Job Market Still Red-Hot; Inflation and High Rates Not Going Away Soon

Scott BuchananLeave a comment

As noted earlier, the main driver in inflation since 2021 has not been supply chain issues, but ongoing wage increases in (mainly) the service industry, fueled by a tight labor market. Some headlines note recent decreases in job openings, etc., suggesting that the end of inflation is near. The point of this post is that measures of labor market tightness remain at very high levels, and so it will be a while yet before the Fed can claim victory over inflation and start meaningfully reducing interest rates.

Below I will post a set of charts (courtesy of Seeking Alpha article by Wolf Richter) which make the following point: most measure of labor tightness remain at least as high as they were in late 2019, just before the pandemic hit. It is true that things have loosened up in the past few months, but that just means the labor market has gone from white-hot to merely red-hot. Let the data speak:

We hold that the current  tightness of the labor market is largely a result of pandemic policies which incentivized a whole tranche of experienced workers to take early retirement and also put lots of cash in our pockets which we are spending generously on services .  Those workers are not coming back, but at some point in the next 1-2 years the excess Covid cash will run out and we may finally get the long-expected recession. But if the government rushes in with enhanced unemployment benefits to ease the recession pain, we would expect inflation to remain well above the nominal 2% target

Let’s start an AEA Working Paper Series

mdmakowskyLeave a comment

For the purposes of this blog post we are the supreme chancellors of the American Economic Association and we are mad with power. The only question is what shall become of this power? What will be our legacy? For me, the answer is obvious.

An AEA Working Paper Series. A working paper series for all!

Wait, maybe we need to walk that last bit back. After all, a working paper series for all already exists. It’s called the internet. Or at least SSRN. What exactly is it that we want again?

If we’re being honest, what we want is to post our papers to the NBER working paper series (WPS), but some of us aren’t members. That’s still not a call to action, though. Are we just trying to replicate a club that we aren’t members of? What are the benefits of posting a paper to the NBER WPS that we desire for our own research? Better to work our way backwards from what we specifically want than complain about what we don’t have.

What I think we want to solve is the research dissemination problem in economics. The review process can last anywhere between 1 and 5 years, during which time research is, at best, fully internalized into the field before being formally accepted, but can also become stale, outmoded, or even leap-frogged by parallal researchers. Worse still, research can be missed. Fields, observations, questions, they all have moments. For a piece of research to have an impact, it is paramount that it be within the purview of researchers, policy makers, and journalists during those moments. The NBER has solved this problem through the prominence of it’s WPS, but only for members.

So we want the AEA to replicate the NBER WPS, but for everyone? Sure, but it’s not that easy, since solving the problem for everyone presents an actual paradox. The whole reason the NBER WPS has solved the research dissemination problem is exactly because it is not open to everyone. Researchers, policy makers, and journalists take the work posted within the NBER WPS seriously because they trust the filter. They trust the NBER to only grant membership to serious researchers. They trust members to only post papers that are sufficiently developed that they are ready for public consumption. They trust it because they need to trust it. There is far too much research produced to possibly be consumed without a massive quality filter. The journals used to provide this service, but they became too slow and the NBER filled the gap.

The problem we are trying to solve is not how to create just any research filter, but the source and nature of that filter. The American Economic Review, Journal of Political Economy, Quarterly Journal of Economics, they were (in theory) pure quality filters. They were meritocracies. Sure, there was always plenty of grumbling about journals being clubs (and there is, as it turns out, a lot of merit to those complaints), but the club component was at least nominally less dominant. The NBER, on the other hand, is a club, full stop. A useful and important club that has advanced the discipline in countless ways, but still a club.

So, to return to our motivating question, is there a way to offer the benefits of the NBER WPS outside of a pure club structure? If we have apply a quality filter, can we do so in a more openly meritocratic way that grants at least the prospect of access to a wider group of researchers?

Your first thought might be “We can read and evaluate the papers individually”…but that’s just an academic journal, and we already know the problems there. For a WPS to matter we need both sufficient scale and speed. The NBER solved this by filtering people, not papers. That is, I think, exactly what an AEA WPS needs to replicate. And that, to my mind, brings us to heart of the matter: can we create a WPS membership filter that is open and meritocratic, or is that a contradiction in terms?

Can the American Economic Association create a membership-only Working Paper Series that offers then benefits of the NBER WPS, but with less dependence on the path dependent forces that currently shape NBER membership?

Let’s start with the block of granite that is the entire AEA membership. Can the AEA offer a functioning WPS that includes the papers of all of it’s members? I don’t think so. Too many people, too many papers. Management, including quality control, would be too costly. More problematic, the number of papers coming out in weekly/monthly digests would be too large to be useful to readers. We need to cut it down, but how?

1. Price

No reason we can’t charge members who want access to the WPS a $100 a year on top of their dues to pay editors and managers. Discounts for graduate students and faculty in lower income countries would be important, but straightforward. That will lower the numbers, but not enough. Worse, a modest price would be insufficient, and might even backfire, as a quality filter.

2. Educational or institutional requirements

We can set up minimal standards for WPS membership. The simplest: a Ph.D. Stricter: faculty appointment. Strictest: faculty appointment in an R1 accredited institution. Is this fair? No, but I’m not sure what qualification requirements would be perfectly fair. You could, of course, have separate series for current graduate students, with the graduate series posting quarterly. Any of these would still include far too many papers, but we’re making progress.

3. Prior contributions

What if we limited WPS membership to established researchers? For example, limiting the WPS to individuals who have previously published in one of the six AEA journals? This strikes me as the most feasible to me, particularly from the point of view of the AEA and its strong interest in maintaining the integrity of its journals. It would make the numbers manageable.The AEA could also partner with other top associations, such as the Econometric Society, European Economic Association, and Royal Economic Society to create a list of 10-20 journals. Publication in one of these outlets would grant WPS membership access for 20 years. This would still advantage graduate students co-authoring with stars to jump start their career, but do you honestly think there’s any world in which writing with brilliant scholars isn’t an enormous advantage? Marginal improvements folks, that’s what we’re going for.

4. Citations

Perhaps research impact could be a channel for membership? It seems to me any researcher with 25 citations within the previously establish list of journals has established their bone fides as a researcher. This seems good to me on it’s face, but difficult to implement.

5. Current member/editor sponsorship

This is basically what the NBER does. I am bit hesitant to include qualification via the exact channel I am rebelling against, but there is also something to be said for allowing some discretion in opening the door for others, particularly when we consider the obstacles facing disadvantaged groups when trying gain access to the academy. I’d be far more interested if current member/editor sponsorship for AEA WPS membership were exclusively limited to junior researchers from groups targeted for greater inclusion.

6. Two of the previous four

My guess is that having multiple channels to WPS access is the best way forward, but with the caveat that a researcher has to qualify on more than one dimension to establish themselves as an active, top-tier researcher. Limiting access in these manners will keep the monthly flow of papers limited to a manageable, consumable quantity. The filter imposed will ensure the necessary level of quality, while at the same time granting access on dimensions sufficiently orthogonal to the traditional high school -> undergraduate->grad school prestige pipeline filter. Because that is the real goal here: to solve the economic research dissemination problem for broader subset of scholars. This isn’t a perfect solution, but I think it would stand as a significant step forward.

So there it is folks. The seed from which the AEA WPS will surely spring forth in the next 5 years, surpassing the NBER WPS and becoming the go-to channel to stay abreast of research at the bleeding edge of economic knowledge. I look forward to paying my dues and posting my first paper.

GPT showing off on Conversations with Tyler

Joy Buchanan2 Comments

Since posting it in January of 2023, our post on a failure of ChatGPT has been one of the most popular articles of the year in terms of web traffic. Read ChatGPT Cites Economics Papers That Do Not Exist

LLMs will make up nonsense lies, but it might sound sophisticated and serious. As human editors, we are not used to detecting that kind of problem, because usually if something sounds serious that means it has been written by a serious thoughtful person (usually).

That’s a problem, but ChatGPT is really good at some tasks.

Instead of pointing out the fact that ChatGPT is not perfect, Tyler Cowen wants people to see the potential. He has done an entire podcast interview with ChatGPT, asking it to take on the voice and role of deceased writer Jonathan Swift.

I’ll share part of the transcript:

COWEN: In 1709, you, Jonathan Swift, still were calling yourself a Whig. What exactly induced you to switch to the Tory side of the ledger?

SWIFT: My shift from the Whigs to the Tories was a gradual and complex process, influenced by several factors, including personal connections, political developments, and ideological disagreements.

During my early years in politics, I was indeed more aligned with the Whigs, who championed principles such as constitutional government, religious toleration, and the supremacy of Parliament over the monarchy. However, over time, I became increasingly disillusioned with the Whigs, particularly as their internal factions and power struggles intensified.

The Whigs’ support for the war with France, which began in 1702, was a point of contention for me. I believed that the war was costly…

The replies seem nuanced and insightful. Nothing made me suspect that they were factually inaccurate, although I do not know enough about Irish history to judge.

Is there any human who could have produced this script? I think so, although it would have required a lot of work. If one of these replies is better than anything a human Swift scholar would produce, how would we know?

GPT4 can write good summaries for the work of a prolific author like Swift, because the model can train on lots of examples.

GPT4 could probably write a good biography of a modern figure by pulling together all of the writing by them and about them. Maybe GPT4 could efficiently scrape up all mentions of this figure online and synthesize them faster than a human scholar. However, we observed GPT3 completely making up citations when we tried to get it to do economics summaries.

I’m concerned that humans will use GPT4 to write but not do the requisite fact-checking. That could introduce a new corpus of work that the next LLMs will train on, which might be full of lies. Humans might not admit to using GPT, and therefore we wouldn’t have a mechanism for using extra scrutiny on AI-generated writing from 2023. Humans can make mistakes too… so the ultimate solution could be an all-powerful AI that somehow does begin with a fairly accurate map of the world and goes around fact-checking everything faster than human editors ever could.

Minor Investment

Zachary Bartsch8 Comments

Gary Becker, the Nobel laureate in economics, applied economic reasoning to social circumstances and particularly to families. He argued that children are a normal consumption good, and people consume more children with higher incomes. However, he also emphasized a quantity-quality trade-off. More children in a family means fewer resources and attention for each child. Higher-income couples may opt to invest in classes, training, and spend more time with a unitary child rather than increasing the number of children.

However, goods have multiple attributes and children do not merely provide a stream of consumption value while in the household. They offer access to future resources when they become employed themselves. Having more children or higher-quality children increases the economic benefits that older parents can enjoy, such as more help with household activities and the ability to travel with their adult children. Old-age benefits such as social security now serve the function of insulating people from their prior investments in future consumption.

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Hospitals Just Got Easier to Build in West Virginia

James Bailey1 Comment

West Virginia just repealed their Certificate of Need requirement for hospitals and birthing centers. Until now anyone wanting to open or expand a hospital needed to apply to a state board for permission. The process took time and money and could result in the board saying “no thanks, we don’t think the state needs another hospital”.

Now anyone wanting to open or expand a hospital and birthing center can skip this step and get to work. This means more facilities and more competition, which in turn leads to lower health care spending relative to trend.

Of course, the rest of West Virginia’s Certificate of Need requirements remain in place; if you want to open many other type of health care facilities, or purchase major equipment like an MRI, you must still get the state board to approve its “necessity”. In some cases, you shouldn’t even bother applying; West Virginia has a Moratorium on opioid treatment programs. Ideally West Virginia would join its neighbor Pennsylvania in a complete repeal of Certificate of Need requirements.

But making it easier to build hospitals and birthing centers is a major step. Hospitals are the largest single component of health spending in the US, and improved facilities might help reduce West Virginia’s infant mortality from its current level as the 4th worst state.

Update 4/7/23: A knowledgable correspondent suggests that the law may only allow existing hospitals to expand without CON (while totally new hospitals would still require one), citing this article. The text of the bill itself seems ambiguous to me. The section “Exemptions from certificate of need” adds “Hospital services performed at a hospital”. For birthing centers by contrast, new construction is clearly now allowed by right: exemptions from CON now include “Constructing, developing, acquiring, or establishing a birthing center”.

Whiteboard Macroeconomics

Jeremy Horpedahl2 Comments

There’s nothing that economists love more than a good blackboard (or in modern times, a whiteboard) to work out some basic models of how we think the world works. Supply and demand rules in microeconomics, but macroeconomics has a few good blackboard models too.

So I was excited to see when a member of Congress was using a whiteboard to work through some basic economic logic, as Rep. Katie Porter did in this video she tweeted using the textbook macroeconomics aggregate demand and aggregate supply model:

However, while I haven’t taught macroeconomics in about a decade, it seems there are a few flaws in her analysis. Flaws enough that this probably wouldn’t get a passing grade on an oral exam. I could detail them myself, but… I will leave this to the readers as an exercise! For fun, even if you don’t think this is the best model in the world, just assume it’s a good model. What did Rep. Porter miss? Leave a comment.

Work From Home Sours Financing for Office Buildings, Which Threatens Regional Banks

Scott Buchanan1 Comment

As you drive through cities and many suburbs near cities, you see lot and lots and lots of office buildings. Employees by the tens of millions used to get dressed and fight their way through traffic to get to these building every weekday, park, and go up to their desks to do their white-collar jobs.

The demand for new office space seemed endless, and so developers borrowed money to build more office buildings, and firms like real estate investment trusts (REITs) also borrowed money to buy such buildings in order to rent them out.

Covid changed all that. Suddenly, in early/mid 2020, nearly all office buildings went dark, and people started working from home. With affordable computers and internet access, and with Zoom and other conferencing tools, it was found that workers could get their jobs done remotely. Even after vaccines rolled out in early/mid 2021, concerns over contagious Covid variants kept offices closed. 2022 was when things started opening up again big time, and by end 2022/early 2023 there were stories in the news about companies ordering employees back to their desks.

By January, 2023 Bloomberg could report “More than half of workers in major US cities went to the office last week, the first time that return-to-office rates crossed 50% of their pre-pandemic levels.”  However, that movement seems to have stalled, and has even reversed in some cases, as workers have pushed back strongly against being forced back to the cubes.  Notably, Elon Musk initially banned remote work at Twitter after taking it over in November, but after rethinking the costs of maintaining offices, has shut down Twitter’s offices in Seattle and Singapore, telling employees to work from home

Per the Morning Consult, “The pandemic lockdown triggered one of the swiftest, most significant behavior changes in human history. People’s habits changed overnight, and through the successive lockdowns, shutdowns and new standards, these new habits became ingrained. The experience triggered new, positive associations with working from home, working out with virtual trainers, cooking, gardening and more. A vast web of neural pathways formed to hold these new associations – and that web runs deep.”

And thus, many office buildings remain largely empty, which in turn is resulting in rising defaults on the loans for these buildings. A number of high profile corporate owners in recent months have deliberately (in their own pecuniary interest) defaulted on their loans, forfeited their equity interest in a building , and handed the keys back to the mortgage lenders, who are now stuck with big losses on their loans and with holding a building that nobody much wants.

There are many ramifications of these trends. The one I will focus on is how this extended underutilization of offices affects the parties that lent money to build or buy these buildings.  In many cases, those lenders were smaller (regional) banks. They have much greater exposure to commercial real estate loans than the larger banks, which may cause serious problems in the coming months.


Eric Basmajian calls out some key differences between large and small banks in the U.S.:

At large US banks, loans make up 51% of total assets.  Small banks have 65% loans as a percentage of total assets. So small banks have a lot of loans, and large banks have a lot of cash, Treasury bonds, and MBS.

…At small US banks, loans make up 65% of assets. Of that loan portfolio, real estate is 65%, meaning a lot of real estate exposure….Within that real estate loan portfolio, almost 70% was commercial real estate lending.  So small banks have a high concentration of commercial real estate loans…. Within the commercial real estate category, the highest concentration is “non-residential property,” which can include office buildings, retail stores, and data centers.

….So small banks have a potentially large problem. Deposits are starting to leave after the SVB crisis in search of more safety, but also in search of higher yields on safe assets like Treasury bills.  Deposit outflows will make it hard for small banks to grow lending and may cause a deleveraging.  If deposit outflows are severe, deleveraging will cause banks to sell securities or loans.

Securities can be pledged at the Fed for a relatively high-interest rate. This keeps a bank solvent but at a material hit to earnings.  The loan portfolio is a much bigger problem because the value of these potentially permanently impaired assets will be called into question.

Basmajian summarizes:

There are major differences between large and small US banks.

Large banks hold a lot of reserves, Treasuries, MBS, and residential real estate loans. The asset mix at large banks is very conservative.

Small banks have most of their assets in loans, with commercial real estate holding the highest weight.   Small banks appear to have outsized exposure to highly impaired office buildings which could generate significant losses.

It will be critical to monitor lending standards and availability at small banks because, in the post-2008 cycle, small banks are the lifeblood of credit to the private economy.

Six ideas to reduce firearms deaths

mdmakowsky1 Comment

Firearm deaths are a problem, both mass shootings and the broader class of gun violence. I am not open to the argument that mass shootings are per capita irrelevant given their low frequency relative to other deadly events. The reality is that mass shootings, particularly school shootings, are sufficiently frequent that they generate a predictable news cycle that culminates in the increasingly familiar despair over a political stalemate. We live in that despair and there is no denying it.

Firearms deaths cannot be dismissed as insignificant portions of the risk landscape. Firearms are the leading cause of death in the United States before the age of 18, outpacing traffic accidents and cancer. Yes, they fall to third place if we exclude teenagers. Yes, that is in part because of the progress we’ve made on traffic safety and cancer. Fine. Great job all around. None of that reduces the salience of firearms if we are trying to reduce child mortality.

I’ve written about firearms restrictions and mass shootings before and I am sufficiently pessimistic that I expect to write about it again. There was another mass shooting at a children’s school in Nashville. I admit I am sad and angry. I am trying to not be despondent. A nine-year old girl lost her life trying to pull a fire alarm to save her classmates. Her bravery shames me away from despondence. It should be shaming a lot more people, if I am being honest.

I am, however, also on the record that the stalemate of US firearms policy is an…ahem…

So what can be done? While “do nothing” is in fact often the optimal policy, I don’t believe that is the case with regard to firearms. Let’s talk some options through, both in terms of potential efficacy and political feasibility, all framed within the broader objective of reducing the supply and demand for killing capacity.

1. Ban aftermarket firearm modification of any sort, including cosmetic changes

End the toyification of firearms. If you believe that firearms are tools, great, but the firearm market would seem to disagree with you. We banned flavored tobacco products to keep then away from kids. Let’s ban the toyification of firearms to make them less appealing to idiots.

A firearm should provide you no more identity-signally consumption than owning a pick axe. It’s a tool. Treat it as one. Any modification should destroy it’s resale value and carry risk of misdemeanor punishment if observed in public (i.e. a gun range or hunting). Guns should be as plain as a shovel. I’m already judging you for owning this death toy. Owning it in school colors, or with a punisher logo, or in don’t you just love it purple? Congrats, now I’m even more sure I’m absolutely right and you should be banned from owning anything deadlier than a toaster oven.

I’ll be honest that I am speaking more anecdotally from personal interactions with enthusiastic assault weapon owners, but a big part of the appeal is no different from owning a 400 horsepower sports car or giant truck. Assault weapons ownership makes them feel powerful and cool in a way that a standard 12 gauge shotgun wouldn’t.

While I know the NRA will, by dint of their own pure policy of universal opposition, resist limits on firearms modification, the legal merits of opposing bans on after-market firearms modification would be considerably weaker. Firearms manufacturers, on the other hand, would earn better margins on weapons forcibly more uniform in design. Further, the returns to scale would favor larger incumbent firms, hopefully weakening lobbying resistance.

2. Tax ammunition, scale it with killing power

The tax on bullets should be onerous. The tax on ammunitaton with higher killing power (e.g. hollow points), armor piercing capability, or explosiveness should be so burdensome that the scale of acquisition should be trackable in a national database. It’s not just about reducing the amount of ammunition floating around society, but rendering large scale acquisition trackable.

I don’t know if this is politically feasible. A baseline tax on all ammunitition would be resisted feverishly, but focusing on deadlier ammunitition might create a window of feasibility.

The vegas shooter fired over 1000 rounds into a crowd, wounding and killing a total of 473 people. He had fourteen AR-15s, some of which had 100 round magazines and bump stocks to facilitate the fastest and most efficient means to commit as many murders as possible. Is it a perfect world if a $35 tax on top of the current $15 box of 20 rounds limited him to 500 rounds? No, but there are at least 10 more people alive today. And in the current landscape of firearm violence in the United States, I’ll take any marginal gain I can get.

3. Hold people responsible for crimes committed with their guns

Not just parents, either, but that’s a good start. I was given a rifle by my parents when I was 16. If I committed a crime with it, they should have been held responsible. Same should go for all weapons. If you can’t lock your guns securely, you shouldn’t own them. Firearms manufacturers absolutely have the ability to biometrically lock them. They don’t because it isn’t required. Legal liability would increase demand for exactly this ability. Biometric locks mean fewer accidents, gun thefts, and would reduce the broader supply of guns as people would be far more likely to have older weapons destroyed.

Now, I know some would argue that legal liability is a back-door tax on firearms. Here’s my counter-argument: yes, it absolutely is a tax, but if responsibility for your firearms is a tax you can’t afford, then you can’t afford a firearm. That’s called being an adult.

4. Absolute ban on names and images of perpertrators unless they are at large.

You will not become famous. There will not be a Netflix series about you. Your identity will be scattered to the wind long before it could even be resigned to the dustbin of history. Is this politically feasible? I think so. Sure, podcasts and tweets about shooters will still inevitably pop up still, but anything that lowers the historical status of shooters, the better. Broad regulation of when to name shooters seems low risk, high benefit.

5. End No-knock raids

People will own fewer guns if they feel safer in their homes, which means at the very least fewer firearms accidents. Reaffirming 4th Amendment rights would go a long way towards reducing citizen’s desperate need to express their 2nd Amendment rights. Ending all no-knock raids is more than politically feasible, I would go so far as to say it is potential political winner, though I’ll concede there will resistance from police unions.

6. Ban assault weapons

Let’s close with most discussed policy solution, an outright ban based centered around power and kill capacity. Banning a good with high demand is always difficult, just ask the war on drugs. If we’re going to try to ban assault rifles, we need to go in with our eyes open. Assault weapons are by and large consumption goods, if not outright toys, and in case you can’t hear the derision in my tone let me be clear I am absolutely judging you for owning one. They have zero value for hunting: a .556 round from an AR-15 will destroy your quarry. Better hunting option: anything firing .45-70 caliber ammunition. An assault rifle has negative value for defending your family at home. The through-wall collateral damage leaves you as likely to harm your family as any intruder. Better home defense option: any 12 gauge shotgun. An assault rifle is not a bulwark against tyranny any more than a samurai sword would have been living in a rural town in the Jim Crow South. We all need to accept that we are woefully outmatched in terms of physical and human capital in a confrontation on the local monopsolist on violence. Better option: join a peaceful political action organization. Join a major political party. Hell, join a local religious group. Resistance against tyranny is about numbers, not the stopping power of the weapon you or your drinking buddies are holding.

There is absolutely no more reason for civilians to own high power, high capacity assault rifles than there is for them to own anti-aircraft guns or weapons grade plutonium. It’s a disaster and it’s stupid. So why are we stuck here? Short answer: gerrymandering and lobbying. How do we get out? High shame campaign. Aggressive, unrelenting politics of shaming. No quarter taken, none given. Ads. With. The. Victims. It will be awful, I will cry. You will cry. It’s the only way. Why can 18 year olds vote? The Vietnam draft shamed us into giving draftees the right to vote before we sent them to die. Shame works when it is this pointed and undeniable. And there is no denying our shame.

Adam Smith in Taylor Swift

Joy Buchanan1 Comment

See my latest post for Adam Smith Works.

TAYLOR SWIFT’S ANTI-HERO AS A SMITHIAN ANTHEM

The song “Anti-Hero” by Taylor Swift was the number-one song on charts in the United States and globally when it was released in October of 2022. Based on the record-breaking and continued popularity of the song, Swift’s struggles with self-loathing resonates with us. 

 It’s me, hi, I’m the problem, it’s me
 At tea time, everybody agrees

The theme of the song is that Swift feels like a moral monster who is exposed to the watching eyes of society. She imagines proper people gossiping about her flaws at teatime. This reference to British tea culture makes a perfect segue to the moral philosophy of Adam Smith. Those who only think of Smith as an early observer of modern economies might be surprised, but regular readers of AdamSmithWorks won’t be. 

The impartial spectator is a key concept in Smith’s theory…

At the end I even quote the song “Shake it Off.”

Fed Priority #1: Financial System Stability

Zachary Bartsch2 Comments

The Fed was founded after a spat of banking crises.

We know that the Federal Reserve also has the goals of full employment and steady, moderate inflation. Since the 1990s, that’s meant 2%. But it’s a relatively recent addition to the Fed’s policy goals. The primary purpose was initially and always has been financial system stability.


In 2008, the Fed demonstrated that it’s willing to attain financial stability at the cost of employment. After and during the financial crisis, the Fed purchased mortgage backed securities (MBS) from private banks at a time when their value was highly uncertain (and discounted). The purpose was to replace these assets of uncertain value with less risky assets. At the time, there was resentment that these security holders were insulated from losses while the homeowners whose loans composed the MBS did not get comparable relief. I remember arguing that the Fed, with the cooperation of congress, could have just paid part of the mortgages on behalf of the homeowners such that there were fewer foreclosures and fewer personal bankruptcies. That way, both the borrowers wouldn’t default and the debt holders would enjoy stable returns.


But, the primary goal of the Fed is financial system stability. Pre-financial crisis, banks had loaded-up on securities of uncertain value with the help of regulatory arbitrage and some lending shenanigans. The Fed needed to avoid the ensuing catastrophe that was a consequence of the greater-than-anticipated realized risk. Importantly, catastrophe to the Fed is financial-sector specific. Markets losing liquidity, bank-runs, and financial sector business failures all qualify as the stuff of concern (all of which occurred). While making mortgage payments for specific mortgages would have been popular amongst many debtors, it also would have taken much more time to implement. The Fed wanted to avoid more financial instability than had already occurred. And frankly, the Fed’s first priority isn’t to take care of the public. Given the alternative between a slow popular option and a quick adequate option, the Fed has demonstrated an inclination toward the latter.

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