Association of Opening K-12 Schools and Colleges with the Spread of Covid-19 in the United States: County-Level Panel Data Analysis,” CESifo Working Paper No. 8929, March 2021.
[ix] Vlachos, HertegÃ¥rd, Svaleryd, “The effects of school closures on SARS-CoV-2 among parents and teachers,” PNAS
[x] Riley, Wang, Eales, Haw, Walters, Ainslie, Atchison, Fronterre, Diggle, Ashby, Donnelly, Cooke, Barclay, Ward, Darzi, Elliott, “REACT-1 round 9 final report: Continued but slowing decline of prevalence of SARS-CoV-2 during national lockdown in England in February 2021.”
[xi] Vlachos, HertegÃ¥rd, Svaleryd, “The effects of school closures on SARS-CoV-2 among parents and teachers,” PNAS ;
Lessler, Grabowski, Grantz, Badillo-Goicoechea, Metcalf, Lupton-Smith, Azman, Stuart, “Household COVID-19 risk and in-person schooling”
Forbes, Morton, Bacon, et. al. “Association between living with children and outcomes from covid-19: OpenSAFELY cohort study of 12 million adults in England,” BMJ Husby, Corn, Krause, “SARS-CoV-2 infection in households with and without young children: Nationwide cohort study”
[xii] “Updated estimates of the prevalence of long COVID symptoms,” ONS
[xiii] Lessler, Grabowski, Grantz, et. al., “Household COVID-19 risk and in-person schooling”
[xiv] Riley, Wang, Eales, Haw, Walters, Ainslie, Atchison, Fronterre, Diggle, Ashby, Donnelly, Cooke, Barclay, Ward, Darzi, Elliott, “REACT-1 round 9 final report: Continued but slowing decline of prevalence of SARS-CoV-2 during national lockdown in England in February 2021,” Real-time Assessment of Community Transmission Findings”
[xv] Prather, Marr, Schooley, McDiarmid, Wilson, Milton, “Airborne transmission of SARS-CoV-2,” Science.
[xvi] Van den Berg, Schechter-Perkins, Jack, Epshtein, Nelson, Oster, Branch-Elliman, “Effectiveness of three versus six feet of physical distancing for controlling spread of COVID- 19 among primary and secondary students and staff: A retrospective, state-wide cohort study”
[xvii] Gurdasani, Alwan, Greenhalgh, Hyde, Johnson, McKee, et. al., “School reopening without robust COVID-19 mitigation risks accelerating the pandemic,” The Lancet
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Friday, March 19, 2021
FEDS 2021-017: Liquidity Networks, Interconnectedness, and Interbank Information Asymmetry
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FEDS 2021-016: The Fed’s Discount Window in “Normal” Times
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Thursday, March 18, 2021
The Economics of the 2021 American Rescue Plan
The $1.9 trillion COVID-19 relief bill offers a powerful reminder of the government’s role in modern economies. Today, millions of Americans are counting on federal aid to help weather the economic shock of the pandemic. And so are businesses struggling to stay afloat, especially those in the hard-hit service sector.
“Whenever we’re faced with a contagious disease like the coronavirus, the government has an important role to play,” says Darden Professor Anton Korinek, whose areas of expertise include macroeconomics, international finance, and inequality. “Big crises are inherently times of enormous redistributions. Some corporations have gotten massively richer, others have gone bust. Some people lost their jobs and careers they may never regain, while others can work from home and save on travel. In some ways, their lives have actually improved.”
So what are the best policy measures in a pandemic-ravaged environment, characterized by unequal impacts?
The Case for Crisis Insurance
If you ask Korinek, this is really Economics 101. “It’s about providing insurance to spread out unequal impact,” he says. “Economists generally think that the government should provide such ‘crisis insurance’ whenever the private market can’t. One example is unemployment insurance.”
When we face risks that are individual-specific, notes Korinek, such as the risk that our house may burn down, it’s relatively easy to buy insurance in the marketplace. However, when we’re confronted with unforeseen, economy-wide risks, like pandemics, it is essentially impossible to be insured. “The way I view the hand of the government during a crisis,” says Korinek, “is not that it distorts markets. Rather, it makes up for missing markets. The market is incomplete, and the government is making it work better.”
Automatic Stabilizers
The first line of defense in a crisis, says Korinek, is the type of insurance economists call “automatic stabilizers.” Built into government budgets, automatic stabilizers are mechanisms designed to increase spending or decrease taxes during economic downturns. Because they don’t require new legislation, automatic stabilizers can help families ease financial difficulties when times are bad without lengthy congressional approvals. For example, when a household’s income declines, the taxes generally decrease. In addition, a household may become eligible for unemployment insurance, food stamps, or Medicaid.1
However, automatic stabilizers provide limited insurance. “The U.S. has the weakest automatic stabilizers among developed economies,” says Korinek. “Unemployment insurance, for example, lasts for a brief period of time and covers only a fraction of lost income.”
Discretionary Ad Hoc Stabilizers
To buffer the effects of the pandemic on the economy, the U.S. Congress has already enacted a number of bipartisan COVID-19 related bills, including the $2.2 trillion Coronavirus Aid, Relief and Economic Security Act — known as the CARES Act — and the $2.3 trillion Consolidated Appropriations Act, which was signed into law last December, after weeks of intense negotiations between Democrats and Republicans.
But how effective were they?
Poor Targeting
“Desirability of insurance,” says Korinek, “is proportional to our ability to target — to get relief where it’s most needed. And those discretionary ad hoc relief measures like the CARES Act had massive targeting problems.”
The CARES Act sent the $1,200 checks to joint tax filers earning up to $150,000 and single filers up to $75,000. While households earning that much received stimulus cash — even if they didn’t suffer any income losses from the pandemic — millions of low-income families got nothing, largely because they weren’t on tax rolls.
Some of the targeting problems were caused by the woefully outdated digital infrastructure. “Individual bailouts,” says Korinek, “were distributed through the unemployment insurance computer systems, which are so antiquated that it was impossible to program anything but a fixed amount — $600. That’s why everybody who was unemployed got an extra $600 supplement, regardless of how much income they lost.”
We could certainly learn from countries like France, which have well-oiled social insurance infrastructures. “When the French government ordered all restaurants closed,” says Korinek, “it could automatically pay all restaurant employees precisely what they lost in wages.”
Another example of poor targeting was the Paycheck Protection Program (also known as PPP), which offered forgivable loans to small businesses that kept their employees on the payroll. Because business bailouts were administered through banks, many of the hardest-hit small businesses that lacked established banking relationships were left out.
In addition, the loans cost too much for each job saved. “Providing business bailouts through banks is certainly not ideal,” says Korinek. “We have, at least in principle, the ability to provide much more targeted relief that involves much lower transaction costs.”
Semi-Automatic Stabilizers
The pandemic is increasingly focusing attention on the need to make economic stabilizers work better. “This isn’t only a question of economic efficiency,” says Korinek. “It’s also a question of national security, because we don't know what kinds of disasters we’ll have to provide relief for in the future.”
Korinek’s solution?
“We’d want to have those systems I call semi-automatic stabilizers,” says Korinek. “What I have in mind is creating structures that make it easier to provide economic stabilizers such as the CARES Act. We want to have, for example, computer infrastructures in place that allow us to provide better-targeted unemployment insurance.”
Korinek points out that it can take months of planning before projects that receive stimulus funding are ready to be implemented. And since speed is key during a crisis, says Korinek, “We need a semi-automatic plan in place so that, when we need it, we can essentially press a button to get things rolling.”
Insurance Is a Two-Way Street
The pandemic has increased existing economic inequalities. While millions of people are being forced into poverty, the world’s top 10 billionaires, including Jeff Bezos, Elon Musk, and Bill Gates, have seen their combined fortunes increase by half-a-trillion dollars since March 2020.2The pandemic has also led to soaring public spending, with bailouts often going to those who didn’t need them.
“Another lesson from Economics 101,” says Korinek, “is that insurance is a two-way street. Insurance implies that it is optimal to take from the winners in order to provide relief to the losers.”
There are legitimate questions to be asked about whether one of the policy measures should involve increasing taxes on the winners. “We’ll have to take a serious look at that,” says Korinek. “And it’s important to frame it in the public debate as the necessary second part of what an optimal response to a big crisis with unequal impacts really entails.”
One of the critical lessons from the pandemic is that we urgently need systems in place that allow us to better target relief in the future. It would be really desirable, notes Korinek, to add provisions to do so in the American Rescue Plan that is currently under discussion. We either implement those systems or further undermine our ability to deal with the next large-scale adverse event, be it the next lethal pandemic, a global financial crisis, or worse.
This post originally appeared in UVA Darden's Ideas to Action blog."
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Wednesday, March 17, 2021
The Full Case Against Ultra Low and Negative Interest Rates
The short-term interest rates set by central banks in advanced economies (above all the Federal Reserve) have been trending down for decades. Indeed, they reached record low levels in both nominal and real terms, and then stayed there for a decade, after the onset of the Great Financial Contraction in 2008. Moreover, with short rates somewhat constrained near zero, central banks then turned to increasingly experimental policy instruments to stimulate spending. Since the pandemic, monetary policy has been eased even further. Central banks have justified these historically unprecedented policy measures as being necessary to offset inflation rates that have persistently undershot inflation targets.
One strand of critical thought has questioned whether this fact alone provides valid grounds for such unprecedented policies. Might it not actually be “natural” for prices to decline in response to productivity increases arising from technological advances and globalization? However, this paper raises critical questions of a different sort, extending the earlier work of Koby and Brunnermeier. They questioned the effectiveness of lower policy rates in stimulating more spending, and in turn higher inflation. They suggested that, as policy rates decline, the profit margin of banks shrink and, beyond a certain point (the “reversal interest rate”), banks lend less, not more.
This paper suggests that this is only one valid reason, among many, to question the effectiveness of lower policy rates in stimulating demand, particularly when used repeatedly over time. Moreover, the paper then considers how unintended consequences can cumulate when reliance is put on ineffective monetary stimulus over so many years. The late Paul Volcker summed up just one of many possible exposures resulting when he said, in his autobiography, “Ironically, the ‘easy’ money striving for a ‘little’ inflation as a means of forestalling deflation, could, in the end, be what brings it about.” This paper finishes with an explicit analysis of how negative interest rates might have distinguishing features from other forms of monetary stimulus.
It is a fact that the recovery from the Great Financial Contraction in 2008-9 was the slowest in the post-war period, despite the extraordinary monetary measures. Doubts about the effectiveness of monetary easing go back at least as far as 1936 when John Maynard Keynes wrote “If, however, we are tempted to assert that money is the drink that stimulates the system to activity, we must remind ourselves that there may be several slips between the cup and the lip.” More recently, similar concerns have been raised that unprecedented policy responses might increase uncertainty and suppress the “animal spirits” necessary to motivate sustained spending. Turning to the components of demand, consumption might also suffer if low rates of accumulation mean people must save more to meet retirement goals. Investment might also fail to respond for a whole variety of reasons.
Perhaps more importantly, there is reason to believe that the effectiveness of monetary stimulus diminishes with extended or repeated use. Lower rates induce people to borrow and to spend today what they would otherwise have spent tomorrow. The ratio of global debt (governments plus households and corporates) to GDP had in fact risen by over 50 percentage points prior to the pandemic. However, if the spending is used for unproductive purposes, as is often the case, then the buildup of debt eventually becomes burdensome and slows future spending. In short, there is a negative feedback loop, once referred to by Chairman Greenspan as “headwinds”. At first, these can be offset by ever more aggressive easing but, as the headwinds grow commensurately, monetary policy eventually ceases to work at all.
Growing ineffectiveness is a problem in itself. The ammunition to fight future battles is no longer available. But a bigger problem is that, if monetary stimulus is sustained for a long period, then undesirable side effects accumulate. The first of these is the higher debt level, which increases systemic risk in almost all states of nature. In the midst of the Great Depression, Irving Fisher sketched out how a debt/deflation process can play out with devastating consequences. As noted above, Paul Volcker shared these concerns quite recently.
However, debt accumulation is not the only unintended consequence of relying on monetary stimulus. Such policies also threaten financial stability in various ways. They pose a danger to the survival of financial institutions and to pension funds by squeezing net returns on traditional assets. Moreover, institutions subject to such threats then “reach for yield” in an attempt to compensate, often leaving themselves open to risks that they had not anticipated and have no experience of managing. A related concern is that of growing “moral hazard.” Every time a problem materializes, the central banks or regulators create another safety net to protect the exposed, which then encourages them to behave even more badly.
Similarly, unusually easy monetary conditions over long periods can threaten the effective functioning of financial markets. In recent years, we have documented: recurrent “flash crashes”; waves of Risk-On and Risk-Off behavior; persistent “anomalies” from normal price relationships; growing evidence that normal “price discovery” has been suppressed; and finally, the near-collapse of the US Treasuries market in September 2019 and March 2020. Moreover, easy monetary conditions lead to continuing increases (bubbles?) in the prices of virtually all financial assets and often to real assets (like houses and other property) as well. For a long while, these price increases can mask the other undesired consequences of easy monetary conditions but, as “fundamentals” eventually reassert themselves, a price collapse can easily follow.
Another side effect of easy monetary conditions could be a reduction in potential growth rates. The possibility of “malinvestments” and wasted resources was raised by Friedrich Hayek in the 1930s and has also been treated increasingly seriously by the BIS, OECD, and IMF in recent years. A well-functioning economy, with expanding growth potential, has ample room for companies to both exit and enter. However, there is growing evidence that easy monetary conditions discourage both processes from working effectively. In many counties, the birth and death rates of companies have in fact been falling sharply as indeed have measures of productivity growth.
Nor is this the end of the list of unintended consequences. Easy money in advanced countries spills over into emerging market countries threatening them with the same kind of distortions and exposures. Rising inequality, especially in the distribution of wealth, can have important social and political implications. Ironically, the extended reach of central bank actions could even threaten their cherished “independence”. Finally, since monetary easing in any individual (big) country generally affects the exchange rate, it invites retaliation (currency wars) and also protectionism (trade wars). None of this is desirable.
A fundamental complication is that once well embarked on this path, it is not obvious how a central bank gets off it. There is a kind of “debt trap.” Tightening policy, given high debt levels and the other unintended consequences of past easing, could trigger the very crisis the initial easing was designed to avoid. Conversely, failing to tighten invites still more unintended consequences.
The paper considers some possible scenarios leading to higher future inflation, but concludes that an excessively disinflationary outcome seems more likely. In this event, fiscal policy will have to be used more aggressively (as has been the case since the pandemic) and orderly debt restructurings should be encouraged. This might require some prior structural reforms. The OECD, the IMF, and the Group of Thirty have all recently contended that existing restructuring procedures in most countries are inadequate to deal with the many insolvencies likely to emerge in the near future.
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