Health Care and the Experts: Financial Analogy?

Some co-author or other saw the Myers (fragment-of-a-) Health Care Plan which I put up last Easter, which started with

1. Allow unlicensed health care, wherever it's clearly labeled as such; it won't get public support but people can choose to spend their money on it. The argument against this is apparently that people will make bad choices. Yeah, some will, probably including me and you. So? I've never understood the way some people believe that they (or those they select) can make good choices for others; in fact I'm moderately cynical about licensure requirements as they are now structured, whether for medics or morticians or cosmetologists.

His comment says

I came to look at Chelyuskin but chanced upon healthcare. Your item 1 is the only time I can remember when I totally disagree with you. You say: Some people will make bad choices including you and me. This equates mistakes by poor slobs who lost their houses and livelihoods in 2008 with "mistakes by TJM," that same TJM who, I suspect, belongs to that tiny minority who made money in 2008, because he has both sharp analytical mind and enough money to hire a top-notch money manager. Besides, this just won't work politically: as soon as a poor slob somewhere takes her child to an unlicensed healer, and the child ends up with an amputated limb, the outcry for regulation will be irresistible and, IMHO, justified.

I wasn't sure how to respond to this money-management analogy, and I let it go; I'll give it a try now...

I'm astonished -- and encouraged, because I would not have expected item 1 to be the only total disagreement even in this post, much less in general. And of course it's possible that I'm totally wrong...but I haven't changed my mind yet. Let's take it one step at a time.

The first point of disagreement, a very big one: No, I didn't make money in 2008. In fact in September 2009 I said

I haven't posted for a long time, but it's not that I haven't made any mistakes. Indeed, I've participated to some extent in one of the biggest mistakes of my lifetime -- the market crash of 2008.

Personally, I did see the bubble as such, earlier than some...

In fact I lost much less than I might have because (like my "top-notch money manager" -- I must remember to tell him about that description) I was expecting a downturn at some unpredictable point Real Soon, a small-to-middling wealth-effect recession whenever the bubble popped, and also of course because I avoided real estate. But I did lose, because we weren't expecting what happened. Was this an issue of expertise, in any useful sense of that term? People with far greater expertise than mine, including both the then-current and currently current heads of the Federal Reserve, were denying the problem -- even denying the limited problem that I saw then. (Indeed, since a big part of the problem was excessive risk-taking -- i.e. excessive confidence -- I think those public statements contributed to our still-continuing doldrums in addition to the policy errors I believe they made.) There were indeed a very few people who actually made money by understanding a part of what was going on: a short-seller named Eisman was quoted in late 2008 in The End Of Wall Streets Boom

“We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.

S&P denies that; I haven't heard any coherent excuses for the way they performed as the Supreme Appointed Financial Experts of the American economy (co-equal with Fitch and Moody's, of course). I dunno. Still it's my understanding that Eisman made money whereas on the average, people with more to lose (them with money managers) lost more, disproportionately more, than those with less. That's a Good Thing, as far as it goes -- it didn't go as far as it should because of Too-Big-To-Fail, i.e. some high-income people had their losses made good at the average guy's expense -- but it doesn't fit well with a belief that experts protect us from making disastrous mistakes. As I said in that Sept 2009 post, "To a disturbing extent, I think expertise in (macro)economics has been discredited. I don't believe this is adequately answered by Greg Mankiw's [remarks about economics being non-predictive]". I agree with parts of Brad DeLong's remarks a few days ago in What To Do About Jobs? that

given that most of what we macroeconomists were saying in 2007 was wrong, what, if anything, do we have to say today? Bear in mind that what turns out to have been wrong was pretty much everything that had been done since 1950....

Well, with part of it. As the the Economist (Ryan Avent) said last week,

The narrow point to focus on, however, is that the story in which the housing bust gave us the recession, because America suddenly had lots of houses and workers it couldn't use doesn't appear to fit the data. The economy muddled on despite the housing bust for two years, at which point, for some reason, all sectors suddenly decided that the outlook for growth was much worse than they'd previously believed.

As he says, that fits the Scott Sumner story I've blogged about before, which can be read as very conventional textbook macro and which blames most of the recession on the experts of the Federal Reserve, who simply did the wrong thing in a big way. (There's still room for other blames, of course.) On a more micro-economic level, I'd say that expert stock-picking advice is also of dubious value: I'm a moderate believer in a very weak form of the efficient-market hypothesis, and if this country were to adopt a deduction-free progressive consumption tax system (which it should do on grounds of efficiency/fairness/sanity) I would almost certainly stop using a money manager -- the money-manager's value is rather strongly dependent on his understanding of a complex system that really shouldn't exist. (Also dependent on the fact that his services are mostly deductible, i.e. you're helping to pay. Thanks!) What would I do then? I would switch to a passive management pattern, which in pure investment terms is at least as good and likely better:

In the United States, indexed funds have outperformed the majority of active managers, especially as the fees they charge are very much lower than active managers. They are also able to have significantly greater after-tax returns.

Most of my decisions would then have to do with asset allocation:

The conclusion of the study was that replacing active choices with simple asset classes worked just as well as, if not even better than, professional pension managers. Also, a small number of asset classes was sufficient for financial planning.

Hooray for Malkiel! And for Samuelson and Bogle!. This doesn't prove that financial expertise is worthless, but I don't think it has the kind of value you're suggesting.

Let me put it this way:

• Failure to consult such an expert now and then is really stupid. There are a lot of things a financial specialist knows that are not intuitive; important things.
• Many of these are routine things, how to file this-and-that.
• Many of these are simple things you really ought to learn yourself (why it probably makes sense to own more bonds and fewer stocks as you get older, etc. etc. etc.)
• Some of the others are simply not true, and we don't know which until it's too late (why the top tranche of a pile of mortgage-backed securities deserves its AAA rating, etc. etc.)
• Unlimited trust for your expert is not wise.
• Compulsory obedience to your expert is a really really bad idea, which fortunately is not employed except for the way that S&P and the other experts are embedded in the laws about risk ratings, which effectively required banks to invest in disastrous mortgage-backed securities...
• Perhaps the most important financial skill you can have is that by which you evaluate an expert; nobody else can do this for you, but certification and track-record-checking and recommendations are all important.

Your analogy between medical and financial services is not one that would have occurred to me, but it may have merit. Failure to consult an actual medical expert now and then is really stupid. Medical specialists do indeed know a lot of unintuitive things. Many of these are routine. Many are things you should learn for yourself. Many are false. Trust is a good thing, unlimited trust is a bad thing, compulsory obedience is a really bad thing. Certification and track-record and recommendations...yup. Okay, I'll take the analogy. :-)

Seriously, I think you're saying, effectively, that

If there's one seriously bad (but non-fatal) outcome from an unlicensed healer, public outcry will correctly push us back to requiring licensure

It seems to me you're forgetting something: the licensed doctors we have now are responsible for some 100,000 fatal errors per year (perhaps a little less, perhaps a lot more; see Wikipedia.) Those deaths are on top of a death-toll which I believe to be very much larger: deaths caused by the FDA's prevention of innovation. I'd suggest reading one article, Theory, Evidence and Examples of FDA Harm by Tabarrok and Klein:

Three bodies of evidence indicate that the costs of FDA requirements exceed the benefits. In other words, three bodies of evidence suggest that the FDA kills and harms, on net...

Or you might prefer The FDA: Neither Safe nor Effective ending with a Friedman quote:

“‘The FDA has already done enormous harm to the health of the American public by greatly increasing the costs of pharmaceutical research, thereby reducing the supply of new and effective drugs, and by delaying the approval of such drugs as survive the tortuous FDA process.’ When asked, if you could do anything to improve health in America, what would you do? Friedman replied: ‘No more licensing of doctors. No more regulation of drugs. Not of any kind. Period.’”

Actually, I don't quite agree, but my position is a whole lot closer to Friedman's than to anything that's likely to happen, and I'd accept his as being substantially better than what we have now. (And if we magically went to his, I like you and most others would go right on consulting a conventional MD -- but the MD I consulted might not be in the US. It might depend on what happened to the insurance industry, which would now be free to sell the sort of insurance policy that I'd want to buy.)

Or then again, maybe not.

Update:Stiglitz, Nobel Prize-Winning Economist, Says Federal Reserve System 'Corrupt' according to the Puffington Host:

To Stiglitz, the core issue is that regional Fed banks, such as the New York Fed, have clear conflicts of interest -- a result of the banks being partly governed by a board of directors that includes officers of the very banks they're supposed to be overseeing.

The New York Fed, which was led by current Treasury Secretary Timothy Geithner during the time leading Wall Street firms like Citigroup, JPMorgan Chase, AIG, and Goldman Sachs were given hundreds of billions of dollars in taxpayer bailouts, presently has on its board of directors Jamie Dimon, the head of JPMorgan Chase. He's been there for three years. He replaced former Citigroup chairman Sanford "Sandy" Weill.

"So, these are the guys who appointed the guy who bailed them out," Stiglitz said. "Is that a conflict of interest?" he asked rhetorically.

That really might explain the Fed's behavior... in finance as in medicine, the incentives of regulatory capture and crony capitalism apply. People who exert government's influence are always going to be pushed towards exerting it in favor of those who can exert influence on their behalf, and regulation -- especially licensure, as the power to say who can't compete with you -- is always going to be a Very Good Thing from the point of view of those who have a seat at the table. They may even sincerely believe that they are the only true experts, and that those who do things differently are simply not good for the public. (Or then again, maybe not.)

Update, June 13: In the end, the wealthiest did lose proportionately less from the recession: CONVERSABLE ECONOMIST: Wealth by Distribution, Region, and Age says:

Those in the 90-100th percentiles of the wealth distribution have median wealth of $1,864,000, and mean wealth of $3,716,000 in 2010. That's also the part of the wealth distribution that had the smallest percentage decline in the median and the mean from 2007 to 2010.

I believe that, and I suppose it might have something to do with financial advice, but my current reaction is simply that housing was the most overvalued part of the economy, and those below the top 90% had more of their wealth in housing--and were more likely to have to use up their savings due to job losses in the family. I don't think it has any implications for the health-care analogy.

Two Hundred Trillion Dollars

There are some silly songs on Youtube about the $46,000 debt we're giving each new child at birth; the songs are supposed to make you feel guilty about what we're doing to our children, and I think they're supposed to energize you against the debt-ceiling rise and for the balanced budget amendment. Well, the debt ceiling is stupid, and the balanced budget amendment is a really bad idea, and $46,000 is a ludicrous figure; the correct figure, the figure that the average kid needs to pay (or pay interest on, or pass on with accrued interest to the next generation,) is probably well over half a million. Nobody can know exactly; it depends on future growth of expenses and revenues and population, but $46,000 is a very small fraction of the total.

In April 2010, after the health-care bill's passage, I wrote a "One Hundred Trillion Dollars" context post in which I quoted the Dallas Fed:

Add together the unfunded liabilities from Medicare and Social Security, and it comes to $99.2 trillion over the infinite horizon. Traditional Medicare composes about 69 percent, the new drug benefit roughly 17 percent and Social Security the remaining 14 percent. ... all we would have to do to fully fund our nation’s entitlement programs would be to cut discretionary spending by 97 percent....defense and national security, education, the environment ... All of them [forever]

Today I noticed on Yahoo a more up-to-date and more complete and therefore more scary view of the same concept, from BusinessWeek, in Why the Debt Crisis Is Even Worse Than You Think:

A more revealing calculation is the CBO’s measurement of what’s called the fiscal gap. That figure is conceptually cleaner than the national debt—and consequently more alarming. Boston University’s Kotlikoff has extended the agency’s analysis from 2085 out to the infinite horizon, which he says is the only method that’s invulnerable to the frame-of-reference problem. It’s an approach used by actuaries to make sure that a pension system doesn’t contain an instability that will manifest itself just past the last year studied. Years far in the future carry very little weight, converging toward zero, because they are discounted by the time value of money. Even so, Kotlikoff concluded that the fiscal gap—i.e., the net present value of all future expenses minus all future revenue—amounts to $211 trillion.

How does that work? Well, let's think about the Smith family and the Jones family, each expecting the same future expenses spread out over time. Joe Jones intends to pay as he goes; he hasn't borrowed anything. Sam Smith has borrowed enough money from a bank to fund an investment account which will pay exactly the same expenses. In fact, aside from the issue of bank profit, he had to borrow exactly the net present value of those future expenses. (He has a triple-A rating, of course. For now.) You can think of various ways that they're in different situations, but the Smith and Jones families are basically comparable: the payments on Smith's loan will not over time be appreciably different from Jones' direct expenses. So we can think of both of them as having the same financial future: if one is in trouble, they both are. And right now, the US has the same financial future as if it had made no unfunded promises but had borrowed a grand total of $211,000,000,000,000.00. So far.

Is that exact? No, of course not. Things might not be quite that bad, they could be even worse: as the article says, the calculation is quite sensitive to assumptions about future events and policy. But it's accurate enough to say that the "debt" is not what we should worry about; we should worry about the "fiscal gap".

Of course, if you worry about the debt, then it makes sense to talk about the deficit: $850 billion dollars last year. What if you're worried about the fiscal gap? Does the deficit become irrelevant? Yes, really; as Kotlikoff says:

The gap was $205 trillion last year, measured in today’s dollars. That’s an increase of $6 trillion. ... Hence, the real deficit we should be worrying about is more than six times larger than the $850 billion official deficit capturing all the attention.

In other words, Congress and the president’s administration could agree to run a balanced budget, making this year’s official deficit zero, and the nation’s true indebtedness would still rise by $5.15 trillion!... the main reason is that we are one year closer to having to pay 78 million baby boomers roughly $40,000, on average, per year in Social Security, Medicare and Medicaid benefits. Because the fiscal gap is a discounted present value, one year makes a big difference.

If you think back to the Smith and Jones family, and imagine the fiscal gap as an implicit debt, then the $5 trillion is mainly the result of our failure to pay even the interest on the $206 trillion we owed last year -- we do have a really good interest rate as long as we keep the AAA rating, but it's not zero.

So, should we balance the budget anyway, even if it's inadequate to do so? No -- not in years with high unemployment. I'd agree with Calculated Risk: Debt Ceiling Update

A politician can say "We should have a balanced budget". It sounds good, but why aren't they challenged about operating vs. capital budgets? And about business cycle spending (obviously revenue falls during a recession - and spending increases)?

What they really want is a balanced operating budget over the business cycle. You can't put that in the Constitution. It requires effective government and constant vigilance.

But even capital vs. operating budget doesn't quite do it for me: I want the fiscal gap, over the business cycle, to remain a limited multiple of GDP. Fifteen times GDP? Okay, fifteen times GDP. (It would be nice to shrink it.) But don't let it keep growing (as a multiple of GDP) from one business-cycle peak to the next.

And with all that, should my taxes be raised? Yes, emphatically so -- my taxes should be raised as part of a plan to deal with the fiscal gap. I can and should pay more taxes than most people; that part's understood. I'm not in Kerry's league for lifetime income, not even in Obama's, but I can pay more taxes than I do -- it won't even cut my consumption until taxes get quite a lot higher. What I don't think most raise-taxes people understand is that even though a fairly substantial tax hike won't be a "hardship", won't seriously cut my consumption, it will cut my reinvestment. It has to. So it will reduce the money available to future generations of taxers; in fact a dollar of tax revenue increase now is somewhat more than a dollar of tax revenue decrease later, because you'll have spent the money before it grew. So it's crucial, when you take my money, to take it as part of a plan to deal with the fiscal gap--otherwise the gap grows and you've taken some of the resources we'll need to deal with it. (I tried to go over this in the aforelinked One Hundred Trillion Dollars post.) In any case, if you actually want to fix things, focus on consumption, not income. (I'll still pay more than average, I promise.)

And is it hopeless? Not at all. We still see, e.g. Foxconn to replace workers with 1 million robots in 3 years. We still see Sarcos Exoskeleton Bringing Iron Man Suit Closer To Reality and the beautiful Watch Festo's SmartBird Robot Soar Over TED Conference. We still see Loss of memory due to aging may be reversible and, for young and old, How Khan Academy Is Changing the Rules of Education. We may even see Could 100 Kilometer high towers usher in the next space age?

The SpaceShaft concept isn't as ambitious as the space elevator but it is much more feasible. For 130 million Euros we could design and construct a 100 kilometer tall SpaceShaft within a decade. Once we have SpaceShafts up and running, the frontier of space will finally be open to humanity.

Or then again.... maybe not.

update: Fixed silly typo which had billions instead of trillions.

The Greenspun Recovery Plan: November 2008

My co-author, rather than updating his Project Afghanistan page for 2010, sends me a link to Philip Greenspun's Economic Recovery Plan -- minimum steps for averting a Depression in the U.S. , with a note that I "will probably find this congenial", probably meaning that it's closer to my views than his, but interesting. So I look at the minimum steps as of two years ago for averting a Depression in the US, and the first thing I notice is that we didn't do those things and we didn't get a Depression, so they weren't minimal steps for avoiding a Depression. QED. (I think we avoided a Depression because the Fed wasn't quite as stupid as it was in the 30s, but I've probably talked about that enough and Greenspun never mentions it.) Greenspun says the minimal steps are

Reducing Government Spending In 2006 we were spending roughly 36 percent of GDP on government at local, state, and federal levels ... We need to [reduce] government spending to 30 percent of GDP within two years and ...

Well, actually I often think about this measure of the size of government; I don't like it much, especially when transfer payments are most of government spending, and ultra-especially when the big transfers like SocSec and Medicare are going to older people, who have other income, sometimes more income than the younger ones, and are also taxpayers. Government salaries are hardly more than a rounding error here. Let's say my income this year is $100 and yours is $10; the government takes $40 from me, carefully evaluates your needs, gives you $10 and spends the rest on other stuff. I now have $60 and you have $20. Now let's suppose that we replace this with a linear tax which is simpler, but nominally even higher: the government takes (50%-$20) from everybody, so it takes $50 from me and $5 from you over the year, and gives each of us $20 in weekly payments. I end up with $70, you with $25. Okay, has the government expanded or shrunk? It collected $55 where before it collected only $40, and borrowed nothing in either case, so obviously it's "bigger" -- or is it? Or is this the wrong question? I'd choose a linear tax at the Federal level (no deductions at all, except that your 401(K) can hold any investment paper you like including your bank account, so money is taxed only as you spend it), and I'd watch state/local experiments with more complicated schemes, but I don't believe "spending/GDP" would measure the result in an interesting way. No, this is not congenial.

Greenspun goes on:

What about Keynes? Japan is a good example of the failure of Keynesian economics in the globalized era. The country spent hugely on public works projects in the 1990s,...

Well, yeah. As Sumner has written over and over again (and as Bernanke wrote years ago), Japan's central bankers have repeatedly chosen a monetary policy calculated to prevent growth no matter what fiscal policy was adopted. Very odd, but Greenspun isn't making a suggestion so much as countering a fiscal-policy suggestion -- yet he never brings monetary policy into it, which I find even odder.

Now we get into strange territory:

Investor Representation on Public Company Boards Right now the shareholders of a public company are at the mercy of management. ...

I don't get this one at all. If management salaries and bonuses are "looting" companies, then investors should do better by choosing the least-looted companies; we are perfectly free to vote with our feet. I think that my simplified no-deductions tax scheme would reduce the value of superstar friends-of-Bill-or-George-or-Barack managers, I see crony capitalism and regulatory revolving doors as significant problems for democracy as well as startup businesses, but I don't see where Greenspun is coming from here.

Depreciation of Capital Expenses...

Oh, please. I believe this to be another non-problem: if a cash-flow-negative company has good earnings prospects it can borrow the money for its first few years. This is routine. If it doesn't, then flexible depreciation won't help.

Education... Our country's best performing schools (all of them private) have non-unionized teaching staffs. We can't afford to experiment with unionized teachers anymore...

Ummmm, well, absotively posilutely maybe. Or not. I could see a federal role for educational infrastructure, mostly in the form of teaching/testing material (especially educational computer games) to be freely used by anyone who likes it. I would like to introduce competition for every school...I would like lots of stuff. My impression of the overall generational impact of the teachers' unions is extremely negative, but I would put this way down on any list of stuff I'd like.

Transportation System Reform... Public transit unions should be eliminated because ...

I think I see a theme here. Greenspun doesn't like unions. Well, I dunno as how I like what they've gradually grown into all that much myself, but if Greenspun thinks that businesses don't invest in NYC because they're afraid that public transit stoppages will keep workers from getting to work, I think he's going just a teensy bit over the top. The main transportation reform we need is for transportation of bits so telecommuting works better than it does. (This will greatly relieve NYC traffic congestion, but congestion charges should be applied also: my E-ZPass should be charged a few cents, about once a block, whenever I drive in NYC -- rather than just once on the GW Bridge as I head to the city and Icon Parking. And E-ZPass should be required for driving in the city. Period. But the Feds should have nothing to do with it, and it has little to do with averting a recession, so it doesn't belong here.)

Predictable Product Liability System We need a fixed range of prices for people killed or injured by products...

Wow. Well, I guess we're working on Exodus 21 KJV

28 If an ox gore a man or a woman, that they die: then the ox shall be surely stoned, and his flesh shall not be eaten; but the owner of the ox shall be quit. 29 But if the ox were wont to push with his horn in time past, and it hath been testified to his owner, and he hath not kept him in, but that he hath killed a man or a woman; the ox shall be stoned, and his owner also shall be put to death. 30 If there be laid on him a sum of money, then he shall give for the ransom of his life whatsoever is laid upon him. 31 Whether he have gored a son, or have gored a daughter, according to this judgment shall it be done unto him. 32 If the ox shall push a manservant or a maidservant; he shall give unto their master thirty shekels of silver, and the ox shall be stoned.

Wow. I guess I sympathize with Greenspun, and with those who disagree with him. Hmm... It doesn't belong here. What else?

Labor Market Deregulation We may soon have deflation. Workers who are young or with poor skills need entry-level jobs in order to build skills and experience. They won't be able to get them if the minimum wage is set higher than the market-clearing wage. ...

Well, here again I think I'm seeing a tendency to look at the current (2008) emergency and see one's prior preferences as solutions to whatever's wrong. Yeah, I think that some entry-level unemployment, along with the increasing use of gadgetry in your neighborhood McDonald's and Burger King, are driven by the minimum wage. And I'd like to get rid of it, as one of the items that gets replaced by the weekly payments of my linear tax scheme above. But I'm averse to pushing it into a "minimum steps" for Depression-aversion.

Substitute Web-based Education and Trade for Foreign Aid We don't spend a large percentage of GDP on foreign aid, but the perception is that the absolute amount is large and nearly all of it is wasted or siphoned off by Third World officials. ...Let's start with a simple message that business investors can embrace: "We've eliminated all U.S. foreign aid spending."

That's interesting, and again I can mostly support his substitution (especially the end to farm subsidies) as better support for developing-country economies. But I simply wouldn't put it in this list at all.

Immigration Policy ...With our crushing overhang of government debt, entitlement programs, and public-employee pensions, the only question we can afford to ask about an immigrant is "How much in taxes will this person pay and for how long?" Countries such as New Zealand apply a point system.

Well, that's interesting. And I do think that our excess housing inventory could have been fixed, reducing the minor recession that we would have gotten even if the Fed had chosen NGDP level targeting from (at least) early 2008 onwards, by admitting a whole bunch of people on a points system. And our current immigration system is so awful that any rational basis would be better than what we've got. But It Doesn't Belong On This List.

Now, my short-range recovery plan, for whatever it may be worth, would be Sumnerian -- it would have to do with my acceptance of Sumner's view of the immediate causes of the recession. Note again that Greenspun was writing in November 2008. As Sumner says,

1. The NGDP and RGDP collapse ... occurred almost entirely between June and December 2008. I argue that NGDP targeting could have prevented that collapse..... the financial crisis of September 2008 did not cause a stock market crash, as the markets expected the Fed to continue its multi-decade policy of keeping NGDP growing at about 5% a year. If the markets had given up on the Fed in September 2008, they wouldn’t have waited until October to crash. 6. I argue that stocks crashed 23% in early October on little financial news. Instead, there were ominous reports of rapidly falling orders all over the industrial world. Markets then sniffed out Fed passivity, a failure of the Fed to do what it takes to maintain the Great Moderation. They became demoralized. 7. I argue that the only significant Fed policy during the October crash was the [contractionary] IOR program,

The recession's unemployment has gradually become more structural, but I believe more monetary response would still help a lot. Indeed, I believe QE2 did help a bunch.

Whatever. Yeah, I'm Greenspunish in some ways. Okay, I'd really like "Market Deregulation" on a really large scale -- in fact I'd like to move away from regulatory government to required-insurance government. Hm... that's not a Greenspun concept. Overall, I don't find Greenspun all that congenial. Interesting, and he's dissatisfied with many of the same things I am, but not congenial. There's an overlap between his thinking then and my thinking now, but then I overlap quite a bit with almost everybody.

Except, of course, for me. I hardly overlap with me at all, and since whichever of us is right I'm certainly wrong, these thoughts belong on this blog.

NGDP Level Targets; Incentives and Feedback

As I said awhile back, I think The Fed Did It.

Think of a zillion spreadsheets carrying business plans and personal plans forward a few years, each projecting current trends. Aggregate cash flow -- that's "Nominal GDP". NGDP. Money. Some of those spreadsheets, some of those plans, will fail and others do better than expected, but generally the aggregate cash flow rises each year as population goes up, as productivity goes up, and as inflation goes on. If it falls or rises a little away from the expected trend implicit in all those individual plans, we adapt. If it falls sharply below trend, then cash isn't going around as expected and plans start failing simply because cash isn't going around: businesses fail and it's not their fault. Things are broken. We have a recession, a bad one. In fact, people act by plans and promises, betting on their projections, so we get a recession as soon as the expected NGDP growth fails so that people stop buying and employers stop hiring.

That's my version of the Scott Sumner explanation of the recession. So...

I'm looking at the monetary policy argument between Sumner, DeLong, and now Woolsey, pointing out at least one DeLong error, which DeLong summarizes at DeLong Smackdown Watch: Nominal GDP Targeting Via Index Futures - Grasping Reality with a Shiny Red Nose: Merry Christmas, Everyone!

Right now, in December 2010, we want to give people an incentive to take actions that expand the money supply if they think that nominal GDP at the end of 2011 is likely to be lower than $17.5 trillion and to contract the money supply if they think that nominal GDP at the end of 2011 is likely to be higher than $17.5 trillion.... Touche...I think....

I think I follow most of it, perhaps all of it -- well, not all of it, but I'm not sure that my confusion is a result of not following. I'm still confused about incentives and feedback in the proposed market.

Woolsey's idea, which Sumner defers to, is that the Fed would offer dollar contracts, in effect loans at an interest rate depending on future NGDP; these would be hedged, in fact Woolsey says that

the Fed's goal should be to remain fully hedged. The market expection should be that NGDP remain on target. The long positions of the bulls should be exactly offset by the short positions of the bears. If the market expectation is that NGDP will be above target, then the purchases of the bulls will be greater than the sales of the bears...

and the Fed can use this as a guide to bring NGDP growth back on target.

In other words, the Fed will say "we will define the NGDP growth path, and if you bet against us expecting us to fail then we will use that as a guide to get back on track and thus make sure that you don't make any money." This strikes me as an inadequate incentive. If the bulls/bears bet, then they will provide the feedback by which they don't make money; if they don't bet, there will be no feedback and they could make money by betting. Bulls and bears alike are being asked to make self-negating prophecies. My thoughts turn to Curry's Y combinator and the standard "paradox",

Y not = not(Y not)

but that's probably just me.

I really don't see how this will work; if I'm right (unlikely), then we do need a secondary market to provide the guidance, a "derivatives" market of a sort, a prediction market: we need to let people bet instead on their self-fulfilling prophecies of how much expansion/contraction the Fed will have applied, on net, in their efforts to get to the NGDP target level. My preference is still, as I've said, to use some version of the Wilshire Index, to have the Fed use some version of a daily-rebalancing stock/bonds/money portfolio as a primary tool of monetary policy, to help with what DeLong calls "a Minskyite downturn--a flight to quality because of a collapse in the market's risk tolerance and a shortage of safe assets." The bears can make money if the Fed has to raise its stocks+bonds percentages in trying to reach the desired NGDP, and the bulls can make money if it has to lower them; if bears outweigh bulls or vice-versa, then that portfolio percentage will adjust. (It may adjust anyway if the Fed board actually believes they won't otherwise make target; unlike Sumner and Woolsey, I'm not really confident of an autopilot solution. But of course autopilot would be better if we could be sure it would work.)

Or then again, maybe not.