I don’t pretend to do a better job at explaining what is wrong with current US trade policy than Justin Wolfers does here. His completely correct take is that tariffs do not do what their proponents claimed they would. What he does not do, was not trying to do, was explain why sometimes they COULD NOT work and, even more explicitly does not attempt to explain, why sometimes they SHOULD NOT have worked. We can use Wolfers’ categories to take those additional steps.

Leverage for Getting Better Deals

Using trade policy to try to influence other countries to change their trade policies in a way to benefit the US is a valid objective. Where this can go astray is failing to understand what a better deal is and why it is better. Seeking to remove an obstacle to US exports is good because it promotes more mutually beneficial transactions. The way that it is beneficial to the US is that it promotes reallocation of production and consumption into a pattern of higher market value.

Reducing the Trade Deficit.

Wolfers shows that the trade deficit has not fallen, but that could be due to other factors. The more important point is that trade deficits CANNOT be reduced with “trade” policy imposing restrictions on imports or removing foreign restrictions on US exports. The reason is simple: trade policy can only readjust relative prices. The gross flows of imports and exports are determined by the macroeconomic relation between total investment and total saving. If saving falls short of investment (for example because of a large fiscal budget deficit) foreign capital will flow in to fill the gap and it will show up as an excess of imports over exports.

An Industrial Revival.

There are reasons to think that different strands of economic policy have come together to discourage manufacturing output^[1]. The deficits that, through the capital import/exchange rate mechanism, pull in imports and discourage exports affect manufacturing more than services. In addition, the USG in both embassies^[2] and in trade negotiations has prioritized gaining access for US agricultural products in foreign markets.

So even leaving aside externalities and security arguments, seeking to favor manufacturing is not an absurd policy objective. The problem is that trade policy, specifically tariffs, is not a good instrument to use to pursue this objective. Tariffs fall short for two reasons.

First is the classic problem that a tariff only promotes production for domestic sales of the tariffed item. A tariff creates no market for exports of the item. (And when import restrictions are used at scale, they become, through the exchange rate, a tax on exports.^[3])

Second is a more recent concern. The classic problem concerns a simple product that is produced with no imported inputs. That is highly unrealistic today. For example, I have a friend in Texas whose firm manufactures modular steel buildings. Tariffs on steel may reduce steel imports and promote steel production but they raise the costs of modular steel buildings.

And, to take a step back, to know that tariffs can be here today and gone tomorrow – Liberty Day tariffs were found to be an unconstitutional infringement of Congress’s power to tax – introduces uncertainty into business investment decisions, whether on the producing or the using side of the tariff equation.

A better instrument for promoting the manufactured production whose increase is sought with tariffs is a direct subsidy on that production.

National Security

Tariffs also are not the best instruments for promoting security of supply of validly strategic items. In part there is overlap with the industrial revival policy in that a tariff, by making only domestic sales more profitable, foregoes the cost reductions from spreading investment costs over export sales too. More to the point, however, tariffs on imports from all countries equally reduce the security of supply from diversified sources. As with other reasons for promoting manufacturing production, the better instrument is a subsidy, but in the national security case, combined with no restriction from non-hostile sources.

Tariffs Raise Revenue

Yes, they do. They are a tax on the users of the tariffed good. Nevertheless (maybe this refrain is getting old) they are not the best way to raise revenue, even to raise revenue from taxing specific goods. More revenue would be generated with a tax on both imports and domestic production of a given item. There is a contradiction in attempting to use tariffs both to reduce imports/promote domestic production and to raise revenue. The more effective a tariff is at one, the less effective it is for the other. And, they do not raise revenue if they are not legally imposed.

^[1] For context, however, most of the changes in relative prices in manufactured goods, particularly mid-tech Midwestern manufacturing, were from transport (container ships) and communications technology and reduced anti export bias in trading partners (China’s decision to join the world economy) ,not changes in US policy

^[2] While working on economic policy reform in Indonesia, the USAID Economic Growth team met regularly with the Embassy Agricultural attaché team who were also working on economic reform, inter alia, removing restrictions on imports of US honey, apples, and chicken parts!

^[3] All exports, not just manufactures, however.
[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

Image prompt

: Trade negotiators on opposite sides of a table with skeptical onlookers on both sides.

Quico Toro has a nice post criticizing “decarbonize electricity, electrify everything.” (in developed countries) as an exclusive strategy for reducing the harm from climate change. I agree that strategy leads climate activists to bark up the wrong tree or many different wrong trees. What I disagree with is that one comes away from Toro’s post with little idea of which tree or trees they SHOULD BE barking up. The point here is not to criticize Toro, because the same can be said about most climate realists. So, in the spirit of “yes, but …,” let’s see where his analysis falls short.

As long as I can remember, first world climate activists have been organizing politically to get their countries to curb greenhouse gas emissions

This is exactly what they should do provided the advocacy is for cost effective reduction and b) the advocacy extends equally to all countries. This is not to say that the policies that produce cost effective reductions (compared to no policy) will lead to the same or similar relative reductions. It is an error of the COP process to encourage countries to adopt quantitative target with no sense that different countries face different trade-off with regard to what if cost effective for them. See [here, here, and here]

[Climate activists’] strategy goes by a pithy, four word slogan: ““decarbonize electricity, electrify everything.” This approach has been so dominant for so long that climate people just don’t question it.

But it’s not a good strategy. For six related reasons:

1. Electricity is a small fraction of the energy we use.

2. Many energy-intensive activities can’t be electrified.

3. Rich countries emit a small and decreasing share of global emissions.

4. Energy is only one of the sources of greenhouse gas emissions.

5. Greenhouse gases are only one of the ways people change the climate.

6. New greenhouse gas flows are a tiny percentage of the stock of greenhouse gases in the atmosphere.

It is an incomplete strategy, but not per se “bad.” Point by point.

1. Made sufficiently cheap, zero-CO2 emitting electricity could be quite a large fraction of energy we (the world, not just developed countries!) use: heat pumps warm and cool, electric vehicles can replace hydrocarbon fueled ones, electrical heat can substitute for combustion in industrial processes

2. Electricity can create hydrocarbon fuels from atmospheric CO2 and water for use where more energy density is required -- aviation, some heavy ground or sea transportation. Cement is more difficult but over time it absorbs CO2. The key is making zero CO2 emitting electricity sufficiently cheap.

3. Indeed, cheap electricity using technologies are needed more in developing countries than in already rich countries. Climate advocates have to be internationalist to be effective.

4. True but energy use is the one we have the best handle on. Carbon capture and sequestration is just another use for cheap electricity.

5. True, but nothing about promoting cheap CO2 free electricity stands in the way of other kinds of CO2 emission’s reduction policies.

6. Again, this is true and hugely important but irrelevant to advocacy for cost effective policies to reduce further accumulation of CO2 in the atmosphere. The same models that show what cost-effective policies ARE, also guide adaptive public investments and insurance companies in setting premiums of hazard insurance.

____

Devoting your climate activist juices to parochial fights over how your electricity is generated means focusing on a tiny section of one part of one aspect of a much bigger problem —how humanity changes atmospheric chemistry— which itself is not the whole of the problem of human impacts on climate.

First, these are not or should not be “parochial” fights. Creating the incentives to deploy cheap, zero-CO2 emitting electricity _globally_ IS a pretty large part of changing atmospheric chemistry. Moreover, it presents no essential conflict with any other strategy for reducing the harm from climate change.

Complaining about Just pointing out the errors of climate activists does not get put one nuclear power plant or geothermal installation on a downward-sloping cost curve, or get time of day electricity pricing scheme implemented, or one CCS facility built, or better climate policy model built, or one border adjustment tax on imports from countries that do not have carbon taxes enacted.

Better to turn on a zero-CO2-emitting powered LED searchlight than to curse the darkness.

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

Image (Toro’s numbers):

As the Washington Post reports, The Fed confronts a powerful new economic force, Kevin Warsh has got it into his head that AI may produce big challenges for the Fed:

The Fed watches all of this [AI] attentively. …:

Will the application of AI cause a significant, sustained rise in productivity across the economy? And if so, when?

Will token usage be complementary or competitive to labor?

Will the next generation of AI models demand even greater capital intensity, or will the models themselves help devise a capital-light solution?

[H]ow much of the surplus goes to owners of scarce assets—AI labs, chipmakers, energy producers, and cloud providers? Over time, how much of that value accrues to businesses and consumers?

What are the broad implications for workers and for the employment side of the Fed’s mandate?

The Fed is our all-purpose macroeconomic manager and whatever AI does, it will be part of the Fed’s job to manage the macroeconomics of these (valid) issues. [The rest of the government will, please, ensure that AI does not produce a paper-clipocalypse or fall into the hands of Sec. of War Hegseth and that the after-tax and transfer income distribution is acceptable enough to permit the gains that AI promises.] But in this post let’s look at what this means for the Fed and its role in ensuring that monetary policy does not get in the way of AI.

The real challenge to the Fed comes from shocks that affect certain kind of goods and services production more than others. But to understand those shocks, first consider an unshockable one sector Output-Labor-Price (OLP) scenario depicted in “Utopia.” In that scenario, AI permits a big increase in supply of labor from Q1 to Q2, but the technology is highly complementary. The wages of labor (and returns to other owned resources) rise in tandem from P1 to P2. The single price is not sticky to upward movement, so the Fed does not need to change its inflation target, although it does have to change its instruments so as NOT to change the inflation target. This may be the scenario that Chairman Warsh had in mind when he speculated about AI being anti-inflationary, permitting stimulative policy instrument moves (interest rate decreases) while holding to an inflation target.^[1]

Utopia is boring; let’s consider Midtopia. Same graph but we remove any increase in demand for labor arising from the distribution the gains. With the same shift in supply but no increase in demand, the amount demanded increases from Q1 to Q3 but the wage falls from P1 to p3, not a happy conclusion for employees, but there is no unemployment.

If wages are sticky and can NOT fall, however, the amount demanded falls to Q4 and Q1 minus Q4 becomes unemployed. We have migrated from Midtopia to Dystopia. But this where monetary policy comes in. A central bank operating a Price Level Target regime can inflate the price level to in effect shift nominal So supply out to coincide with Sn raising employment Q2.

Take note. Monetary policy can eliminate macroeconomic unemployment. It cannot mitigate the distributional consequences of the fall in wages from P1 to P3. And this is not an artifact of the one sector OLP model. Think of the Midtopic model reproduced for multiple markets of different goods, different kinds of labor and other resources. Not all prices can fall equally well; some are sticky downward. But an AI generated productivity increase in some sectors means relative prices of “everything” have to change to find a new equilibrium with full employment of resources. It is “Utopian” to think that only the prices of downwardly sticky items will need to rise. If the relative price of downwardly some sticky-price goods has to fall it means that prices of others must rise. The average of some rise and some do not is an increase in the price level. The central bank has to permit/engineer that increase to facilitate the market finding that new configuration of relative prices to prevent some markets failing to clear, resources becoming unemployed.

I examine what central banks have to do, what and how to target outcomes in Sticky Prices. The important point here is the paradoxical conclusion that a positive productivity shock requires the same kind of Fed response to a positive supply shock, stimulate nominal aggregate demand to raise the price level, as to a negative supply shock. The difference is that this comes on top of the need to stimulate nominal demand to accommodate the increase in real output the AI productivity shock brings.

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

^[1] (WSJ op-ed, Nov. 2025): “AI will be a significant disinflationary force,” … it would be “increasing productivity and bolstering American competitiveness.” At his confirmation hearings asked whether AI gives the Fed an opportunity to cut rates, Warsh said, “I think this could be that opportunity.” CNN also reported he’d argued AI could boost productivity and lower inflation, “which would give the Fed room to cut rates.”

Foul Ball

It wasn’t so long ago—in the run-up to the crisis of 2008 and over the decade that followed—when economists and policymakers were speaking of secular stagnation and a global saving glut.¹ It was a widely held view that an excess of capital would sit on the sidelines for a long, long time, because there just wouldn’t be enough compelling investment opportunities. All the good stuff had been invented. So growth would be low and slow.²

Well, times sure have changed. We’ve come to a hinge point in history

A good solid swing at a very mistaken view. Yes, growth was slow but the problem was less technical stagnation than excessive regulation, inadequate public investment (that crowds in private investment) and a poor mix of high public deficits with monetary offset. That one sector, AI, is exempt from these constraints is good, but may not be as big a change as Walsh claims. That the Fed is thinking about what to do if AI DOES produce a positive supply shock is also good, but WHAT it thinks depend on how it deals with shocks generally. We are still in the dark what Warsh thinks about that. from which he draws no or incorrect conclusions.

Strike

You might know about my long-time discomfort with early pronouncements of future policy decisions. I much prefer another path . . . and will make the case for it.

…

Forward guidance as a regular practice was adopted by my colleagues and me during the Global Financial Crisis.⁶ It was essential at the time, and we introduced it with much fanfare.

…

In normal times, the role of forward guidance should be limited and circumscribed. Otherwise, it risks creating ambiguity in the name of clarity. Oversharing policy deliberations and overcommitting to future decisions can lead markets, businesses, and households astray.⁷ And I believe when policymakers make quasi-commitments on interest rates through the cycle, we inhibit our own freedom to make the right calls when it’s time to decide.

Warsh is confused between “forward guidance” that predicts/semi-commits the Fed to certain instrument settings – bad for the reasons he says -- and “forward guidance” about what outcomes for prices or income it seeks over different periods. It was NOT “essential” during 2008-09. Indeed, it was probably detrimental in that guidance about future low interest rate stability was substituted for guidance about what outcomes the Fed should have sought, for a commitment to “do what it takes” not to let inflation fall or the price level trajectory to remain below trend, a commitment not made while Warsh served on the FOMC in 2009^[1].

Strike

To get policy right, we also need to get the relationship right between financial markets and the central bank. The Fed needs clear market signals, as unfiltered as possible . . . from market internals . . . the level and change in asset prices across sectors . . . the prices and trading volumes of Treasury securities. . . the foreign exchange value of the dollar . . . the cost and availability of credit . . . and the price of a broad set of commodities.

These and other indicators should inform the Fed’s near-term outlook on economic activity and inflation throughout the business cycle. They should also reveal the state of broader financial conditions . . . and the risks and uncertainties in the financial cycle.

Warsh comes pretty close here to saying the Fed needs to gather information about the economy FROM financial market conditions. That is a source, but the information the Fed needs most is on its Congressionally mandated objectives, prices, (wages), and employment.

Strike

So, if forward guidance is ill-suited to normal times, then how about the new Fed chief commits—at the very least—to an explicit reaction function? Surely, he should tell us his interest rate path—if, say, the data were to come in hot or cold.

I wish our understanding of the economy were so precise as to provide a mechanical, tried-and-true answer—that some simple function like a Taylor rule could be rigorously relied upon. But our knowledge just doesn’t extend that far—at least not yet—and the factors most relevant to the proper conduct of monetary policy change over time

Warsh here compounds his confusion about forward guidance with a similar one about a “reaction function.” A reaction function is not a rule like the infamous Taylor rule that links deviations of observed from desired outcomes to interest rates, but the creation of a credible expectation that the Fed WILL react with stimulus or restricting to a price level below or above the target of except when the level is shifting up to facilitate adjustment in relative prices resulting from shocks.

Foul Ball

The Federal Reserve’s actions are intended to ensure that the aggregate demand side of the economy is broadly consistent with aggregate supply. However, all we observe directly is activity. We never see, and can only infer, what’s really happening on the supply side. Hence, evaluating the current and expected balance between aggregate supply and demand is imprecise.¹²

The Fed has no more insight into “what’s really happening on the supply side” than on the demand side. We observe points of supply and demand intersection. The functions are modeled.

Infield Fly

The responsibility for 65 months of sustained, elevated inflation sits squarely with the central bank. And that is where it belongs

Yes, the Fed is responsible for inflation, over-target, under-target, on-target inflation, not shocks, not deficits, not supply disruptions. But how MUCH of the over-target inflation was income maximizing and how much was a mistake? And of the mistaken portion, was the mistake intentionally causing more than turned out to be needed? Or did the instruments used result in more inflation than intended?

Infield Fly

The Fed also bears responsibility for maximum employment. Achieving both sides of our mandate over the medium term is not an either/or proposition. I do not believe that the Fed’s dual mandate works at cross-purposes. After all, high inflation itself is very harmful to economic prosperity.

The recognition (absent in the July press conference) of maximum employment is welcome. And while high inflation is “very harmful to economic prosperity,” it would be well to recognize as well that low, under-target inflation as during 2008-20) is also very harmful.

Base hit, well short of the fences

Short-term interest rates are the predominant tool to achieve the dual mandate. Unconventional policies to spur economic activity may suit genuine crises but should otherwise be used sparingly, if at all.

True, but where does this leave the Fed’ balance sheet? And interest on reserves? Its portfolio of mortgage-backed securities of Fannie and Freddie?

Swing and a miss

Money matters. It’s not fashionable these days, but my view is that money has something important to do with monetary policy.¹³ We should pay attention to money created by the central bank and money that comes from the banking and financial systems.¹⁴ It’s true that financial innovations and other factors alter the mechanics that link the monetary base, the velocity of money, and the broader economy. But that is scarcely a reason to ignore the ultimate effects of money on financial conditions and prices.

Money aggregates are a policy instrument like interest rates. The two are linked. Touch one and you touch the other. We don’t add one cup of M₁ to two cups of EFFR for the perfect inflation cake.

Image: A central banker as baseball player with bat labeled “policy” waiting for a pitch.

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

^[1] The “CPI Target” is the equivalent of the PCE target of an increase of 2.0% p.a

Sumner was both less and more than I wanted. Less in that I am not much interested in the history of the “price” vs “wage” stickiness distinction and why the profession mainly talks about the former because I do not see much theoretical point in it. But more in that Sumner, cites Basil Halperin, It was a mistake to switch to sticky price models from sticky wage models, who gives a succinct explanation for why the stickiness could be important:

When most people worry about recessions, they’re worried about involuntary unemployment. If we want to think about the role of monetary policy in recessions, then, it feels natural to worry about sticky wages.

Of course, economists are not “most people” so we also worry about the owners of the “involuntarily unemployed” machines and real estate, in general anyone whose Say supply does not meet Say demand and a market fails to clear. These also reduce real incomes, so why not worry about stickiness of anything in whichever market it occurs?

Before proceeding and at the risk of being too obvious for some and off putting for others, let me show what is meant by unemployment being caused by a failure of price to adjust to a fall in demand.

In the “Fall in Demand” diagram, the original relation between price and amount demanded, D_1, shifts to D₂; for every price, the quantity demanded is less. “Quantity” may be thought of either as hours of labor services or quantity of a good produced with knock on effects on demand for hours of labor services, machine hours, or weeks of real estate occupancy used in the production of the good. Correspondingly, the “price” could mean a wage or rent as well as the price of a good or service. The fall in demand with a flexible price (supply is assumed unchanged) reduces the amount demanded from Q₁ to Q_2. With no change in price, P_1, the quantity demanded falls from Q₁ to Q_u. Q₂ - Q_u is the unemployment that is avoided by price flexibility.

_____

More important than Halperin’s pithy diagnosis of recession, however his essay is a window into the discussion of both wage and price stickiness and hence of stickiness per se. What we will be able see through that window is, to his credit, more than he points to in his essay.

Sumner and Halperin make a distinction in kinds of stickiness, wage and price

1. Wages. Let’s see what wage stickiness means in the simplest representation of an economy. There is one output, “GDP.” There is one production input, undifferentiated labor. There is one relative price, the price of GDP (the price level) relative to the nominal wage. I’ll call this the Output-Labor-Price (O-L-P) model. A recession story is straightforward. Demand falls, the price of GDP falls, the nominal wage does not fall/the real wage rises, unemployment and a reduction in real GDP results. The simple policy implication is that by manipulating the price of GDP with additional demand to prevent the inflexible nominal wage from resulting, avoids the unemployment. This is “wage targeting,” preventing a rise in the real wage.

2. Prices Same model. Same picture but with inflexible prices. Nominal demand falls, (Monetarists will call this an increase in the demand for money) the price of GDP can’t fall so real GDP falls; less Labor is demanded. Unemployment results. The simple policy implication is, again, manipulate aggregate demand (to satisfy the “demand for money” to prevent the fall in nominal GDP and employment. This is “price targeting,” preventing the fall in prices.

In an O-L-P model, however, targeting wages and targeting prices are exactly the same thing; there is only one relative price, one kind of stickiness and so only one target.

But does anyone actually think in terms of O-L-P models? It’s not as implausible as it looks. Go back to James Tobin’s 1972 AEA Presidential address Inflation and Unemployment where he talks about inflation “greasing the wheels” to prevent sticky relative price of labor from producing unemployment. No multiple O’s to produce multiple P’s were necessary to get that result.

But does Tobin unemployment not depend on unrealistic expectations, unrealism that is made implausible by the Lucas critique and the idea of rational expectations? Not necessarily. Stanley Fischer (1977), Long-Term Contracts, Rational Expectations, and the Optimal Money Supply Rule as generalized by John Taylor (1979), Staggered Wage Setting in a Macro Model shows that overlapping employment contracts with rational expectations can produce the kind of wage dispersion among firms that produce Tobin stickiness. Edmund Phelps (1978) in Disinflation without Recession: Adaptive Guideposts and Monetary Policy, drawing on Fischer, Taylor,^[1] explicitly suggests central bank targeting of nominal wages.

Halperin cites Julio Rotemberg (1982), The New Keynesian Microfoundations as the pivot from “wage” to “price.”

[With] Rotemberg, in the mid-1980s there was a switch from the Fischer and Taylor sticky wage models (focusing on the labor market) to sticky price models (focusing on the product market).

[Rotemberg]: “One might ask in all seriousness what is new about the current generation of Keynesian models. The major difference between the current and previous generations (Fischer 1977, Taylor 1980) is an emphasis on the behavior of product markets.”

Guillermo Calvo (1983), Staggered Prices in a Utility-Maximizing Framework consummates the pivot by generalizing Fischer’s and Taylor’s overlapping contracts mechanism from wages to prices.

Note, however, that these models use multiple prices only to get around the rational expectations objection to Tobin. There is still no departure from O-L-P. Even models that tell stories involving multiple prices as the Calvo model are essentially only about stickiness within an aggregate price level. The “multiple” prices do not have first and last names; they are just points in a distribution totally described for policy purposes by its mean. Consequently, maintaining stability of, preventing departures from, the P of O-L-P (or equilibrium trend of P) prevents unemployment and achieves the “divine coincidence” of price stability and full employment.

Only in the work of Kosuke Aoki (2001), Optimal monetary policy responses to relative-price changes and Greg Mankiw and Ricardo Reis (2003), What Measure of Inflation Should a Central Bank Target? do we have models in which sectorally heterogeneous price stickiness affects the central bank target. This is easiest to see in Aoki’s one sticky price, one flexible price sector mode subject to relative price shocks. The conclusion is to stabilize (target) the inflation rate of the sticky price sector. This generalizes in Mankiw-Reis to targeting a bespoke “price” index that very importantly includes wages and whose components are weighted in the consumer^[2] basket by the degree of stickiness but inversely by importance. (Aoki becomes a special case) The suboptimality of failure to successfully target the sticky price index show up as unemployed resources. That is, the divine coincidence holds, or comes close, but only for the special definition of the target.

It is also worth pointing out that in multi-sector models, inflation in the flexible price sectors and hence any aggregate index has to be greater than the sticky sector target while adjustment to the relative price shock is occurring. If the target were stated in terms of the aggregate price level target with the sticky price target as the long-term forward-looking average, the stated target would have to be “flexibly” higher in adjustment periods. In other words, If the target for the sticky price index is an “Average Inflation Target (AIT) or Price Level Target (PLT) then the target for the full index would have to be a “Flexible Average inflation Target (FAIT) or Flexible Price Level Target (FPLT).

• It would be another post to try to explain how, having a theoretical basis in 2003 for targeting sticky wage sectors and justification of the level of the target, both central bank policy and professional commentary continue to circle around targeting of an aggregate price index -- the Personal Consumers Expenditures (PCE) index and the more visible Consumer Price Index (CPI) -- but there are likely reasons.^[3]

• Inertia must play a large part. “Inflation targeting” of aggregate price indexes became a common central bank strategy from the 1990’s. The Fed adopted the PCE in 2000 although it did not formally add the 2% target until 2012.

• Creating a Mankiw-Reis sticky price index is difficult as observed stickiness is endogenous to the sectoral shocks it is meant to deal with. Mankiw-Reis used “one weird trick” (not their words) to calibrate the weights of their estimate.^[4]

• A sticky prices target is likely harder to understand and understanding is necessary for central bank independence.

• Likewise, a sticky-prices target could be less effective in anchoring expectations which partially determine underlying stickiness.

• It is also the case that conventional inflation indexing is adequate when most shocks are demand, NOT relative price shocks as had been the case up until 2020^[5].

• Although not theoretically grounded, efforts to extract the true inflation signal from “noisy” monthly data with core, trimmed, or median indices do some of the work of a Mankiw-Reis sticky-price index.

So, what are the prospects for the Fed to move toward theoretically grounded targeting and discussion of the same? Better than for a long time, I’d say. The appointment of Kevin Warsh as Fed Chairman has many possibilities for disaster – I have had little good to say about it and his initial statements have been ambiguous at best -- but that is not inevitable. The Five Task Forces, Warsh has commissioned and staffed with some of the most relevant people:

• Inflation Frameworks

• Data

• Productivity and Jobs

• Balance Sheet Policy

• Communications

are all relevant to what and how the Fed should target. “Inflation Frameworks” is the question itself. New kinds and sources of “Data” and aggregations of data may be needed to create that kind of sticky price target index that theory indicates. “Productivity and Jobs” is a specific, novel, and possibly important kind of shock (positive, not negative) that a targeting regime will have to deal with. “Balance Sheet Policy” is an underappreciated monetary instrument. “Communications” is a policy in itself, affecting expectations and hence stickiness as well as being necessary for the Fed to explain the difference between the sticky-price index (if that were its real target) and conventional indicators.

_____

How close does this long and productive detour leave us to Halperin and Sumner’s preference for a wage target? This is hard to answer because they do not propose a wage target in the sense discussed at all, but something like a wage bill target. And the wage bill target has the same units as a NGDP Level Target (NGDPLT) which Sumner prefers to a wage (bill) target, anyway.

Therefore, a more interesting and policy relevant question is how an NGDPLT compares with a sticky price target. A supposed advantage of NGDPLT (or even a deflator target) over inflation targets of whatever species is that they “make up” for under/overshooting with subsequent higher/lower rates of change. This is not dispositive, however, because a sticky price target can also be expressed as price level trajectory. Assuming money is neutral in the long run, an NGDPLT reduces to an NGDP deflator target. As aggregate inflation indicators go, an NGDP deflator has the advantage of greater comprehensiveness than a CPI or PCE, but it is an empirical matter whether it is closer approximation to sticky price target (level or rate of change version) than either of the latter would be.

Conclusion

Realistically, I would not expect the Fed to adopt an esoteric Mankiw-Reis sticky price inflation index as its official target. We might hope it would begin to think about the level rather than the rate of change of its target, it being easier to speak about levels in the short run, during adjustment to shocks, but about rates of change for long-run targets. Creation of a Mankiw-Reis sticky price model IS something staff could work on and could inform FOMC decisions.^[6] It is, after all, a formalization of the Fed’s maximum employment mandate and does validate in part Sumner’s and Halperin’s hankering for a wage target.

^[1] With a nod to earlier work of Guillermo Calvo, not the paper cited below which comes later.

^[2] This result comes from optimizing over consumer utility; if optimized for GDP a broader sticky index would result. After all, resources are employed in and can become unemployed from production of non-consumption goods, too,

^[3] The Atlanta Fed does produce a “sticky price” Index, but 1) it looks at arithmetic frequency of price change, not the downward stickiness that can be detrimental for resource employment, 2) it does NOT inversely weight non-sticky prices and 3) it is intended to divine expectations, not items in which failures of markets to clear may occur.

^[4] And the US does not have indexes of wages [Bureau of Labor Statistics produces only disaggregated wage-bill unit value indexes] that theoretically should go into a sticky prices index.

^[5] [1973 oil price exception]

^[6] For perspective, this whole discussion has assumed that some manipulation of some version of inflation rate or price level or some version of output (wage bill or aggregated NGDP) rate of change or level can unstick whatever is stuck, whatever the reason for the stickiness. Axel Leijonhufvud in On Keynesian Economics and the Economics of Keynes argues that, putting words in Leijonhufvud’s mouth, “stickiness,” outside of a corridor of relatively small changes in equilibrium prices, is not the right concept. Prices outside the corridor are not “sticky,” not slowly moving by gradient descent toward a new equilibrium, but chaotically scrambled. A new equilibrium is discovered by entrepreneurs, not be re-established even with the best of central bank targeting. The entire tradition of Keynesian economics (and as Friedman said, “We are all Keynesians now.”) from Hicks’s “Mr, Keynes and the Classics” onward, is not, for Leijonhufvud, the economics of Keynes. Perhaps we have never since the Great Depression gotten far enough out of Leijonhufvud’s corridor for unsticking prices to work. Perhaps we should hope we never do.

Image: Central banker holding up a list of Crossed out items: “Wage,” “Wage Bill,” “NGDP,” “Price” and one item not crossed out: “Sticky Price Level.”

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

^[1] With a nod to earlier work of Guillermo Calvo, not the paper cited below which comes later.

^[1] This result comes from optimizing over consumer utility; if optimized for GDP a broader sticky index would result. After all, resources are employed in and can become unemployed from production of non-consumption goods, too,

^[1] The Atlanta Fed does produce a “sticky price” Index, but 1) it looks at arithmetic frequency of price change, not the downward stickiness that can be detrimental for resource employment, 2) it does NOT inversely weight non-sticky prices and 3) it is intended to divine expectations, not items in which failures of markets to clear may occur.

^[1] And the US does not have indexes of wages [Bureau of Labor Statistics produces only disaggregated wage-bill unit value indexes] that theoretically should go into a sticky prices index.

^[1] [1973 oil price exception]

^[1] For perspective, this whole discussion has assumed that some manipulation of some version of inflation rate or price level or some version of output (wage bill or aggregated NGDP) rate of change or level can unstick whatever is stuck, whatever the reason for the stickiness. Axel Leijonhufvud in On Keynesian Economics and the Economics of Keynes argues that, putting words in Leijonhufvud’s mouth, “stickiness,” outside of a corridor of relatively small changes in equilibrium prices, is not the right concept. Prices outside the corridor are not “sticky,” not slowly moving by gradient descent toward a new equilibrium, but chaotically scrambled. A new equilibrium is discovered by entrepreneurs, not be re-established even with the best of central bank targeting. The entire tradition of Keynesian economics (and as Friedman said, “We are all Keynesians now.”) from Hicks’s “Mr, Keynes and the Classics” onward, is not, for Leijonhufvud, the economics of Keynes. Perhaps we have never since the Great Depression gotten far enough out of Leijonhufvud’s corridor for unsticking prices to work. Perhaps we should hope we never do.

Image: Central banker holding up a list of Crossed out items: “Wage,” “Wage Bill,” “NGDP,” “Price” and one item not crossed out: “Sticky Price Level.” [Chat decided to make the “central banker,” Jerome Powell. :)

]

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

Lars Christensen [https://marketmonetarist.com/2026/08/19/last-chance-a-proposal-for-fiscal-and-nominal-stability-in-the-us/] has set out a comprehensive but imperfect set of monetary and fiscal policies for “nominal stability.” They are good but we should shoot for better than “stability.” The aim should be to create a faster growing, more inclusive economy.

Before launching into my criticism analysis, I want to give Christensen credit for making this about monetary AND fiscal policy. [Thanks spell check; I really did not mean “giggle” policy.] Too often we try to reform one when the other is undermining the objective. To wit:

• Obama did not dare let all of the GWB deficit-creating tax cut disappear because he could not rely on the Fed to compensate with enough monetary stimulation. [It was allowing the price level to remain below the pre-crisis trend as it was!]

• The Fed could not continue reducing inflation to its 2% target in 2025 in the face of the Liberation Day tariff and deportation supply shocks.

So, what is Christensen’s program?

What the US Treasury and the Federal Reserve should announce:

1) The fiscal house needs to be put in order right now:

1a) Introduction of a federal VAT at a rate of 10%.

Not exactly. I don’t know the number but the rate should be whatever is necessary to fully pay for Social Security, Medicare, Medicaid and ACA subsidies, adjusted periodically to keep them budget neutral.

1b) Social Security: the retirement age will immediately be increased by two years. In the future, the retirement age will be linked to US national life expectancy. The same indexation will apply to the Medicare eligibility age.

Whatever! So long as it’s paid for. The age increases are good for undermining the notion of withdrawal from the labor force according to calendar age, regardless of the effect on the deficit.

1c) The revenues will be used to turn the Social Security system into a fully funded system. The VAT is what pays for the transition – one generation would otherwise have to pay twice.

No. The VAT should be a permanent replacement for wage tax and general revenues funding of social insurance.

1d A nominal freeze on all federal spending until the structural budget balance has been restored. With NGDP growing at 4%, this cuts federal spending as a share of the economy by around 4% a year without a single nominal cut.

This is conceptually inconsistent with increase growth. Some federal spending promotes growth some does not. We should be more selective: more for IRS auditors and science and technology, less for crop supports and enforcement of regulations that do not pass cost benefit tests.

_____

2) All tariffs will be scrapped immediately.

Exception for items of strategic importance from China. [This is pretty close to the classic optimal tariff argument.]

_____

3) A framework for nominal stability:

3a) A 4% NGDP level target, with today’s NGDP level as the starting point. The target path will be adjusted upwards once, by the estimated one-off price level effect of the VAT net of tariff removal, so that a tax change is not mistaken for a monetary one.

With all the calls for instrument targeting, a la some version of a Taylor Rule, Christensen is on the side of the angels to support an outcome target, NGDPLT. It would work well enough so long as departures from the NGDPLT trajectory come from economy-wide supply and demand shocks. An NGDPLT rule, however, does not adjust NGDP (inflation) upward for shocks to relative prices. The rule, for example would mean much less than 2% inflation if there were an important positive AI shock to some sectors and not others, the opposite of what would be needed.

It would be better to return explicitly to FAIT, or better said, to a Flexible Price Level Target with a 2% p.a. target for the forward-looking average price level increase target. A Flexible NGDPLT that does allow for addional inflation to adjust for sectoral shocks should be operationally identical to an FPLT; both aim to allow sticky relative prices to adjust to the same shocks.

3b) Interest rates will be fully market determined.

No, they are still being determined by Fed monetary policy, whatever that policy is. The Fed is not the market.

3c) Every quarter, the Fed will announce the growth rate of the money base it will maintain until further notice to keep NGDP on the target path – and it will be judged, and correct itself, against that path rather than against any forecast of its own.

Which vector of policy instruments the Fed chooses to use – interest rates, QT/QE, monetary base, IOR -- is up to the FOMC. The one exception is removing MBS – Fannie/Freddie liabilities -- from its portfolio. This is a microeconomic policy distortion that makes fixed rate mortgages artificially cheap compared to variable rate mortgages.

3d) The Fed and the US Treasury will refrain from all intervention in fixed income and FX markets, other than the Fed buying a predetermined basket of currencies and commodities to ensure the announced growth rate in NGDP for the coming period.

Comment 3c), bis. The Fed chooses its instruments. But the “Fed buying a predetermined basket of currencies and commodities as its means of managing, inter allia, the monetary base instrument, is a novel idea likely to suffer from Cantillon effects that purchases of Treasury obligations does not.

_____

This [program] would ensure that the budget situation improved dramatically and very fast. NGDP would settle at 4% growth, which would deliver inflation of around 2% over the medium term, and US Treasury yields would stabilize, likely just below 4% at the long end of the curve.

It would be an enormous improvement on the status quo, but the program is incomplete w/o replacement of taxes on personal and business income with a progressive tax on personal consumption at rates that ensure the deficit is no greater than productive public investment.

The problem: the US population has not been told the scale of the fiscal challenge facing the nation, and both the Democrats and the Republicans have only unrealistic quick fixes that won’t work. Tariffs and “DOGE” failed, and “taxing billionaires” will fail in the same way.

The federal government is running a structural deficit of around 6% of GDP at full employment, and that is not sustainable for much longer. If Americans don’t realize this very soon, the US is heading for a major fiscal and financial crisis.

The public has been told and there is no “heading for.” The growth-diminishing effects of deficits have been accumulating since GWB tax cuts and refusal to pay for his expansion in Medicare destroyed Clinton’s surplus and aggravated by the Trump1 and Trump2 tax cuts.

If you want to avoid the fate of Argentina over the past 60 years, it is time you stopped behaving like Argentinians – the road there is not hyperinflation overnight, it is a fiscal position that eventually decides monetary policy for you.

The thing to fear is less Argentina’s monetary outcomes, but slow and halting per capita growth for over a century.

Image: Excited economist waving a document with charts and numbers on a blackboard in the background. [Kudos to Chat for the IS-LM diagram on the blackboard!

]

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

_____

Another day, another “we’re running out of time to keep Social Security solvent” cri de coeur. Today it’s from

Discourse

What Americans Need To Know About the 2025 Social Security Trustees’ Report

Today the Social Security and Medicare trustees released the 2025 annual reports on the financial status of the two programs. In a time when Americans find it increas…

Read more

a year ago · Charles Blahous

Charles Blahous.

The endless head scratching from supposedly fiscally responsible “conservatives” searching for “one (or two or three) weird tricks” to reduce Social Security benefits and deficit is wearing thin. Why does Blahous worry about the Social Security and Medicare financial structure now, when his Republican buddies in Congress are gearing up to reduce income tax collections to add trillions to the deficits?[1]

And even in its own terms, why focus exclusively on bringing benefits into line with the revenue of the wage tax that Reagan and O’Neil cooked up in 1983? This is not to say that changing the inflation adjustment formula (especially as Trumps chaotic tariffs are practically y forcing the Fed to crank up more inflation) or adjusting the “retirement” age might not have merit. The world has changed a lot in forty plus years, but why not argue for those changes on their merits, not as surreptitious ways to reduce benefits?

Why not even think about changing the revenue streams? The fiction that “employers” are paying part of the 12.4% Social Security, and 2.9% Medicare wage tax (capped wages for Social Security) is ludicrous. A wage tax is a tax on wages whatever politicians think or tell voters <about who “pays.”>

Why those percentages and not some others? Presumably they seemed reasonable in 1983 and did run surpluses for some time, but the sums for preventing the programs from producing chronic deficits were wrong. Congress could change that if it were concerned about the growth inhibiting effects of deficits. As the deficit-exploding BBB shows it is not.

But more fundamentally why use wage taxes to fund these programs at all? FDR’s decision in 1935 was forgivable. The VAT was not invented until 1967 in the European Union. That, however, does not excuse the 1983 decision to continue with the wage tax.

The wage tax has several disadvantages.

1) It taxes income, not consumption.

2) It drives a wedge between what the employee produces (the “marginal product” of us economists) and the wage received. Whether this causes the worker to put in a little less effort or the employer to try to substitute other factors for labor, <neither is good.>

3) It contributes to the notion that Social Security is contributory provision for future benefits to be received (and the idea is not foreign to Medicare) instead of a “pay as you go” transfer from contemporary not old and not sick people to the old and the sick.

a. [The contribution idea may also lead employees to save less if they view wage tax payments as personal saving.]

b. [It probably lies behind not making benefits fully taxable as ordinary income.]

4) It has proven, as we have seen, that changes in the wage tax rates are difficult, <making> it nigh impossible to prevent the programs from producing large surpluses or deficits <with demographic chanes>.

5) It makes the programs doubly sensitive – both on the revenue side and the benefit side -- to demographic shifts in numbers of workers and retirees

The best time to shift from wage taxation to a consumption VAT was 1983. The next best time is now with a VAT set at a rate to fully fund Social Security and Medicare at whatever level of good on their merits changes in benefits are made.

Image: Shamelessly lifted from Blahous

[Standard bleg: Although my style is know-it-all-ism, I am aware that I could be mistaken or overstate my points. I know there is an amazing range of talents and experience among readers. Bring that to bear by commenting on these posts.]

<Not many changes, none substantive. In other writing I have linked SS and Medicare finance reform to social insurance generally, including ACA subsidies, Medicaid, unemployment benefits and a child allowance. I have also linked the VAT substitution to substituting a progressive consumption tax for the corporate and personal income tax and both to a growth-promoting “fiscal rule:” make deficits no greater than public investment (NPV > 0). https://thomaslhutcheson.substack.com/p/escaping-a-fiscal-trap and https://thomaslhutcheson.substack.com/p/beyond-the-fiscal-trap

>

[1] In other writings

Discourse

Americans Should Be Less Complacent About Social Security

In December 2023, Gallup released the results of its latest survey of Americans’ expectations of Social Security. Gallup has been conducting these surveys in essentially similar for…

Read more

3 years ago · Charles Blahous

Blahous does present benefit reforms not specifically driven by aggregate benefit reduction.

Nunes begins with agreement with Cochrane’s thesis, Warsh faces inflation that is “stubbornly high,” more like 3% than the Fed’s declared long-term target of 2% annual increase in the PCE. By implication he considers this a problem that goes beyond institutional embarrassment for his former colleague at Stanford’s Hoover Institution. So, Cochrane asks rhetorically, shouldn’t Warsh (as the personification of the Fed) just raise rates?

Here is the best one-graph answer I have to this question, taken from a recent paper (also summarized in “Inflation.”) i is the interest rate, 𝜋 is the inflation rate.^[2]

Huh? Raising the interest rate raises inflation? Cochrane is not “off his rocker” as he correctly asserts. According to a thoroughly conventional kind of New Keynesian model the effect of raising the interest rates to a new level and holding it there is first to lower inflation but eventually to raise it. To unpack this a bit, Cochrane is assuming an initial rate of inflation that is a “equilibrium” given spending plans of all public and private sector actors at the given real (i minus 𝜋) interest rate.

“Eventually higher” is a correct conclusion to draw from a model in which money is “neutral” (the price level at which real activity occurs is arbitrary) and the economy “stable” (under an interest rate target). Given these, inflation eventually has to increase enough to re-establish the equilibrium real rate after the nominal rate rises.

Nunes then paraphrases Cochrane’s conclusion:

From this he draws a conclusion about 2022: the Fed’s hikes brought inflation down faster than it otherwise would have come down, at the cost of a small persistent addition to inflation later.

On his reading we are now living in the right-hand side of his own simulation. … [I]t is why the 1970s took three attempts. Durable disinflation, he argues, arrived only when fiscal and microeconomic reform came with it. “It’s 1979 again.”

Nunes should not let Cochrane get away with two non-sequiturs. First, the model is wildly unfit for 2022 when inflation and interest rates were clearly NOT in equilibrium, the EFFR did not remain high indefinitely, and the results were not to produce a fall and then re-establishment of inflation at a new higher equilibrium. Whether the current configuration of policy and outcome is an equilibrium or not is exactly Warsh’s conundrum.

The second is the 1979 reference which, BTW, has nothing at all to do with the model. Let’s look at this:

This ain’t econometrics, but I think Cochrane would have difficult time attributing the increase in inflation between 1976-1981 and the subsequent decline 1981-86 to federal deficits pushing the Fed to accommodate more or less (the Reagan deficits were fiscal reform?) as opposed to the Fed eventually finding how to use the EFFR to get inflation onto a lower path. Not only is 2026 not 1979, neither was 1979!

But even if Cochrane’s conclusions followed from his model, how could this be useful to a central bank with an inflation target and aware that there IS a cost and no benefit to moving between equilibrium inflation paths, and more so if the departure is from a properly chosen optimal inflation path.

Nunes highlights his own disagreement with Cochrane as follows:

Cochrane writes that Warsh is “wisely in my view” … retreat[ing} from guidance. He describes the replacement as a Draghi-like “we’ll do what it takes,” and grants its appeal given genuine uncertainty about how the Fed affects inflation at all. So far, a real disagreement between us.

Then, in the next breath: that approach “requires that people believe that Warsh and the FOMC have an institutional commitment to low inflation, and the independence to survive whatever it turns out to take.” And then, flatly: “Deterrence is not cheap talk. Speak softly and carry a big stick. Where’s the stick?”

And this illustrates the “jagged frontier of my disagreement with Nunes. I agree with Cochrane that Warsh is wise to retreat from forward guidance about future policy instrument settings. And that it would be wise to replace it with a “do what it takes” commitment to a low (the lowest) inflation target that maintains full employment of resources. But Warsh has done more and less than that. I agree with Nunes that Warsh has not and possibly cannot make such a credible price stability commitment because:

a) No one can believe an unconditional “commitment” to price stability to the total exclusion of the Fed’s other, maximum employment, mandate.

b) He has wondered aloud about the Fed’s commitment to 2% PCE as the “price stability” metric.

Moreover,

c) Warsh was nominated by a president that has no principled respect for Fed independence and in practice desires lower interest rates whatever the circumstances.

And to disagree with Nunes where he agrees with Cochrane, the stick is where and what it’s always been. FOMC setting of the EFFR (or purchases/sales Treasury ST securities if it so chose), payment of interest on reserves, of QE/QT in Treasury bonds or Mortgage-Backed Securities of Fannie and Freddie and is just as big a stick as ever. The issue is if the Fed knows when to use it.

Via his discussion of Cochrane’s bus metaphor (TL/DR) Nunes brings us back to the model and the central issue of his criticism of Cochrane.

Ask “what does a permanently higher funds rate do to inflation in ten years” and you get Cochrane’s paradox, because you have specified [the bus’s] wheel angle and gone to sleep.

Ask instead “what rate keeps nominal GDP^[3] on its announced path” and the question never arises, because the rate is not being held anywhere. It is whatever it needs to be this quarter, and something else next quarter.

And here is where the 90% agreement with Nunes returns. Cochrane is trying to interpret Fed policy as an instrument target when Nunes is insisting on a nominal outcome target.

As an act of charity Nunes goes out of his way to resolve the “paradoxical” dip and higher inflation that Cochrane has created. It’s nothing complicated. Nunes just drops Cochrane’s assumption that public or private actors do NOT respond to the interest rate increase.^[4] If private sector actors respond (as is income maximizing) and respond enough to compensate for non-income-maximizing fiscal behavior, one gets the boring, higher rate-lower inflation conclusion.

Nunes does not do so, but perhaps we could interpret the difference between responding and not responding to the rate increase in the model to differences in the credibility of a commitment to lower inflation that accompanies the rate increase.

Nunes concludes with a syllabus of agreements and disagreements that allows me to pick out one in order to insert a final epicycle, more nuance than disagreement.

We agree the rate-to-inflation link is not mechanical. We agree the Phillips curve is a weak reed and that most of the current discussion collapses into expectations.

Cochrane does believe [expectations really do the work]; he says explicitly that expected inflation “is really where the discussion lies.”

But Nunes believes so too. Both have to believe because in a 1-good (GDP), 1-input (labor), 1-price (wage/price level) model that both are implicitly using, expectations are the only thing that can prevent the nominal wage from yielding full employment. Relative prices (plural) or wages (plural) that may have become stuck out of market-clearing equilibrium as a result of a sectoral shock, do not exist! But in a multi-good/input/price world, expectations become more important as they “explain” differential stickiness.

Image: Three scribes, one peering over at the manuscript of the second, who is peering at the manuscript of the third.

d

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

^[1] One can only wish to see an explicit other half from Cochrane.

^[2] I think we are supposed to ignore the numbers on the Y axis

^[3] Jag! “Nominal outcome” I still think that aiming for a consciously chosen PL trajectory with willingness to “flexibly” exceed it in case of extraordinary shocks beats NGDPLT and even Flexible NGDPLT, if the latter is not identical.

^[4] I agree with the criticism that monetary rules have to take account of some assumed fiscal response. The Fed speaks last in any given quarter, but what it has to say depends on what fiscal policy has done and may be expected to do in response. Sometimes one suspects that monetary rules are being proposed in order to affect fiscal behavior, punishing fiscal irresponsibility with recession. FPLT or FNGDPLT regimes will work across both Fiscal policy as a random walk as well as policy maximizes NPV of expenditures without trying to affect fiscal policy.

She looks through supply shocks. The Middle East ceasefire in June, she writes, “demonstrated that supply shocks can be temporary, reinforcing the case for looking through such disruptions when setting monetary policy.”

“Looking through” a supply shock is only half right. A supply shock worth its name (not a self-reversing blip) needs additional inflation to allow the adjustment of relative prices. Whether this requires a change in some policy instrument to engineer enough additional inflation is a separate issue.

_____________

She gets the AI question right, and more clearly than the June minutes managed. The productivity benefits, she notes, “appear further off, while the inflationary pressures from the buildout are more immediate.”

If AI causes productivity increases large enough to be a shock – to change supply and demand in some sectors enough to require changes in relative prices -- move sectoral relative goods and services prices, wages, rents, etc. – that too requires additional inflation and will almost certainly require some instrument setting. The benefits are higher real income not some “disinflation pressure.”

_____________

And her strongest paragraph says that inflation has been above target for more than five years, and “even stripping out temporary factors, measures of underlying inflation have edged down only modestly over the past year or so. Persistently elevated inflation suggests more restrictive policy may be needed. The passage of time without progress would itself signal that more restrictive policy is needed.”

Nunes’s assessment is correct, but the issue is not how long the over-target inflation has persisted but whether all of it has been necessary to adjust to the tariff, oil, and deportation shocks. The adjustment process is temporary so the “passage of time” matters. But how much has been mistaken accommodation of out-of-control fiscal deficits?

_____________

[Paulson looking at “underlying inflation”] is trying to recover a signal about aggregate demand by filtering a price index — removing the sectors where relative prices moved, in order to see what is left underneath. What´s left is meant to represent broad nominal pressure; the part policy is responsible for.

But broad nominal pressure has a direct measure. Total nominal spending is published quarterly (with monthly estimates published by S&P Global), without any filtering, trimming or median-ing.

Yes, but it does not answer the policy relevant question. “Have relative prices adjusted to the shocks?” Presumably haruspicy^[1] of the price and employment/wage statistics is a way of doing so. Whether “filtering, trimming or median-ing” are the proper techniques, only the haruspex knows. 😊

[One big data omission from the Paulson essay and not called out by Nunes (because it does not exist) is disaggregated wage indexes, not unit value indexes.]

_____________

The question “is total nominal spending consistent with 2 percent inflation over time?” is never asked.

Wrong question. The right question is “Are our current instrument settings, including QT/QE, (and the effects of past instrument settings) consistent with 2% inflation at full employment over time?”

___________

Paulson reports anchored expectations as an observed fact at the same time that the anchor was being withdrawn.

Anchored expectations ARE the key. They determine the degree of stickiness of sticky prices. Weaker anchor => more inflation needed to adjust relative prices in response to shocks. The persistence of over-target inflation and the Fed’s inadequate communications strategy, focused on future instrument movements and not on outcomes, tend to undermine the nominal anchor.

But expectations ARE a “mood” and one that in principle is measurable in the market, especially TIPS. The problem is that Treasury does not provide the raw materials for 1-, 2-, and 3-year TIPS that would be more useful for observing changes in the expectations anchor. The problem with TIPS however, is the current observed anchor both 5- and 10-year TIPS are very near the equivalent 2% PCE rate does not distinguish

- a gradual successful disinflation back down to 2% from

- blundering into a recession inflation going negative, policy then reinflation into a recovery that averages out at around 2%

For that we need Treasury to provide tradable “Trillionths” securities of the appropriate tenors.

________

Ask whether the funds rate is mildly restrictive and you get [Paulson’s] candid shrug, and the shrug is the correct answer to that question. Ask whether nominal spending is above or below a stated path and there is no ambiguity whatsoever.

But neither is the policy relevant question, to repeat, “Are our current instrument settings, including QT/QE, (and the effects of past instrument settings) consistent with 2% inflation at full employment over time?”

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

Image: Woman speaking, audience listening receptively, one man obviously disagreeing

.

^[1] Divination by looking at the entrails of a sacrifice.

The problem they address, high transit investment cost is not unfamiliar but the context may be.

The United States once led the world in transit construction. In the 19th century, publicly subsidized railroads^[1] catalyzed steel production, agriculture, and even financial markets. In the early 20th century, America built the largest network of streetcar tracks in the world, igniting the first suburban boom and making homeownership and jobs available to millions.

But America has lost its edge. Today, we lead the world in transit construction costs, and build less as a result. America’s first subway line opened in 1897: a 1.5-mile tunnel in Boston built in just four years at a cost of roughly $5 million (about $200 million today). Had we kept costs steady since, we would be nearly on par with other developed countries. Instead, in 2022, New York City’s East Side Access project finally opened after 24 years of construction and $11.2 billion in expenditures — giving it the dubious distinction of being, per mile, the most expensive transit project ever built.^[2]

The presentation was not focused, however on documenting a problem but on ferreting out causes which they discuss in six categories

Planning:

Transit projects take an average of 5–7 years to complete environmental review and because these come in the first phase of planning, important (and ultimately costly) operational and constructability concerns, such as utility relocation conflicts or right-of-way acquisition challenges get pushed back against project deadlines. In the Boston Green line, “figuring out how to get the [grant] done before 2014, meant not figuring out the project.” As a result, a project that began as a $1 billion endeavor in 2012 had ballooned to $3 billion by the time the governor paused it in 2015.

Grants follow a linear ‘waterfall’ process, with each of many steps — governed by nearly 60,000 words of statute and regulation — required to wait for completion of the last. Yet these do not sufficiently emphasize cost-effectiveness and early risk assessment,

Design

In Europe, standard, non-articulated diesel buses often cost less than $350,000, compared to $500,000 in the US. As the FTA pays for up to 85% of the cost of buses, transit agencies have little incentive to avoid costly, idiosyncratic design. In 2024 70% of bus manufacturing contracts were unique in at least one feature, ranging from transmissions to seat designs to window tint compared to 45% 20 years ago. Yet in the 1930’s private streetcar companies agreed on a standard design that was manufactured competitively by many companies.

“Buy America” rules that apply to components not just final assembly raise manufacturers’ cost leading some to leave the US market.

US subway construction follows a fire safety standard, which mandates side tunnels that connect adjacent train tunnels every 800 feet, about half the European standard adding about $4 million per mile to construction costs without measurably improving safety

Procurement

Fixed-price contracts look like they protect agencies from cost overruns but they are not real — they mask itemized cost and risk rather than transferring it. Also they do not generate data that other systems and bidders can learn from.

Meanwhile mandatory low-bid selection on those supposedly fixed price – around 60% of jurisdictions legally require low bid selection-- is linked to higher costs, chronic overruns, delays, and “lowballing,” where winning bidders make up the shortfall through change orders. This interacts with low in-house capacity and over use of consultants to evaluate bids.

Interagency Coordination.

Power imbalances exist between the transit agency building the project and the third parties that have to give their approval for the project to advance. Relocating utility assets and some impingement of the value of private assets are legitimate costs of a project, but the approval is sometimes used to extract value from the project in excess of costs “border on extortion.” For example in one particularly egregious case, the City of Beverly Hills denied LA Metro necessary street-closure permits until Metro agreed to build the city a new police kiosk. Sound Transit’s program for light rail construction in Seattle has faced requests for expensive, bespoke parking garages.^[3]

Permitting/Regulation

The National Environmental Policy Act (NEPA) requires a comprehensive environmental review of public transit (and other) projects, something not required of private sector projects. Even obtaining a short cut “Categorical Exclusion: (CE) can take transit projects years. Unlike some agencies that allow self-certification, FTA’s administration of the CE is a back and forth intrinsically adversarial process. As IFP explains:

FTA guidance for right-of-way acquisition explicitly states that “[n]o project development on the acquired right-of-way may proceed until the NEPA process for such project development, including the consideration of alternatives, has been completed.” Unsurprisingly, project proponents are often discouraged by the hurdles and oversight required to secure an exemption, and simply defer (or even forgo) acquiring land for that right-of-way. This might lead an agency to build within an existing right-of-way, which avoids regulatory hassle but undercuts the value of the project by moving stations further from jobs and housing

A 1965 regulation intended to be temporary requires that any federally funded project that “would eliminate positions, change job classifications, reduce hours, or reassign workers secure Department of Labor certification that the changes are “fair and equitable” to affected employees.” This is not a safety issue; Systems in Paris, Vancouver and Copenhagen are fully automated. The regulation has the practical effect of preventing any legacy rail transit system from fully automating driving up costs.

One recent study found that automation could reduce US rail transit operating costs by up to 46%, generating an operational profit on the New York and Philadelphia subways, the Boston T’s Red, Blue, and Orange lines, the BART system in the San Francisco Bay Area, and Caltrain.

State Capacity

Specialized consultants have always been important in heavy transit projects. Yet:

Much of the heavy rail construction in the 1970s, ‘80s, and ‘90s in places like Washington, D.C., Atlanta, and San Francisco was managed by agencies with hundreds of staff engineers and project managers on payroll … with per-mile costs much closer to their international peers.,”

Management consultants, however, have less incentive to challenge costly complexity or the inefficiencies discussed above, and their use means that agency staff lose the technical expertise to do so. Moreover, layers of consultancies diffuse responsibility for decisions.

Although some obvious solutions such as eliminating Buy America provisions and self-certification of NEPA compliance, and allowing automation of trains will be politically difficult, IFP attempts to find feasible solutions.

Cost-effectiveness need not be polarizing. Transit advocates should champion spending less, because every wasted dollar is another project never built. Fiscal conservatives have much to gain from faster delivery, because every delay begets more spending. Environmentalists can celebrate the construction of megaprojects that reduce pollution. Cities thrive when the public sector can build, and rural counties deserve buses that aren’t twice as expensive as in peer countries. And more transit ridership means less traffic for drivers

Reflections

Transit Abundance Playbook’s search for ways to reduce the costs of transit projects is clearly the place to start. But not all cost-effective alternative are created equal. An economist like me will ask about the benefits forgone when one alternative is selected rather than another. Granted this is more difficult than minimizing costs as transit investments yield returns over multiple decades and other policies influence this. For example, the value of rail over busses manifests only in the long-term development along corridors and only if land use regulations permit it.^[4] Even in prioritizing reform of design decisions, regulations, and institutional arrangements the effects on project benefits cannot be overlooked.

Benefits are also central to another issue: the costly interaction between local agencies and FTA, and unproductive incentives that entails. But suppose federal funding has no negative consequence for local decision-making, a question of benefits remains. Most of the benefits of transit projects are local — what significant non-local benefit are there beyond general shared prosperity? Federal funding is not the only way to provide useful transit services to the public. New York’s first subway line was privately financed with city ownership of the tunnels and stations. DC’s bus (and earlier streetcar) system was privately owned until 1973 Why should federal funds pay for local benefits? If subsidies are warranted to compensate for reduction in traffic congestion or even income distribution grounds, these are local, not national benefits. I love being able to walk 10 minutes to either of two Metro stations to go to the doctor downtown. Why should a friend in Omaha be taxed to help pay for it?

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

Image: a gaggle of bureaucrats telling a bus driver what to do as he tries to drive

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^[1] I can’t let the implication pass that railroad succeeded because of subsidies, being given public land.

^[2] The California LA- SF rapid rail line may be ethe most expensive NEVER built.

^[3] IFP attributes those to power imbalances, but I wonder if the prospect of partial federal funding make requestors bolder and transit projects more willing to accede to value extraction.

^[4] From casual perusal of the IFP website, it appears that its analyses are conducted mainly by public policy experts with limited economic, opportunity cost, input.

Well, even five-star eateries should have salt and pepper on the table. [They don’t but they should.] Pace Nunes, Warsh HAS (subject to Claudia Sahm’s important post which I’ll get to later) made a nominal commitment, “we will deliver price stability.” It is not his refusal to give “forward guidance” about next month’s EFFR rate that undermines credibility but rather a) his provenance as Trump’s appointee and b) his lack of nuance about resource employment needing to be part of any nominal commitment. No one can believe a bare inflation target. This is why a commitment to a Flexible Price Level Target or a Flexible Nominal GDP Level Target is needed. Those targets are believable and it is the Fed’s actions and communication strategy (not = “forward guidance”) to make them believed.

It is no challenge to Nunes thesis, but it needs to be borne in mind that the post-conference, 10-year TIPS breakeven inflation movement has been just 6 or 8 basis points. Warsh’s press conference only diminished not upended Fed credibility.

It’s also worth asking how in practice does the Fed communicate a reaction function except by explaining its reactions, which the press conference failed to do. Anyone familiar with Nunes work will know his answer: announce an NGDP level target. The “reaction function” is obvious though implicit, to return NGDP to a pre-set and knowable trajectory if NGDP is not on the trajectory. But what if the target is different or if the NGDP target itself is not invariant with respect to shocks?

Perhaps it is also worth nerding over that the increase in the 30-year rate does not HAVE TO indicate a loss of confidence in the Fed’s commitment to its inflation target. The rate would react the same even if the market expected the Fed to heroically hold out against decades of deficit irresponsibility with higher and higher EFFR’s or QT.

Nunes being Nunes knows this and in a follow up to his post clarifies his point:

I don’t have the thirty-year TIPS reading, which is the one that matters here. If most of the long-end move is real yield rather than inflation compensation, the fiscal reading strengthens and the monetary reading weakens. That’s a check I owe rather than a conclusion I have. The nominal thirty-year is indifferent between compensation for inflation and compensation for supply — a dollar is a dollar. Which is why the split only matters for policy, not for the bondholder: one is fixable by the Fed at no cost, the other isn’t fixable by the Fed at all.

Speaking of QT, Warsh didn’t. Does Warsh intend to shrink the Fed’s balance sheet or not? Why hasn’t anyone else pointed to this silence from Mr. Regime Change? [See the “Balance Sheet” section of The Fed’s Five Task Forces]

Speaking of silence, why hasn’t anyone but Claudia Sahm in Warsh: “We’re Sticking With It”… Until January commented on the unexploded land mine remark about the PCE target?

Who knows come after next January what we might say about strategy. I suspect the task forces might have something to add.

Sahm became concerned in 2% of What about Warsh’s commitment to PCE on the basis of his congressional testimony, but that could have been overlooked as Warsh supping with the Devil using a long spoon. But “sticking with” a long-term target for another 6 months is not sticking at all. Surely this ought to have alarmed bond traders as much as Warsh’s tight-lipped-ness.

And linking this to the Task Force only increase the worry. A Task Force recommendation on how to use more up to date, market derived price date is fine so long as it does not become an excuse to pick a different inflation metric for each macro-political context. See the “Data” section of The Fed’s Five Task Forces]

Image: A central bank press conference with the gathered reporters looking at each other quizzically.

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

In reducing the DWL on raising revenue I’ll start with the principle that one taxes what one wishes to have less of. This, I’ll claim is not income. We want MORE income. However it is distributed, more is better. When we tax income we encourage people to substitute non-income earning for income-earning activities. Or what is probably worse we encourage substituting non-taxable income earning activities for taxable ones.

Nevertheless, at present virtually all federal revenue is from taxation of income –51% from personal income taxes. 33% from wage taxes and 9% from taxes on business income.^[2] Therefore, I propose eliminating taxes on income and replacing them with taxes only on the portion of income that is consumed. Taxation for wealth creation!

Wage taxes^[3] that under-fund social insurance – Social Security, Medicare, and Unemployment Insurance – and could fund a child allowance ACA subsidies and Medicaid -- disappear and are replaced with a VAT that fully funds these expenditures. The shift from under to fully instantiates the principle already established of not borrowing to pay for current expenditure. It is a transfer from one group of consumers to another group with no growth diminishing effect.^[4]

Moreover, a VAT dissolves the gap between what an employer pays and an employee earns which could efficiently increase the use of labor. And by removing the similarity of Social Insurance to individual provident savings a VAT should make it easier to adjust rates from time to time to maintain deficit neutrality.

Business and personal income taxes already contain provisions that nudge them toward consumption taxation: favorable tax treatment of capital income, tax credits for business investment, limited deductibility of saving for retirement, education, and medical expenses. It is these provisions that make income taxation so administratively complex. Eliminating business income taxes entirely and removing the limits on deductions for saving, converts these into a single progressive tax on individual consumption. Setting the rates at levels to raise revenues equal to non-social insurance and non-investment ensures that current expenditures are not paid for with borrowing.

Additionally, business taxation is rife with loopholes and special treatment of one type of activity and another that reduce the value of business investment. To the extent that departures from uniform taxation are Pigou subsidies, these should be given explicitly as expenditures.

To see what no borrowing for current expenditures and taxation of consumption instead of income looks like with real budget numbers from 2000 and 2024 (the most recent possible), I had Claude put together this table. It contains a myriad of implicit assumptions in the classifications. Actual budget data do not clearly distinguish current expenditure from investment; why should it? Take these numbers as a “for instance.” Nothing depends on the exact magnitudes of the changes. It’s how the principles work. not how to fix the deficit

U.S. Federal Budget FY2000 vs FY2024 w/wo Consumption Tax

FY2000 GDP ≈ $9.83 trillion; FY2024 GDP ≈ $28.8 trillion

Nevertheless, when we “Do the Right Thing,” apply the principles of income maximization, we DO “fix the deficit!”

Three observations about consumption taxation are in order.

Progressivity

Nothing in the tables indicates the progressivity of the revenue collection. A VAT collects a flat rate on consumption purchases. As consumption is a smaller share of income for high-income people, the VAT is regressive. It is not necessarily more regressive than the tax on wages it replaces. The individual consumption tax would also be regressive for the same reason, but rates can be progressive with respect to consumption. And since some kinds of income are not taxable, the progressive income tax is less progressive that the rate schedule looks.

Progressivity of the combined system is a policy choice.

Levels

Likewise, nothing in the tables indicates the levels of current or investment expenditure. The numbers show expenditures not changing, but there is no reason they should not. Personally, I suspect that investing according to an NPV principle would mean a lot more investment (adaption to the effects of CO2 accumulation in the atmosphere). I’d like to push up the “retirement” age for Social Security (mainly to undermine the whole idea of leaving the labor force at some calendar age) so the Social Security portion of social insurance could go down. But again, personally, I would add a child allowance to the system. But none of that follows from income maximizing fiscal policy.

Dynastic Wealth

With consumption taxation, an ascetic billionaire leaving their wealth to an equally stingy descendent, etc.^[5] could accumulate stupendous tax-free wealth holdings. What to make of this. If we think that not all the returns to wealth accrue to the wealth holder, and that is the point of consumption taxation, then the greater the accumulation the better, right? After all there is very little effective taxation of legacies under our present income tax system.

Against this we might consider the following. 1) Holding great wealth that can at any time be consumed itself is a consumption benefit. 2) Great wealth that can be consumed in the form of political intervention can multiply the effect of smaller (taxable) actual interventions. Therefore, I see an argument in principle, subject to administrative difficulties, of considering a portion of a legacy as taxable consumption of the deceased’s estate.

Conclusion

Starting with a problem posed as a debt or deficit crisis led to reformulation as an income maximization problem. This in turn led to two policy concepts:

1) No borrowing for current expenditures = deficits only to finance investment understood as activities with net present values > 0

2) Taxation of consumption, not income, namely a VAT to pay for social insurance and a progressive personal consumption tax to pay for other current expenditure with rates set to accomplish 1)

I can’t think of a better outcome than starting a conversation about how to fill in the blanks and shore up the sidewalls.

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

Image: Traveling party on narrow road with a gleaming city far away [Could be farther away!

]

^[1] Considering only current expenditure that have benefits. Some like agricultural price supports or some subsidies for “green energy” have costs greater than the benefit.

^[2] And the 4% of revenue from tariffs – to the extent there ARE tariffs -- should be zero. The purpose of tariffs (like Pigou Taxes which ARE zero) is to shift relative prices. Tariff revenue should be rebated to exporters since tariffs are taxes on exports.

^[3] The 33% in FICA taxes includes taxation of some non-wage income.

^[4] Most VAT systems follow the principle, but for clarity this is consumption VAT, the value added in Investent and Exports is not taxed. In theory a consumption VAT is the equivalent of a consumption sales tax.

^[5] Big fleas have small fleas

Upon their backs that bite’em

And small fleas have smaller fleas

And so, ad infinitum.

The Boyd Institute

The Fiscal State of the US, in 12 Charts

As we ramp up our new sprint on America’s debt & deficits crisis — yes, “crisis” would be an apt characterization — we thought it would be useful to start with a high-level overview of the fiscal problems facing the country. And what better way to set the scene, we asked, than with some charts? So, here’s 12 of them, weaved together with some commentary…

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5 months ago · 71 likes · 22 comments · Peter Banks and William Miller

The Boyd Institute

14 "Ground Truths" on Debt & Deficits

The debt & deficits conversation in America is currently dominated by two camps. The first is comprised of welfare-state advocates and those making MMT-adjacent claims, basically insisting it doesn’t matter — “the deficit is just a number” or “we owe it to ourselves” or “but look at Japan!”. The second camp is those who treat it as an imminent apocalyps…

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3 months ago · 79 likes · 39 comments · William Miller, Peter Banks, and The Mont Pelerin Review

I do not agree with all of this diagnosis 100%. [Do I agree with anything except the Nicene Creed 100%?] But I wholeheartedly cheer on the idea that America is in a “fiscal trap” from which it should escape. Here is a list of the contest submissions.

Brian Moore, Project Hail Mary Zero —.

Performative Bafflement, Achieving fiscal solvency by not letting private equity bros torture grandma to death

Eli Sheets, “Staying Is Nowhere” (submitted as PDF¹)

Fractal Inklings, The Generational Deal

S.B. Orson, What If We Just… Bought Our Way Out? —

Deion A. Kathawa, Bariatric surgery for Leviathan, STAT!

Grant Varner, How Does America Escape Its Fiscal Trap?

Deflated Man, A Social Security Severance for Workers in the age of an AI-Bolstered Workforce

S. de Erney, Punt to the People on Social Security Reform

Erek Tinker, Gerontocracy and Its Discontents

Nathan Smith, Welcome and Tax Mass Immigration to Escape America’s Fiscal Trap

Malevitis, Fixing the Deficit without Bankrupting the Young

Harsh Bhudolia, How America Escapes Its Fiscal Trap: Fifteen Doors Out

Quy Ma, The Velocity Problem

Synthetic Civilization, The Tax State Reads Wages. It Cannot Read Compute. .

The Old Continent, Stocks, Flows and Fiscal Madness

Mike Alexander, How to balance the federal budget

Todd Wohling, A US Sovereign Wealth Fund as a Foil to US Debt

Abdulganiyy Abdulwasiu Olanrewaju, “The Growth Covenant” (submitted as PDF²)

The Mont Pelerin Review, How Do We Solve a Crisis Very Few People Care About.

No Hot Takes, The Fiscal Cliff Crisis Isn’t An Accounting Problem.

Reid, We’re not going to solve the debt crisis.

Alan Schmidt, Unleash the Soldier of Fortune and Slash the Deficit.

Nick Manteris, Fifty-Five Years and Zero Reversals.

Grace M. Lo Porto, The Dollar, the Petrodollar, Gold, Tariffs, and How To Escape The Fiscal Trap.

Mizanur Rahman, Ph.D., Will Deglobalization, Reciprocal Tariffs and Sanctions Resolve U.S. Payment Imbalances?

AG Johnson, Twenty-Five (Mostly) Terrible Ideas to Fix America’s Debt Problem.

Joel Jones , Deficits and Moonbeams.

Annoying Peasant, DOGE, Done Right.

If you stop reading here, I’ll be happy for having slightly boosted the salience of the issue of debt and deficits (although even happier if you also subscribe for free to this Radical Centrist Substack). Nevertheless, I’m not posting this solely to highlight the US defcits problem but to reiterate my own views by way of contrast with some of the diagnosis and proposed escapes. It is not an analysis of any one of the proposals

Debt

First, I want to take on the framing of the “fiscal trap” as about “debt.” We’ve all seen the chart that shows debt as a percentage of GDP projected to exceed “levels of WW2.” Why is that significant? Should WW2 spending have been financed with less debt and more taxes or vice versa? What is the utility function that has “debt” as an argument? When was debt as a percent of GDP acceptable and when does (or did) q it become problematic? Doesn’t that framing imply that the actual damage only occurs at some future date when the ratio is greater than x%? Debt is just the algebraic sum of past deficits/surpluses and its ratio to DGP is not a useful target to try to manage.

Deficits

With deficits we are closer to decision variables but some of the same kinds of questions arise as with debt. Should deficits be smaller or larger or negative (surpluses)? Why? What determines the optimal deficit? How can we escape; do we need to escape a “trap” at all?

Revenues and Expenditures

Following the trail, deficits are, after all, just the difference between revenues and expenditures. Whatever we say about “deficits,” is just shorthand for talking about revenues and expenditures. The deficit cannot be wrong if the revenues and expenditures are right.

Here it may help to distinguish between current expenditures and investment expenditures. The former are those whose benefits approximately coincide with their cost. The latter are those with near-term costs and long-term benefits. About these we know the income-maximizing rule: invest so that the present value of the benefits equals or exceeds the cost when discounted at the same rate as the marginal private sector investment. And the equality of the discount rates ties this to the rate of interest paid on borrowed resources, on the deficit. This suggests a rule of thumb, to borrow no more than the sum of public investment.^[1]

This does not resolve the difficulty in practice of the current expenditure/investment distinction along a couple of dimensions. No real decision has all its costs up front and all its benefits in the far future. That may be one reason that US fiscal data does not report an “investment” category of expenditure. Activities as different as building military barracks, funding the development of vaccines under Warp Speed, or a grant to a local government to partially fund an infrastructure project are not close analogies to a firm’s decision to build a new widget factory.

Moreover, viewed as a rule to be used politically any procedures to enforce it suffer from Goodhart’s Law, “when a measure becomes a target, it ceases to be a good measure.” The UK struggled to implement Gordon Brown’s Golden Rule – borrow only to invest over the economic cycle – only to abandon the attempt in the financial crisis. Still, is there a better place to start? Were not the expenditure decisions during coalition era “austerity” much worse?

The rule of thumb does not give an amount of the deficit or a ratio of the deficit to GDP but suggests that those are not the right questions to ask. And that is as it should be. The state of the economy, changes on the relative returns on private, and public investment changes what the deficit should be. Let’s look at some of the implications.

• Should the Fed ever again allow the economy to fall into recession, it would have consequences for the deficit. In recession returns to private investment fall and the prices of many goods, services, and categories of labor exceed their opportunity costs. Both these factors push up the discounted value of public investment and mean that a higher deficit to finance those investments is warranted. But the inverse is also true. Recovery from recession ought to mean lower public investment. This gives an income maximization route to Keynesian conclusions resting on the PV calculus of public investment, not on aggregate demand management or the multiplier.

• New technologies can increase the returns to private investment more than to public investment – railroads in the 1870s, electricity and the internal combustion engine in the 1920s, the dot-com boom in the 1990s [and AI in the 2020s?] – and suggest lower public deficits. That private finance my outrun the returns does not mean the returns were not real.

• An increase in interest payments on existing debt does not ipso facto call for a reduction in public investment or in the deficit. They are however an increase in current expenditure that requires an increase in revenue if they are not to break the borrowing only for investment rule of thumb.

Perhaps it is surprising, but this income (or growth) maximizing approach does “solve” the “debt” problem on its own inadequate terms. Since defcits finance only public investment, debt grows only as rapidly as assets and interest payments grow only in line with return on investment.^[2]

Image: Split screen 1) Multiple speakers excitedly shouting out their messages 2) A single speaker calmly addressing the same skeptical audience

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[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

^[1] There is a lot more to be said about decision rules for public investment than make NPV > 1 that makes “the” discount rate different from the public sector’s borrowing rate. Hence, “rule of thumb, not “rule.”

^[2] Some public investent may be in the form of capital grants to individuals and firms, however, so not all assets create public assets nor all returns revenue or cost saving.

The Honest Broker

Why Europe's Heat Waves Are Getting Worse

The image at the top of this post is real — not AI. It shows the Earth as a thermostat with the message: “You Control Climate Change.” The 2006 PR campaign was developed by the European Commission — in the words of European Commission President José Manuel Barroso…

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2 months ago · 402 likes · 61 comments · Roger Pielke Jr.

and

The Honest Broker

Why Cutting Emissions Can't Fix Europe's Heat Waves

This is the second of two posts. Part 1, “Why Europe’s Heat Waves Are Getting Worse,” argued that “climate change” is not a cause of European heat waves but an outcome — the detected change in the statistics of weather, produced by several interacting factors. I sorted those factors into three bins: the direct effect of greenhouse gas…

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a month ago · 241 likes · 77 comments · Roger Pielke Jr.

on heat waves in Europe. As usual they are fact filled and a useful corrective to the idea that reducing CO2 accumulation in the global atmosphere can reduce extreme weather here (wherever here is) in the near future.

It was not hard for Pielke to come up with examples:

• World Weather Attribution claims that scientists can now “predict how heat waves will grow more frequent and intense unless emissions are cut drastically.”

• A climate scientist, David Faranda, argued that to prevent severe early-season heat across India and Pakistan: “The only sustainable solution is to stop burning fossil fuels and reduce emissions.”

• UN Secretary-General António Guterres, in his Call to Action on Extreme Heat, agreed: “To tackle the root cause, countries must phase out fossil fuels — fast and fairly.”

No useful conclusion can be drawn from these incorrect, because incomplete, premises. It is perverse of “climate activists” to generate that message and of MSM to disseminate it. Its most likely effect is to promote short term symbolic efforts, most likely of high cost per unit of CO₂ emissions prevented. Such efforts not only distract attention from cost effective policies, but, because they are high cost, cannot be applied at scale to actually solve the problem. Good for Roger or anyone else who debunks the “thermostat” fallacy.

This is an example of a larger issue of attribution of specific weather events to “climate change.” First let’s dispense with the solecism. Specific weather events make up “the weather” and the weather over years and decades is “the climate” which can certainly change. But the whole is not the cause of the part. One cannot attribute a weather event to “climate change,” but whatever causes climate change.

Attribution done right is the result of modeling that identifies a probability distribution of event X at time “t,” given levels of CO₂ and other factors at time “t” so that there is a probability P₁X_t of X occurring. This is compared with the results of the model given alternative levels of CO₂ (and other factors) estimating a probability of P₂X_t. of X occurring. Comparing P₁X_t with P₂X_t. is the measure of the probability that X_t can be attributed to the changes in CO₂ (and other factors). It is worth noting that the uncertainty about the attribution gathers up the uncertainties about both P₁X_t and P₂X_t.

I [Pielke] am unaware of any robust quantification of how much of Europe’s heat wave trend comes from greenhouse gases versus aerosols versus soil moisture versus circulation changes versus modes of variability versus cities — much less the complex inter-relationships among these various factors.

Pielke is effectively claiming that the P₁X_t and P₂X_t cannot be established. It is not quite the case because the failure to untangle exogenous variables, CO2 accumulation and aerosols from intermediate outcomes, soil moisture and atmospheric circulation does not imply not being able to establish the total effects of the exogenous variables, only that the models have not done so.

Nevertheless, Pielke’s counter message. And even if completely correct on its own terms, is also problematic. Kim Lund puts it well, in a comment on one of these posts:

It’s certainly true that cutting CO₂ emissions isn’t like turning down a thermostat. Regional climate, ocean heat content, ice sheets and atmospheric circulation all respond on different timescales. But that isn’t a new or controversial point, nor is it one that most climate scientists have ignored.

But I find his suggestion that climate advocacy broadly rests on a promise of near-term improvements in weather borderline misleading. That simply isn’t how many of the leading scientific bodies and communicators have framed mitigation.

In other words, debunking popular misleading climate claims is not enough. Not enough and it can itself give rise to an opposite idea, that nothing should be done to halt CO₂ accumulation in the atmosphere, which is not synonymous with reducing fossil fuel use. Event attribution is ultimately neither here nor there. Every extreme event is data points in estimating a model linking CO₂ emissions and geophysical events. They are _examples_ of the kind of events that CO₂ emissions mitigation can make less likely in the long run and that calls for preparatory adaptation in the short run.

How MUCH mitigation and adaptation are justified depends on weighing the benefits of mitigation and adaptation (highly dependent on good climate models) and the costs of mitigating (with alternative policies) and adaptation. Too much – virtually all -- of the discussion of policies has been of the form of debunking extreme positions -- climate change denial and existential risk -- and not enough on developing and using models that can shed light on those costs and benefits.

And within this dysfunctional debate between alternative extremes, hides another, between mitigation and adaptation. “Adaptation” is sometimes used as an argument against incurring any cost to mitigate emissions at all, instead of part of the cost of failing to mitigate. But at other times adaptation is not recognized as a real instrument for reducing the harm of CO₂ emissions that reduce, without eliminating, the benefits of mitigation.

Attribution would seem extraneous to these debates except that the same models that can properly attribute, are the models that should inform mitigation and adaptation decisions.

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

Image People suffering from a heat wave

Mont Pelerin Review

The Man Who Knew … offers a balanced review of Greenspan’s public service, too judgmental in parts and too forgiving in others

Greenspan and price controls:

Greenspan, a private consultant with no formal post at the time, watched with dismay as Nixon imposed wage and price controls in August 1971

It is true that the effect of any given monetary policy instrument depends on the environment it works in. Very specifically the same instrument setting can affect aggregate demand more or less depending on expectations. If government (or the Fed itself) can wave a magic wand and cause expectations of inflation to fall, inflation will fall. Therefore, in principle, price controls could be that magic wand even though the microeconomic effects reduce real incomes. The effects of change in expectations, however, does not let the Fed off the hook of responsibility. It is in charge of the combined effects of expectations and monetary policy instruments. In practice, price controls as anti-inflation instrument belong in the same dustbin as other policies that are hypothetically positive under quirky assumptions --industrial policy, minimum wages, and optimal tariffs.

Greenspan and Ford:

Greenspan [now at Ford’s Council of Economic Advisors] thought [in 1975] that recovery was underway and urged fiscal restraint, which proved to be incorrect and cost Ford the election (as well as Greenspan the [possible future] role of Treasury Secretary).

No, it did not. Fiscal policy does not cause recessions or recoveries, inflation or deflation because the Fed, not fiscal policy, controls aggregate demand. Knowing whether not LARPing macroeconomic management was a _political_ error is not my comparative advantage, but I think it generally does not go well.

Greenspan and Social Security

Fast forward “

Reagan handed Greenspan a thankless assignment: chairman of the National Commission on Social Security Reform, convened in 1981 as the program’s trust fund hurtled toward insolvency, possibly as soon as 1983.

Whatever his level of substantive responsibility, probably low, the outcome was a huge mistake. The VAT had been invented by then. There was no excuse in 1981 for continuing to fund Social Security (and Medicare) with a tax on wages, especially not using a tax whose rate was supposedly fixed permanently.

Greenspan at the Fed:

Greenspan took the chairmanship of an institution his younger Randian self had once dismissed as a “historic mistake,” charged with managing precisely the kind of centrally planned money supply he’d spent his twenties railing against.

The Fed’s response to the worst stock market crash since 1929 – a mass outpouring of liquidity – became known as the “Greenspan put.” It is, however, just what Flexible Price Level Targeting looks like. He was channeling Powell 2020. 😊. Seriously, Greenspan deserves credit for inventing the idea that the Fed should prevent recessions, not just respond to them.

_____

As the economy slowed heading into the 1992 election, [GHW]Bush wanted faster rate cuts to juice growth before voters went to the polls; Greenspan, wary of reigniting inflation and protective of the Fed’s independence, moved more cautiously than the White House wanted.

GHWB was probably correct that Greenspan was not properly inflating enough and letting it be known that the Fed WOULD inflate enough to maintain full employment. On the other hand, Greenspan was right that Fed policy was none of GHWB’s business.

_____

Greenspan used his credibility with Congress and Wall Street to help sell Clinton’s 1993 deficit-cutting package, reasoning that lower government borrowing would ease pressure on interest rates and free up capital for private investment and the resulting run of balanced budgets, the only ones the federal government has produced in the past half-century, vindicated the bet.

How odd that this Fiscal Policy 101 lesson has been seemingly forgotten. “Free up capita; for private investment nods in the direction of a proper fiscal rule: no borrowing for current consumption, “current” meaning activities (at marginal costs and marginal revenues instead of market prices) with NPV < 1.

And how more than odd that Greenspan did not use his “credibility with Congress” to oppose rather than to support the deficit-creating GWB tax cuts in 2001

_____

On the regulatory side, Greenspan’s underlying model of the world had always assumed banks and their boards, armed with better information and sharper incentives than any regulator, would police their own risk-taking. Greenspan never claimed markets or regulators were flawless, but he trusted the former over the latter by a wide margin. That trust proved selectively well-placed.

Prudential regulation ought not to be in the Fed’s portfolio but to the extent it was, it was a significant failure not to head off the excessive risk-taking of financial institutions before 2008. THAT, not more restrictive monetary policy, is the instrument for reducing systemic risk

_____

He saw the systemic danger building at Fannie Mae and Freddie Mac years in advance, warning Congress repeatedly from 2004 onward that the government-sponsored mortgage giants’ enormous, thinly capitalized balance sheets courted disaster.

As regards Fannie and Freddie, more prudent regulation would have helped, but their failures –price level declines => mortgage delinquencies => agencies’ capital erosion --were basically downstream of the Fed’s failure to act sooner to prevent the expectation and the fact of the price level and NDGP falling not only below trend, but falling absolute terms.

More fundamentally, Fannie and Freddie exist to subsidize long-term fixed rate mortgages with an implicit Government guarantee. A financial crisis is when the subsidy becomes explicit.

_____

At the time, [the dot-com crash] Greenspan was praised almost universally for engineering a soft landing after the crash, but was later blamed for contributing to a much more destructive bubble in the housing sector.

Engineering soft landings or avoiding having to engineer soft landing is exactly what a central bank is supposed to do. The “housing bubble” was not macroeconomically destructive; the Bernanke Fed’s failure to act according to Flexible Average Inflation Targeting/Flexible NGDP Level Targeting was destructive. Blaming Greenspan, however, served both proto-“Progressives” and proto- “MAGA” narratives.

_____

Cato

Jai Kedia at Cato says Greenspan Followed Policy Rules and So Should the Modern Fed. No, he did not and no, it should not. The errors are instructive.

The first claim is that in Greenspan’s tenure movements in the Effective Federal; Funds Rate moved according to a “Taylor rule,”

The rule posits that central banks should increase interest rates when inflation (𝜋𝑡 ) spikes or when the economy as measured by real output (𝑦𝑡) operates above its potential capacity (𝑦𝑡_𝑝). Conversely, interest rates should be reduced when inflation falls or when the economy operates below its potential

Near the end of his tenure, Kedia discovered in a 2003 paper that the Greenspan Fed behaved as if it were making decisions following an estimated Taylor Rule78%^[1] of the time. And Monsieur Jourdain discovered that he had been speaking prose 100% of the time.

But that is just one way of describing Fed behavior. In the 1990s, many central banks adopted formal inflation targeting, usually at around 2% per year. The Fed did not adopt an inflation target until 2012, but during Greenspan’s tenure acted as if it had been targeting the PCE price level growth of 2.17% per year 98% of the time.

The point here is not to play R square envy about how to describe Fed behavior. Two very different things are being compared. A rule for how to manage one specific monetary policy instrument is not the same as a target for an economically significant outcome like inflation or NGDP.

This is Kedia’s second error. The Fed should NOT run according to a rule, even one which someone like the “Maestro” Alan Greenspan can break 22% of the time. Congress created the Fed and gave it a specific job: price stability and maximum employment. Creating a rule for instrument manipulation that, according to certain parameter estimates will on average achieve the mandate is beating around the bush and about as close to central planning as a Libertarian think tank can come. How to define the target and what to do when is not being met is an ongoing discussion. One of new Fed Chairman Warsh’s Task Forces [See https://thomaslhutcheson.substack.com/p/the-feds-five-task-forces ] is looking into this. But the outcome is not and should not be a rule.

Image: a confident central banker (who looks like Alan Greenspan, if that is permitted) on Judgement Da

y

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

^[1] This is the Coefficient of Correlation of the regression equation specifying the rule.

The commercial also informed us that WAYMO was under Federal instigation for one of its vehicles driving past a school bus (presumably one with its warnings property deployed). I understand that there is an alternative technology that can be used for piloting motor vehicles. Using it, a usually sober human being called a “driver” employs instruments within the vehicle to control its speed and direction. I know of an instance in which one of those “driver controlled” vehicles (I was the “driver”) drove past a school bus. There was no Federal investigation. Rather, the driver had to pay a fine. This seems like a good way to deal with the vehicles-passing-school-bus issue, not preventing the circulation of self-driving taxis.

What was surprising about the commercial was that it existed. Woah! This was not just some “I’z afeared o’ them new-fangled tegnolgy thangs!” Someone was spending real money. And, depressingly, they must think it has some chance of success.

Image: Horse and buggy being overtaken by a self-driving car [I do not know why Chat made this a drive on the left scene.]

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

The five Task Forces are

1. Communications: Review how the Federal Reserve conveys policy deliberations and decisions amid uncertainty.

2. Balance Sheet Policy: Examine the costs, benefits, and institutional implications of the Federal Reserve’s current balance sheet regime.

3. Data: Improve the quality and timeliness of real economic signals that inform the Federal Reserve’s policy judgments.

4. Productivity and Jobs: Assess the economic impact of new general-purpose technologies, including artificial intelligence, to inform the Federal Reserve’s policy judgments.

5. Inflation Frameworks: Revisit how the Federal Reserve understands and responds to the drivers of inflation

   

Marcus Nunes has commented here but is most interested in #5, as I am, and makes that the topic of his post. Like everything he writes, it is worth reading. But for my purposes I want to have a look at all five. They are not orthogonal and mutually inform each other. There is not a lot in Warsh’s public statements to go on in knowing his intent for the Task Forces. This is appropriate if he intends maximum latitude in the recommendations each may bring. The people that will be leading each Task Force are impressive and both the triumvirate structure and the selection of members with contrasting views point to consideration of a broad range of issues. It’s also convenient as it allows me to put forward the issues in each area I think are important, not to predict where they will come out.

Communications

“My colleagues discussed possible improvements in the form and function of Fed communications. This new Task Force will build on that effort and, I expect, propose some well-considered changes.”

Both words are important, but start with function. As concluded in an earlier post [… What the Fed Isn’t Saying], Fed communication has three functions.

• Utility. Communications is a policy instrument; it affects market expectations which in turn affects the response to other policy instruments. If markets expect the Fed to do X it hardly has to actually DO anything to accomplish X. [If the Fed had made clear in 2009 that it was going to use QE to keep the price level ticking up at the pre-crisis level, it might have needed to purchase fewer long-term assets than it did.]

• Legitimacy. Congress has granted the Fed great powers, to exercise on its behalf Congress’s Constitutional power [Article I, Section 8] to coin money and regulate its value. The Fed needs continuously to prove that it is worthy of those powers.

• Credibility. Markets need to know that Fed actions come from its own judgment of what is needed to achieve its Congressional mandate of price stability and maximum employment not what the president may wish for his advantage.

As for form, long statements by the Chairman or short, dot plot, staff background analysis are all worth re-examining. The key is the content of forward guidance. This should be of the results the Fed expects from its actions, not prognostication about future actions, what movement of policy instruments will be.

Balance Sheet

“Review the benefits and risks of the current ample-reserves regime and the composition of the Fed’s balance sheet … [and] assess alternative frameworks for the conduct and operation of monetary policy.”

Warsh is on record as disliking the Fed’s large balance sheet but the basis of the objection is less clear. Several issues get compounded here: size, term structure, composition, and rate of change/how the change is effected. And each of these has different meanings and policy issues for the asset side or the liabilities side of the balance sheet.

Filling in the 4 x 2 matrix here would disfigure this overview.

Data

“Evaluate new information sources and consider methodological changes to improve data gathering, with the aim of giving policymakers more accurate, relevant, contemporaneous, and, perhaps most important, actionable information on the state of our economy.”

Here it really would be useful to know what problems Warsh has in mind. From his own earlier statements and the leadership of the Task Force it looks like the objective is getting more real time data from private sector sources, things like Task Force leader Chetty’s Opportunity Insights or the (unfortunately no longer active) Billion Prices Project. More, timely, private sector data is good, but what information is to be extracted from the data? Warsh did say “actionable.” Prices seem the most obviously related to the Fed’s mandate and BLS (CPI) and Commerce (PCE) have long lags. Employment is equally important but harder to extract (?) from real time private data.

Without minimizing the usefulness of this focus it seems remarkable narrow. Two areas stand out: expectations and price data methodology. As argued in the Communications section above, expectations to use an overworked LLM phrase, do real work. The Fed ought to pay attention to expectations particularly expectations about their mandated objectives, price stability and maximum employment.

Back in 1997 Treasury began issuing Treasury Inflation Protected Securities (TIPS), carefully paired with non-protected securities to permit extracting market expectation of inflation from trading data. These are issued at 5-, 10- and 30-year tenors and the 5- and 10-year instruments are adequate for tracking how well the anchor to 2% inflation over the long run is holding up. They are not so useful for expectations over 1, 2, or 3 years, which is more like the durations of periods of extreme divergence between actual and target inflation – 2008-09 (negative), 2000 (negative), 2022(positive).

Expectations for GDP growth (the almost exclusive driver of maximum employment) are no less important and for this the Fed has much less to go on. Equities markets being the best choice on a poor menu. They have, paralleling Samuelson’s about economists, predicted 9 of the last 5 recessions. The Fed (the economy generally) needs a better indicator of broad market expectations for growth. This could be accomplished by Treasury starting to issue “Trillionths,” securities similar to Robert Shiller’s “trills,” that pay a fixed percentage of GDP at determined future dates.

Inflation measurement ought to be another major area of concern. The treatment of rent and the rental equivalence for owner-occupied housing and of interest on consumer loans are important for public perceptions of inflation, and hence expectations, and revising them is worthy of consideration. Much more of direct interest to the Fed, however, is wage data. As I argued in https://thomaslhutcheson.substack.com/p/improvements-in-macroeconomic-data, the Bureau of Labor Statistics does not produce indexes of wages as it does of prices of goods and services. Instead, it produces disaggregated unit value indexes which are useful, but are subject to changing composition of jobs, as people with higher or lower wages make up larger or smaller portions of the observed employment category.

There is a similar problem with import and export price data. BLS does not produce price indexes but unit value indexes of imports and exports or disaggregation of prices by degree of exposure to trade shocks even though these have been the important sources of disruption of sectoral relative prices.

A Fed request to Treasury and BLS to produce more useful data would be a reasonable outcome of the Data Task Force.

Productivity and Jobs

“Survey the pace, the reach, [and] the economic impact of new general-purpose technologies, including AI, and explore the implications for the Fed in pursuit of our employment and inflation mandates.”

It’s good to place this task in perspective. The Fed’s entire function is to survey the economy so as to keep the models by which it pursues its mandates current. Presumably this is mainly about AI, although massive high-speed movement of data probably has not run its course. AI in the form of Large Language Models are transforming work.^[1] The looming issue is, assuming that AI can raise the productivity of many, potentially very many jobs, how does that affect total employment? And whichever way the impetus lies – the Task Force leadership leans in a no employment loss direction – what are the implications for Fed policy of the mechanisms by which no employment loss occurs?

The easy path to that conclusion is historical analogy. Steam engines, electricity, and ICE vehicles increased labor productivity without producing mass unemployment. They created new jobs, “Why should AI be different?” To which a reply could be, “Why might NOT AI be different?” A growth theoretic general equilibrium economic framework provides a more fruitful path. By analogy with comparative advantage, even if AI can do _any_ job better, more cheaply it cannot do them all equally cheaply and will be used for those which it has a comparative advantage and not others. But even that fails to take account of the rise in total that will create new jobs to be done by AI or humans.

But both these paths require reallocation of demand and employments across sectors. In terms of implications for the Fed, AI is “just” a positive supply shock. Like any other shock, it requires adjustment in relative prices of goods and services, and of land, capital, and labor resources. And like any other shock, the Fed’s response, depends on the size of the shock. One difference, however: compared to a negative supply shock, the potential increase in total output, translated into aggregate demand by Fed policy, means fewer markets in which relative price adjustments are inhibited by downwardly sticky price/wages. The Fed’s job is easier, requiring less over-target inflation when relative prices can adjust without requiring a fall in real incomes of sticky-price resources. And that’s where it ends, or would. Other policies, however, can inhibit the reallocation of resources across sectors, reducing the increase in output, making prices stickier. These would make the AI shock more like a negative supply shock and imply more over-target inflation to maintain full resource employment. Improvements in data will help the Fed see what kind of steed it is riding.

Inflation Frameworks

“Examine the drivers of inflation, first principles, and weigh the full range of ideas for delivering price stability in a changing economy.”^[2]

We end where we began. What should the framework be? How to communicate, what to do with the balance sheet, which data to use, what effect AI will have all come down to what the Fed actually DOES, deciding within which framework? Nunes sees the Task Force choosing between or coalescing three different approaches -- New Keynesian (which he takes as the status quo), fiscal theory, and financial stability -- while having omitted consideration of NGDP Level Targeting. I agree that adding NGDPLT to the mix would be an improvement, as would adding back the apparently discarded Flexible Average Inflation Targeting (FAIT) or better said Flexible Price Level Targeting (FPLT). I think, however, the Task Force should be more ambitious.

Starting from first principles of real income maximization and the constraint that prices of different goods and services are differentially flexible, I would wish the group to ask what is the best target toward which Fed monetary instruments of EFFR, IOR, and QE/QT should aim in an economy subject to positive and negative aggregate demand shocks and positive and negative sectoral supply and demand shocks? If they did, I suspect they would come out with _Flexible_ NGDPLT with a rate target built up out of an estimated real productivity growth rate and an optimal rate of change of prices derived from the degree in which “prices of different goods and services are differentially flexible” and estimates of the base level of micro shocks (a “Brownian movement” of supplies and demands). Flexibility would be to allow for different amounts of over-target NGDP when the economy encounters major shocks like the 2008 financial crisis, 2020 Covid/Putin, or a truly disruptive rate of AI adoption.

Image: Five numbered rooms, each with people in intense discussion

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

^[1] They have transformed the job of how this Substack is produced, permitting more ambitions posts that require a lot more work. Whether productivity has increased depends on the value of the additional input.]

^[2] Not to make too much of one sentence, but there are a couple of little clouds in Warsh’s statement. The first is, “drivers” of inflation. Perhaps this means no more than exogenous events to which the Fed, as a “driver” needs to take account of. The second is, “delivering price stability.” This is an inflation framework, but the Fed’s job is to deliver both price stability and maximum employment.

Onward!

Roger Pielke comments at length and in detail on the Statistical Review of World Energy but his conclusion says it all

Carbon-free energy is growing. Decarbonization continues its long, slow, pre-policy downward trend. Global fossil fuel consumption continues to increase. The carbon intensity of energy has barely budged, drifting downward ever so slowly. The gap between the required rate of change to hit aggressive decarbonization targets and the observed rate in the real world widens every year.

If we are to achieve deep decarbonization this century, the lesson to take is that we should start thinking about some different options for how to get there. What we have been doing isn’t working.

Pielke builds his analysis around the identity

CO2 = CO2/E * E/$ * $

CO2 emitted equals the CO2 emitted per unit of energy used times the energy used per dollar of world GDP times GDP. This is not very good scaffolding because it is hard to translate into a policies => objective framework. For one thing “decarbonization” should not be the objective but something like maximum future income net of harm caused by CO2 accumulation and net of the cost of adapting to that accumulation^[1]. Depending on the cost of CCS, there might well be continued use of fossil fuel and so no total decarbonization at all. For another increasing energy efficiency contributes to income maximization although it does not advance “decarbonization.” Finally, if “decarbonization” is the objective then de-growth reduces CO2 emissions quite well.

The formula rightly puts CO2 free energy at the center of climate change policy, but fails to take account of total energy use being an input to income. Reducing CO2/E Is key, but Pielke, having called CO2/E to center stage, gave the protagonist the anticlimactic line, “…isn’t working.”

__________________

Roger Pielke also gleefully reports that Another Pillar of Climate Advocacy Collapses

This requires some explanation as it is mainly an inside baseball kind of issue. Back in the Paleo-Bush era, (2004) Stephen Pacala and Robert Socolow of Princeton University argued in “Stabilization Wedges: Solving the Climate Problem for the Next 50 Years with Current Technologies” that humanity already possessed all the technology needed to solve the climate problem well into the 21st century.

The idea was that by starting then and consistently employing a series of specific existing technologies for 50 years, the concentration of CO2 could be stabilized and the level of use of fossil fuels held steady. Over time each technology would displace a growing amount of CO2 emission producing a stack of long thin triangles on a graph that the authors called “wedges.”

Many climate advocacy groups latched onto the wedges rhetoric for advancing their pet solutions, but as Pielke says and said then,

We didn’t [have them] then and we still don’t today.

Well, yes/no is almost never the right answer in economics. What would have been the cost of employing 2004 technologies to stabilize CO2 concentrations by 2054? What would it be with 2026 technologies? Pacala and Socolow did not say and the climate activist groups did not ask.

A bad rhetorical framework for policy advocacy, but did it really affect policy? Did it discourage research into zero-CO2 emitting technologies -- solar, nuclear, geothermal, CCS, wind? Did it even direct policy at discouraging CO2 emissions efficiently?

Either way, imagine Pielke’s schadenfreude when it was discovered that the original paper was promoted by British Petroleum, that a BP executive even suggested the “wedges” terminology! The paper’s authors were looking for ways to get around the Bush “do-nothing” attitude and BP was happy to support an approach with little immediate impact on oil and gas production. Pielke was pleased not just that he had been right in objecting to “wedges” but that being right, at the time, had earned him many critics.

____________________

Katharine Hayhoe true to her profile (“fact-based, practical, and hopeful”) touts The Great Solar-Coal Flip.

The UK, the birthplace of the Industrial Revolution, turned off its last coal-fired power plant in 2024 and now gets nearly half its power from sun and wind. China, long seen as the poster child for coal, now installs more wind and solar power annually than the rest of the world combined, and is hitting its renewable energy targets well ahead of schedule.

Now, the U.S. is getting in on the solar race. There’s already more solar than coal on the Texas grid, and for the first time on record last month, solar generated more electricity than coal across the whole U.S.—12.8% versus 12.2%. This is a huge flip from just five years ago, when coal-generated power outweighed solar by a factor of three.^[2]

All this is fact based, practical, and hopeful but for policy, “So what?” This kind of cheerleading for zero-CO2 technologies was critical back in the bad-old days of claiming that doing anything about climate change was too expensive. Does Hayhoe now get to the same conclusion because it is so inexpensive? Is getting the present Administration out of the way of zero-CO2 emissions ALL that is necessary? I don’t believe she believes that. But the silence is even a weaker bottom line than Pielke.

___________________________

The NYT reports that Democrats Change Their Tune

… some of the party’s leaders argue that they should stop trying to throttle oil and gas, which heat the planet when burned. It’s a rejection of the approach taken during the Biden administration, which treated climate change as an existential threat and tried to stop new drilling and pipelines.

This is good news, but as “news” it is off center.

Although the Biden administration (the Sanders-Warren administration, in effect) came in “talking” about throttling oil and gas, it did not do a lot until late when it quite unwisely “paused” LNG export projects. [See: Why Not LNG Exports] Both talk and action needed to change. Reducing the US supply of oil and gas will have little effect on CO2 emissions. What the US does not produce will be (largely) substituted by production elsewhere. Effective policy needs to focus on reducing US demand for fossil fuel combustion by deploying ever-less expensive substitute technologies, an approach that can be exported to the rest of the world (as Hayhoe points out). IRA could have been such a policy shift but it omitted the “less expensive” part, offering excessively large subsidies which can permit “more expensive” substitutes.

________________________

David Wallace-Wells opines “We Need to Retrofit the Planet. The Heat Wave Proves It.”

There are three big things to know, I think, about the astounding climatic anomaly that happened in Europe [in late June], with records shattered in half a dozen countries, more than a thousand people dying in a single week and roads melting and tram tracks buckling and bus drivers fainting and crashing in the historic heat.

1. The heat was anomalous. “In a stable preindustrial environment, according to one estimate, the region could expect such an event once every 26,000 years.”

But the environment has changed.

2. “A heat wave of this magnitude has grown more than 100 times as likely just since the landmark European heat wave of 2003.”

3. “Measured against a base line of rising global temperatures, the heat in Bordeaux, France, for instance, registered only its fifth-largest deviation over the past century.”

As an aside, note that although it may be reasonable to attribute the increase in likelihood of heat waves to the accumulation of CO2 in the atmosphere, the data presented are NOT derived from a model linking the probability of this kind of event to CO2 accumulation. They come from simple averages and time series analysis. In other words, the headline got it right, “retrofit.” Whatever may be done to prevent further CO2 accumulation, adaption to the effects of already accumulated CO2 (that IS the most reasonable hypothesis for the change) is the topic of Wallace-Wells’s opinion piece, not mitigation of future accumulation.

And what better place (or worse) to start than the glee some US pundits express at slower take up of air-conditioning in Europe that in the US, supposedly driven by misguided public policy in discouraging it or “irrational” European preferences. Wallace-Wells and others have long lists of reasons why less use of AC has made sense in Europe, reasons ranging from construction materials (brick and mortar vs stud and drywall) to geography (the often cited Bordeaux is as far north as Bangor, ME.)

And even if Wallace-Wells does not draw any strong policy conclusions, I will.

a) Precisely because the estimates of the heat anomaly do not come from a proper model linking CO2 emissions to specific geophysical changes we are not well positioned to optimize investment adapting to the increase.

b) Adaption is costly and public investment as a share of GDP in the US at least (I don’t know about Europe) has decreased, so adaption woud have to fight for a expanding slice of a shrinking pie. This has fiscal (read, tax increase) implications.

c) The cost of adaption is part of the reason we should do cost effective mitigation of future CO2 emissions. Note “cost effective.” Mitigation that costs more than adaption (roof-top solar with net metering and no time-of-day metering is my favorite example) makes little sense.

___________________

Matt Yglesias asks Should Data Centers Pay a Carbon Tax? No, although they might pay for their local externalities (if any) with something called a “carbon tax.” (The Manhattan entry fee in NYC was called a “congestion charge.” Wrong name but good policy. “A rose by any other name …”)

The “No” is also the opportunity to explain again that

a) “Carbon taxes” are not collected from the emitters of CO2 who ultimately pay it, but collected as an excise tax on the first sale of a fossil fuel into the economy in proportion to the carbon content.

b) Their level should be derived from the same CO2 emissions => geophysical changes models that investment in adaption should be derived from.

c) As the least costly way of reducing CO2 emissions, they are the most exportable to any country that in fact wishes to participate in reducing global CO2 emissions.

d) A CO2 content border adjustment fee prevents domestic consumers from offshoring their CO2 emissions to countries without carbon taxation and encourages said other countries to adopt carbon taxation.

Thank you for your attention to this matter.

Image: Rancher with brush cutter. [Chat gave me weed eater and I didn’t insist.]

^[1] Yes, this elides the issue of how to value the dead weight loss of consumption today vs consumption of our supposedly much richer descendants. My personal view is that for this kind of comparison we do NOT discount future consumption because it is future at all. We might shade the relative value somewhat on account of future pc consumption being higher than ours, just as today we should tax people with high consumption at higher rates than those with lower consumption today.

^[2] To get really nerdy comparing Kw capacity does not really compare CO2 emissions. It depends on when those Kw become KwH and at what time of day they are generated.

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

I am not obsessed with “Kevin Warsh at the Fed.”

I am NOT obsessed with “Kevin Warsh at the Fed!”

But others keep writing about it and not getting it quite right. And not even the whole “Kevin Warsh at the Fed,” but “Kevin Warsh and the Fed’s communications strategy.”

As per the xkcd (not the New Yorker) cartoon, when “Someone is WRONG on the internet,” what’s a Radical Centrist to do?

Of these “others” Brad DeLong was the first to catch my eye with his snarky, Betteridge’s Law-violating headline, “Is Kevin Warsh As Bad A Central Banker as He Seems?” https://braddelong.substack.com/p/is-kevin-warsh-as-bad-a-central-banker

DeLong cites the earlier, “more polite,” Claudia Sahm (whom I only happen to have read second), “Where is the Fed Headed” https://stayathomemacro.substack.com/p/where-is-the-fed-headed.

Best historical nuance and theoretical rigor prize goes, not surprisingly, to Marcus Nunes for the apt but, for my purposes, not transparently titled “Bernanke Revises His Revolution.” https://marcusnunes.substack.com/p/the-architect-revises-his-revolution

The common theme is bad communications, the inadequacy of Warsh’s refusal to provide “forward guidance” about future movements of policy instruments. Both DeLong and Sahm think said forward guidance is a good thing and DeLong has an “impolite” speculation about Warsh’s motive for the refusal. Nunes’s criticism is more nuanced but no less negative. Let’s start with him.

Nunes has a long but instructive lead in; here goes:

“Bernanke got the substance right and will not name the rule: a reaction function, described in scenarios, that never commits to the level that would make it a promise. The missing word in both is the same. Level.”

The substance is not quite right. A reaction function does not commit to any target whether rate of change or level (and which level?)

It IS a “level” -- price or NGDP -- that the Fed manipulates, but to commit to a non-arbitrary level trajectory is impossible. One might have a model that gives the optimum rate of change of NGDP or prices in an equilibrium of given price stickiness and average size and frequency of micro shocks, but not the level of that trajectory at any future point.

“Warsh says: stop hedging, and promise the destination.”

This would be acceptable if the announced destination were the right one. Promising to competently drive the stagecoach to Chicago when the passengers want to go to Denver may be not good communication but poor service. It is not even a good indication of competent teamstering.

Communicating Fed intentions via “for instance” predictions of future policy moves IS better than seemingly unconditional prediction, but it’s better just not to predict future movements at all.

I wonder if part of the Fed’s communications problem is the taboo about ever saying that in some circumstances it intentionally inflates. It is NOT always “fighting” this agentic inflation dragon, sometimes unsuccessfully. It is driving the coach sometimes at a gallop even if the passengers are more comfortable at a slow steady pace.

Nunes correctly points out how unconditional predictions can go wrong.

When events diverge from it, as they almost always do, the credibility built on the forecast cracks. Bernanke rereads two episodes this way. His 2013 taper tantrum, when a stray remark about slowing purchases sent yields up three-quarters of a point, and Powell´s 2021 “transitory” call, when the Fed put all its chips on one forecast.

In the context of announcing self-limiting tranches of QE, Bernanke’s “stray remark” WAS a major blunder. Markets naturally took it as prediction.

How specific the Fed should be about an outcome target in the short run is a matter of judgement. The point Powell needed to convey was that temporary over-target inflation was a way of getting to the objective, target inflation with full employment. The Fed would make inflation temporary, not just predict it.

[Bernanke’s reflective] complaint is that the [dot plot interest rate] projections pretend to a certainty the Fed does not possess. They are nineteen individual guesses at the single most likely path, with no shared assumptions behind them, and the public, the press, and sometimes the Committee itself read that modal path as a plan.”

The driver of the stagecoach is not SUPPOSED to know in advance which way to turn the team of horses. That depends on the twists and turns in the road ahead. [Heaven help the passengers if the driver actually lets their previous guesses about upcoming direction of the team affect pulling on the reins in real time!] The driver can reassure the passengers, after each turn if needed, that the destination is still Denver and that they intend to get there without the coach going off any cliffs.

Here is where it gets live.

Nunes brings the analysis to bear on Warsh, who is changing Fed communications strategy, “but not in the way Bernanke wants.”

Warsh made a flat commitment: the Fed will deliver price stability … deleted the reaction-function language from the statement and withheld his own dot. He took cuts off the table and floated a hike.

Line that up against Bernanke’s proposal and they point in opposite directions. Bernanke wants the Fed to reveal more of its conditional response. Warsh, at his first meeting, revealed less of it and committed harder to an outcome.

Nunes has a nice picture of the Fed communications strategy in two dimensions: how binding its commitment to its objective and how it will act to get to the objective, locating all the actors and including where he thinks it should be.

Analytically I could stop here, but DeLong and Sahm are much heavier hitters and their views are useful.

Sahm adds two important points. How does Warsh’s communications strategy impact Fed independence? What will happen to inflation, with and without Fed policy changes.

Independence remains important even with the recent SCOTUS decision preventing Trump from summarily firing Lisa Cook. Sahm appropriately quotes Cook:

This was never about mortgage documents signed years before I became a Federal Reserve governor. It was an attempt to remove me on a manufactured pretext because I refused to bow to political pressure and continued to set interest rates based only on what would best serve the American people. That is the most fundamental obligation of a Federal Reserve governor. Today’s ruling affirms a principle that has underpinned sound economic stewardship for generations: that the Federal Reserve must make all its policy decisions guided by evidence and independent judgment, free from political interference.

Where this circles in on Warsh is the (too narrow) framing of independence as “setting interest rates” and market fears that Warsh would merely be the instrument by which the president would see interest rates reduced. Even with interest rate fears scotched for the moment, there are other policy instruments to keep an eye on: IOR/total Fed balance sheet, Treasury/non-Treasury obligations within the total, term structure of the Treasury obligations, and prudential regulation of financial institutions.

Sahm has a sophisticated and granular discussion of inflation expectations, sector by sector. Here is the summary:

Can we be confident inflation is headed to 2%? No, we cannot. Underlying or trend inflation is more likely to be between 2.5% and 3%. That’s good news relative to the current 4.1% pace, but it overshoots the 2% the Fed said it would deliver. That doesn’t mean that 2% inflation is out of reach; it just means either economic conditions will have to shift toward disinflation or the Fed will need to raise rates.

What does this mean analytically? “Economic conditions” just means how close supply and demand are to equilibrium, product sector by product sector, labor, real estate and capital goods market by market. Sahm goes through various examples of markets moving toward equilibrium, economic conditions that in the aggregate are pushing the inflation rate down toward the 2% target. Another name for “economic conditions” is the Phillips curve.

But of course, how markets are moving depends on how Fed policy intersects demand and supply movements, by sector and market. In principle the Fed looks at the “economic conditions” in the aggregate and decides if it likes the result, the combination of unemployment (of all resources) and inflation. If not, it moves an instrument in its vector of policy instruments. Or the Fed will need to raise rates.

The outcomes resulting from the intersection of policy and the environment are illustrated in the simple Marshallian cross below. The Fed controls inflation by moving the policy curve, “interest rates,” forward or back in the diagram below. But the illustration contains a danger. It implies one price of one input to equilibrate one market. Such a model is silent about policy to deal with shocks, disequilibria of relative prices, that Sahm in fact analyses. In this one-dimensional rendering, the difference between the optimal target and the optimal instrument collapses to an identity. Caveat usor.

And so, Sahm, too, circles in on Warsh and Fed communication:

The Supreme Court sees [by a disquietingly narrow margin] the Fed as special in its independence from political control [no, from executive control] and at a moment when inflation is one of voters’ top concerns. Monetary policy won’t be made by politicians, but it will have political consequences and shape the lives of millions. That’s a lot of power to entrust to Fed officials.

To keep that trust and maintain independence, the Fed’s guiding principle in communication should be transparency in service of accountability. The Fed cannot guarantee that unemployment and inflation will be low, but it can guarantee it will pursue those goals diligently and show its work. Hiding behind jargon or staying quiet won’t deliver.

The implication is that stating a bare objective without explaining how it will be achieved, as Warsh did, is inadequate even with dot plots from other members. Here Sahm may be conflating communication that projects outcomes from that which projects policy instrument movements. Both are “communication” but only one leaves policy unconstrained by past statements misinterpreted as promises.

DeLong is even more critical than Sahm of Warsh’s lack of communication, and he has a theory about Warsh’s motivation: the desire to stay on good terms with 11 Wall Street and 1600 Pennsylvania Avenue. He cites Keynes on the importance of proper communication:

“[A market economy cannot work properly if the money… is undependable. Unemployment, the precarious life of the worker, the disappointment of expectation, the sudden loss of savings, the excessive windfalls to individuals, the speculator, the profiteer—all proceed, in large measure, from the instability of the standard of value…. The costs of production… the rewards of labour, enterprise, and accumulation… [and] a fourth cost, namely risk; and the reward of risk-bearing is one of the heaviest, and perhaps the most avoidable, burden on production. This element of risk is greatly aggravated by the instability of the standard of value….”

DeLong’s critique of Warsh confuses – hopefully because Warsh is himself confused and could become unconfused – a Fed that communicates:

a) the reasoning which brought it to a decision, the effects that it expects that decision to have on outcomes of interest, and its targets for outcomes of interest

with

b) the policy instruments that it may expect now to use in the future.

What Warsh communicated was only his target, price stability, which taken literally would be grounds for impeachment as the Fed has a maximum employment target as well. But it is a target.

Note that in the quote, Keynes emphasized reducing risk in an outcome, inflation, not an instrument — interest rates or money supply — by which inflation may be made more productively predictable. To be predictable in ways that prevent the economy from achieving maximum real income is worse than unpredictable.

Conclusion

What can we make of all this advice? All agree that the Fed should communicate more fully than Warsh’s taciturn statement plus dot plots of the other governors. But communication does not mean the same thing to all, nor for the same reasons. Ultimately, how fully a message is communicated cannot be separated from the substance being communicated. I hear that it does not matter what you say in opera as long as you sing it. That is not the case in central banking. What, as well as how, should the Fed communicate?

Nunes would have the Fed commit to an NGDP level trajectory rule, with instrument moves evergreen and mechanical: tighten if NGDP is over target, loosen if under. Communication here serves utility — there’s nothing left to interpret.

Sahm implicitly agrees with inflation targeting, and for her communication is about legitimacy. Forward guidance about instrument movements shows commitment to the target. The Fed may not follow through with the guidance, but it earns its legitimate independence by showing its work.

DeLong also implicitly accepts the inflation target but wants the Fed to have credibility that its decisions about how to reach that target are its own. Its judgments must not be seen as pressured by politicians or markets. It establishes credibility by communicating with conditional guidance, announcement of a Bernanke-2025-like reaction function.

Utility. Legitimacy. Credibility. All are indispensable but insufficient. None fully grapples with the Fed’s dual mandate to seek price stability and maximum employment. An NGDP level target rule incorporates a particular combination of price-income objectives, NGDP = Price level × Real Income (~ maximum employment of all resources), but there is no theoretical reason to believe that any given rule is optimal.

Taken as a rule, the inflation target favored by Sahm and DeLong (and seemingly espoused by Warsh) would be worse, in giving no weight to employment at all. Of course they do not intend inflation targeting to be a rule, but this leaves open what is being communicated.

The resolution is flexible NGDP level trajectory targeting, or flexible inflation (better said, price level trajectory) targeting, with “flexible” understood as the Fed’s willingness to allow or engineer over-target NGDP or price level growth in the presence of sectoral shocks, to facilitate changes in relative prices of goods and resources needed to maintain full employment of resources. The policy instrument movements needed to achieve the desired flexibility would be the same. In contrast, the communications implications, especially for inflation targeting, are substantial. The Fed would at times have to say out loud that it was “allowing” (engineering) “over-target” (“excessive”) inflation or NGDP growth. That would be a tough job for Warsh or anybody else.

[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]

I usually write about economics, but for the occasion I could try my hand at why celebrating the Fourth of July is a very good thing whatever your taste for hamburgers, hot dogs and potato chips. I could, but a lot of other people have already done so and much better than I would be able to.

For example, Matt Yglesias says They Should Teach Patriotism In Schools.

Jerusalem Demas says You Have To Love America TO Save It

My personal favorite, however, is embedded in Halina Bennet’s complaint at Trump’s attempt to hijack our 250^th, Nobody Likes a Party Crasher. All mention historical openness to immigration as one reason for feeling pride in our country, but I found Halina’s evocation of her own family’s history most moving. In comments, however she got some pushback for having highlighted immigration over economic opportunity in general and more fundamentally, the creation of a Constitutionally protected liberal democracy. I think the emphasis on immigration is correct. Other nations have created liberal democracies and offer opportunities for people who are born with little but nevertheless contribute much to their societies. Maybe the US is the top of that heap, but it is a heap. We are unique in receiving immigrants and turning them into Americans.

That is why I find anti-immigration sentiments like Stephen Miller’s incomprehensible

The idea that immigration of the kind of immigrants we’ve actually had has led to could lead to catastrophic negative consequences is to hard to understand. That it is on the margin negative and that we really should prevent illegal immigration is quite reasonable. Personally, I think that even the illegal immigration we have had is in fact still positive, but YMMV. But immigration in general? Highly positive.

Matt Yglesias claims Better Immigration Can Help Fix the Debt. Focusing on the positive fiscal effects of immigration, especially for reducing the Social Security deficit is probably savvy politically – Slow Boring is a political Substack – but that is not the only way immigration would reduce the deficits – income and excise taxes rise with rising real income as well. Nor are fiscal effects the most important channel of net benefits. Immigration, although positive for both deficit reduction and increasing real incomes, is not the only or even a sufficient way to eliminate the deficit of the social insurance system nor is it the only way to raise real incomes of non-immigrants.

[See here for debt and deficit views.]

[See here for social insurance reform.]

It’s worth thinking about four different kinds of immigration:

a) Selective, H1b visa type programs “entrepreneurs” for cash, etc. These are people who have the potential to earn high incomes.

b) Regular family unification/lottery immigration and seasonal workers

c) Explicitly humanitarian grounds political asylum and TPS.

d) Illegal (and invalid asylum claims) immigration

My guess is that all are net economically beneficial to non-immigrants (which does not imply that d) should be tolerated). One needs a very pessimistic view of American Capitalism to think that an increase in voluntary transactions between immigrants and non-immigrants would not produce benefits for both parties. Each, however, has different fiscal and total private costs, benefits and distributional consequences.

Obviously, each can be tweaked and each has marginal costs/benefits that differ according to their stock and rate of flow.

- It is difficult to conceive of a rate of flow of a) that could become negative.

- It would take a pretty loose interpretation of family unification to turn that category negative and any seasonal worker program has a market equilibrium that is still net positive.

- There is no upper limit to the number of people who would not benefit by coming to the US, but there is to the fiscal cost. [Examined carefully, it’s likely anyone worth persecuting for their political beliefs and actions is an a).]

- The only economic issue concerning d) is cost of enforcement, but I think any reasonably small effort known to be consistently applied would be sufficient to make d) negligible without any behind the border enforcement beyond deporting d)’s who commit serious crimes.

I’m an economist and the economic benefits of immigration and increasing those benefits with reforms are important to me, but they are not the real kicker. Rather, looking around, I have to ask, what’s the downside of immigration? What do the Stephen Millers of the world see that they do not like?

The little town in East Texas where I grew up has changed a lot since the 1950s. There was, I suppose, no one born abroad living there. Now there are many Mexican restaurants (serving authentic Tex-Mex food, not the California type abomination) staffed by immigrants. There was a priest from Sri Lanka officiating Mass. I talked with a convenience store operator from Pakistan. What’s wrong with any of that? And even if you kind of don’t like it, how do you get from “kind of don’t like” to Miller’s “a nation destroying itself.”

I don’t get it.

One of Ronald Reagan’s best lines was in his farewell address:

“You can go to live in France, but you cannot become a Frenchman. You can go to live in Germany or Turkey or Japan, but you cannot become a German, a Turk, or a Japanese. But anyone, from any corner of the Earth, can come to live in America and become an American.“

That is a Fourth of July message.

Image: An ethnically mixed group celebrating the Fourth of Jul

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[Standard bleg: Although my style is know-it-all-ism, I know that I can be mistaken and am prone to overstate my points. Also, there is an amazing range of views and experiences among readers. Bring those to bear by commenting on these posts. Both other readers and I will benefit.]