Targeting Federal Reserve’s independence is misguided, part 2

Published in Standard-Examiner, November 16, 2014, Ogden, Utah

VIJAY K. MATHUR

In part 1 of my column I discussed the Federal Reserve’s (Fed) structure, its responsibilities and implementation of monetary policy, independent of political interference. Here, I discuss different views (of Monetarist and Keynesian schools) on the conduct of monetary policy and the issue of the Fed’s independence from political pressures.

First some background. One of the conclusions arrived at by Professor Ben Bernanke, former Fed chairman, in his path-breaking book “The Great Depression,” is that in all countries monetary contraction was the major cause of the Great Depression of the 1930s. Even with widespread bank panics, sharp price decreases, and output and employment contraction, monetary policy was circumscribed by the prevailing gold standard. Countries that abandoned the gold standard had greater flexibility in initiating expansionary monetary policy (U.S. after 1933) to provide liquidity to banks and stabilize prices, hence output and employment. Bank panics significantly affected supply of output.

Congress created an independent Fed in 1913 to avoid financial panics before World War I. The Fed faced the most severe test in the Great Depression. Some conservative politicians and economists have questioned the Fed’s independence and its discretionary monetary policy.

Nobel Laureate conservative economist Milton Friedman (now deceased), leader of the Monetarist school, argued that discretionary monetary policy could be destabilizing to the economy in the short run. This could happen due to time lags in gathering information and uncertainty about the monetary policy’s effect on the economy. In the long run, monetary policy could be more effective in stabilizing prices. Friedman argued that a rule-based policy, such as a target rate of growth in money supply, is more credible and creates more certainty in markets, thus creating price stability in the long run and encouraging firms to increase output and employment. It is ironic that Friedman was fearful of political pressures on the Fed on its decisions.

Perhaps those politicians who wish to have more control over monetary policy do not like the discretionary nature of the Fed’s policies pursued in the Great Recession of 2007-2009 or their quest for control may be guided by Friedman’s views on monetary policy.

An activist monetary policy for the short run is the Taylor Rule, proposed by Stanford University Professor John Taylor. Andrew Abel, Ben Bernanke and Dean Croushore argue that the Taylor Rule establishes interest rate, rather than money supply, as an intermediate target of monetary policy to provide economic stimulus.

The rule states that the inflation-adjusted federal funds rate (real interest rate) responds to the difference between actual output and full-employment output and the difference between the actual inflation rate and the target inflation (considered to be 2 percent) rate. Therefore, if the economy is at full employment output and actual inflation rate is 2 percent the Fed should set the real interest rate at 2 percent. It should decrease the real interest rate below 2 percent if the economy is weak and increase it above 2 percent if the economy is overheating.

Keynesians recommend a flexible and activist monetary policy, depending upon the state of the economy. Monetary policy could be effectively used not only to stabilize prices but also to promote growth and employment. The Fed followed the Taylor Rule as a guide to achieve its goals in the short run. To make the economy grow in the long run it followed quantitative easing (QE). QE provides liquidity by buying assets such as government securities (Treasuries) and private sector securities. The Fed recently ended QE due to a pick up in economic growth; however, it would keep short-term interest rates very low for the near future.

Total attention of many conservatives to inflation rate is unwarranted. The Federal Reserve Bank Act of 1978 requires the goal of full employment. Despite the limited role played by tax and expenditure policies to combat the recent Great Recession, monetary policy had been very effective in boosting employment and growth, and in controlling the inflation rate.

The inflation rate now is hovering around the target of 2 percent. The current unemployment rate of 5.9 percent is close to full employment unemployment rate, and the U.S. is the only advanced country experiencing potential economic growth of 3.5 percent. Had Congress enacted robust tax and expenditure policies, the unemployment rate and growth would have been even better. Congress even ignored the advice of Professor Bernanke as Fed chair, on fiscal policy in his 2013 testimony in the Senate committee. Political debates and dysfunction in Congress undermined prospects for timely action on fiscal policy. Control of Fed’s monetary policy by politicians, feared by Professor Milton Friedman, will not establish the Fed’s credibility.

The study of 16 advanced countries by Professors Alberto Alesiena and Lawrence Summers found lower average inflation rates in countries with greater independence of central banks. Effectiveness of monetary policy would be compromised with more political intervention and supervision than what we have now.

Congress would be more productive if it settles on certain principles of its own to guide debt, tax and expenditure decisions in a timely manner to deal with recessions and inflation episodes, rather than being mired in endless political debates and indecisions.

Mathur is former chairman and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also writes online for this paper. He lives in Ogden. Part one of this two-part series was in the Nov. 9 Standard-Examiner.

Targeting Federal Reserve’s independence is misguided, part 1

Published in Standard-Examiner, November 9, 2014, Ogden, Utah

VIJAY K. MATHUR

The Federal Reserve System (Fed) played a major role in averting depression in 2007-08. Historically, rigidity in monetary policy was one of the main causes of the Great Depression of the 1930s. However, it is alarming that many media pundits, politicians and Americans lack even rudimentary understanding of this institution and its role in stabilizing prices and the economy.

Many Republicans and some Democrats in Congress are calling for more transparency and congressional control over the Fed. Former Congressman Ron Paul even wants to eliminate it. Most are unaware of the fact that the Fed is already subject to congressional oversight. There are audits by the GAO, external audits and regular congressional hearings on Fed’s policies. It appears that politicians who disagree with the monetary policy want more control. This should concern all Americans.

It would be a travesty if monetary policy were conducted in the political theater. In this column I attempt to familiarize readers with the Fed and its role in the conduct of monetary policy, while in part 2 I will discuss different views on the conduct of monetary policy. Monetary policy requires deliberate flexible and timely strategies and actions to deal with recession and inflation episodes. Had monetary policy been subjected to political debates and media hysteria in 2007-08, we would have had a financial panic here and abroad and perhaps worldwide depression.

To avoid bank panics like those in the 19th century and early 20th century, Congress passed the Federal Reserve Act in 1913 to create the Fed. The Fed is the bank for banks and not the bank for individuals and businesses. A Board of Governors provides the leadership, and the president appoints its chairperson and six other members. Currently, economist Janet Yellen holds that position. There are 12 regional Federal Reserve Banks (Fed banks) with boards of directors, in 12 districts, to provide services to members of the Fed in their districts and carry out policies. Utah’s banks are in the 12th District, under the supervision of the Federal Reserve Bank in San Francisco. Member banks in the district are owners of the district Fed bank. The Federal open market committee (FOMC) is the main policy making body.

The Fed’s goals are price and financial stability, low unemployment rates and economic growth. Monetary policy deals with decisions on money supply (quantitative easing is an extension of this policy) and interest rates. Among many different measures, M1 is the simplest measure of money supply. M1 consists of currency in circulation held by non-bank public and deposits in checking accounts of banks (demand deposits). Fed does not print money to change the money supply, as some media pundits and politicians believe. As shown later, it can change M1 by affecting demand deposits of depository institutions.

The Fed supervises and regulates domestic and foreign banking institutions, and other large complex financial firms. Fed banks provide services such as check clearing, wire transfers and electronic payments to depository institutions. Fed banks also hold members’ reserve accounts, lend money to members and distribute currency to meet public demand.

Fed banks are not profit-making banks, as some believe. However, they do provide services to the U.S. Treasury, and other U.S. government and international agencies. They receive deposits of the U.S. Treasury for items like federal unemployment taxes, income taxes, corporate taxes, payroll taxes and certain excise taxes. They earn their income from interest on government securities, which they hold in the conduct of monetary policy, and fees for services to depository institutions. Excess of annual earnings over expenses of the Fed are returned to the Treasury.

Three main tools of the Fed to change money supply and interest rates are 1) required reserve to deposit ratio (RR), 2) discount rate (interest rate on loans to depository institutions) and 3) open market operations by FOMC (buying and selling of securities, such as Treasury securities, Government bonds and mortgage-backed securities). Increasing (decreasing) RR, increases (decreases) banks’ reserves with the Fed, leads to less (more) lending by banks, hence less (more) demand deposit creation, and therefore less (more) money supply. Increasing (decreasing) discounts rate incentivizes banks to borrow less (more) from the Fed and lend less (more), thereby contracting (expanding) money supply.

The open-market operation is the most effective tool of FOMC. Since most people and institutions, domestic and foreign, hold securities in their asset portfolios, selling (buying) securities at attractive prices decreases (increases) money supply in the economy. All the tools affect banks’ reserves at the Fed and hence money supply. Banks’ reserves also affect the federal funds rate (short-term interest rate) banks charge on mostly overnight loans to other banks that need funds, thus affecting other short-term interest rates in the market.

Economists Andrew Abel, Ben Bernanke and Dean Croushore state that money supply affects economy through changes in interest rates, foreign exchange rate and perhaps supply and demand of credit. The economic effectiveness of monetary policy through these channels requires an independent Fed, free of political pressures.

Mathur is former chair and professor of economics and now professor emeritus, Economics Department, Cleveland State University, Cleveland, Ohio. He also writes online for this paper. He lives in Ogden.

Job market for college graduates not what it used to be

Published in Standard-Examiner, September 24, 2014, Ogden, Utah

By VIJAY K. MATHUR

There is a misunderstanding among many Americans that in today’s economy, those who wish to get a good high-paying job must get a bachelor’s degree. Colleges and universities further confirm this misunderstanding. They emphasize higher average salaries of bachelor’s and/or higher degree holders as compared to those with associate’s degrees and high school graduates, even though there are vast differences in salaries across disciplines for bachelor’s and/or higher degrees.

Data show that high school graduates with technical training and experience would earn more than some college graduates with four-year degrees in arts and humanities. I do not intend to discourage arts and humanities majors. However, many high school graduates would be well advised to pursue some technical training in marketable skills if their goal is to get well-paid jobs. Their net benefit from a bachelor’s degree after six years with overloaded debt, in a discipline with poor labor market demand, would be minimal.

The 2014 study at the Federal Reserve Bank of New York (NY Fed), by Jaison Abel, Richard Deitz and Yaquin Su (www.newfed.org) illustrates well the transformation in the labor market environment for college graduates. They find that even though college grads (with bachelor’s degree or higher) as a group have half the unemployment rate of all workers, the unemployment rate of recent college graduates is much higher than all college graduates from 1990-2013. A tough unemployment rate for college graduates tends to decline with age from late 20s to late 30s, but it significantly increased during 2009 -11 as compared to 1990-2000.

The NY Fed study also finds that the underemployment rate (percentage of college grads working in jobs that do not require a college degree) for all college graduates is around 33 percent and close to 44 percent for recent college graduates in 2012. A significant fraction of underemployed in both groups is earning higher salaries and/or wages in career-oriented skilled jobs such as electricians, dental hygienists, and mechanics, with average salary of $45,000 in 2012. They earn more than the salary of many (close to 15 to 30 percent premium in 2012) with bachelor’s degrees in low-wage jobs.

Abel and Deitz, in another study at NY Fed, Sept. 4, 2014, find that annual wage of bachelor’s degree holders at the bottom 25 percent of the wage distribution is the same as for high school graduates. But data on rate of return of college education based on averages could confuse many. For example, some rough estimates on the rate of return (net of cost of education) generated by Abel and Deitz show that on average a bachelor’s degree earns 15 cents and associate’s degree earns 12 cents on $1 of investment. However, as expected, majors in engineering, math and computers or health sciences earn much more than majors in social sciences or education.

For many high school graduates who are not fully prepared for college, a better option would be to attain an associate degree to acquire marketable skills. According to the Utah Education Task Force Report, May 22, 2013 (le.utah.gov) 18 percent of full-time and 17 percent of part-time students were in remedial courses in Utah’s four-year USHE Institutions in 2010-11. Total completion rate for first time students at a four-year public institution over six years is 32.21 percent, almost half the rate for the nation as a whole. This is not an efficient use of resources in higher education in Utah.

The Wall Street Journal reported, Sept. 12, 2014, that U.S. manufacturers are having a difficult time filling positions in skilled trades in 2014. To meet this skilled gap, President Barack Obama and some state governors want to implement German-style apprenticeship programs. Apprentices would work at jobs for pay and train for a broader range of skills, transferable to other jobs. For many high school graduates, a more rewarding and cost-effective strategy to earn a good wage would be to obtain an associate’s degree in marketable skills. This strategy will also lighten their debt burden and give them work experiences. They can always pursue higher education in the future if they so desire.

It is time to think of a different strategy for providing the workforce for the future. Simply said, all high school graduates going to four-year institutions to obtain bachelor’s degrees is not a cost-effective and welfare-maximizing strategy. Professors Frank Levy and Richard Murnane of Harvard University report in “Dancing with Robots” that since 1980, due to technological revolution, routine manual and other work tasks are declining. Work tasks that require non-routine manual skills, skills to work with new information, and abilities to solve unstructured problems are increasing.

Getting a four-year bachelor’s degree will not assure a promising work future for many. It is hoped that higher education institutions are ready for challenges in education and to prepare students to develop human capital to meet the demands of new technologies and information infrastructure.

Mathur is former chairman and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also writes online for Standard-Examiner at http://www.standard.net/Guest-Cpmmentary. He lives in Ogden.

Compromise can be done on fiscal isues

Published in Standard-Examiner, March 21, 2014, Ogden, Utah

Vijay K. Mathur

Bloomberg, on March 5, reports online that President Barack Obama's budget of $3.9 trillion for fiscal year 2015 benefits low-income families, college students, researchers and infrastructure. It raises taxes on airline passengers, wealthy and multinationals. As a percentage of the Gross Domestic Product (GDP), the projected deficit will be 3.7 percent in 2014 and 3.1 percent in 2015, a decrease of more than 6 percent from 2009, when President Obama took office.

Congressional Republicans disapprove of the president's budget. For Republicans, major fiscal problems are deficits, debt, taxes, and entitlements. They claim that if we reduce income and corporate tax rates, entitlements, and regulations, growth rate and jobs will increase, budget deficits will decrease and debt rate will slow down. Rep. John Boehner, Speaker of the House, R-Ohio, criticized the president's budget and wants a balanced budget.

Rep. Paul Ryan, R-Wisc., has proposed reducing growth of entitlements and considered that overlapping poverty programs create disincentives for work. Rep. Dave Camp, R-Mich., has proposed a tax code overhaul. His proposal reduces the corporate tax rate from 35 percent to 25 percent and exempts from taxes 95 percent of repatriated foreign profits. It also reduces individual income tax rates and tax brackets from seven to three. Mr. Camp wants to replace the Earned Income Tax Credit (EITC) with payroll tax reduction. He claims, just like Rep. Ryan, that his tax reform will induce substantial economic growth.

It appears that a compromise could be negotiated on fiscal matters, while noting that Rep. Boehner's balanced budget idea is wishful thinking, given the economy's economic condition. However, the CBO reports, March 2013, (www.CBO.gov) that budget deficit in 2014 will be 4.4 percent of the GDP -- less than half of the deficit in 2009.  

The long-run goal should be to fix long-term fiscal problems in mandatory programs, claiming 71 percent of the revenues in 2013. Social Security, including disability payments, Medicare and Medicaid alone constitute 82 percent of mandatory outlays. Therefore, budget trimming over the long run should start with reforming these programs.

Here are some areas of probable compromises for the near term:

1. Expand the Earned Income Tax Credit (EITC) to individuals with no children, for job creation and reducing poverty.

2. Consolidate poverty programs with built-in work incentives. Even with thin empirical evidence on reduced work effort due to entitlements, it would be worth negotiating and implementing to improve efficiency.

3. Minimize use of "tax extenders" -- routinely extended tax subsidies, mostly to corporations. Tax Policy Center (www.epi.org) reports that tax extenders, expired on Jan. 1, if extended through 2024, it would cost $46.6 billion per year.

4. Reduce the corporate income tax rate. Reduction of tax on foreign profits should be temporarily granted on the portion of profits invested in non-financial investment activities in the US.

5. Treat "carried interest" of private equity firms' partners and capital gains as earned income for tax purposes. Many Republicans and Democrats in Congress are inclined to make these changes in the tax code.

6. Most agree that one of the effective ways to fight poverty is through education and training for high end and skilled jobs in the technology-driven economy. Expenditures on R&D are necessary to maintain competitive edge in global markets and foster growth. The president's budget boosts spending on these programs and on preschool education for all children. Most evidence shows that early childhood education pays a very significant economic dividend to children and the society at large. Data from the Office of Management and Budget (www.whitehouse.gov/omb) show that the estimated outlay on "Education, Training, Employment and Social Service" was 6 percent of the total outlay in 2013 and 2014 budgets. This meager sum should be increased.  Reducing tax extenders, tax revenue from treating "carried interest" and capital gains as regular earned income would be sufficient to pay for education, training and R&D.

7. Carbon tax and tax on Internet sales (with credits for local sales taxes), could be implemented in place for reductions in income tax rates and tax brackets.  Carbon tax is an efficient way to reduce pollution and dependency on fossil fuels, while offsetting any revenue loss from reductions in income tax rates and brackets. Internet sales tax on all suppliers, with the proposed credit, will enhance competition among all sales outlets.   Favorable tax treatment of out of state Internet sales, serving as substitutes to local outlets' sales, undermines competition. Internet sales already have price advantage due to lower display costs of products. 

Former Rep. Lee Hamilton of Indiana, Standard-Examiner, March 8, opines on the current dysfunctional Congress and Congressmen that, "Their aim seems to be partisan and ideological, rather than a constructive effort to solve nation's problems."  Hopefully all parties heed this criticism by an experienced and respected Congressman.  

Congress and the administration have a stake in working out the compromises in fiscal matters to make this democracy function and serve as a model to the rest of the world. For democracy and a democratic government to survive and sustain itself, it must work on consensus, not dissension, positivism not negativism, and welfare for haves and have-nots. 

Mathur is former chair and professor of economics, and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. He also writes blogs at http://blogs.standard.net/economics,etc.

Moral hazard problem in media reporting massacres

Vijay K. Mathur

Published in Standard-Examiner, Ogden, Utah, December 19, 2013

Ari N. Schulman published an informative report last month in the Wall Street Journal on current research concerning mass killers. It cites many psychological studies on motives of mass killers. Recently, we all have witnessed a series of massacres that psychologists characterize "as a single, typically very public event." Various researchers are of the view that most massacres, for example, at Los Angeles Airport, Newtown, Virginia Tech, Aurora, and the shopping mall in New Jersey, are well thought out, planned, and occur in clusters.

Schulman reports that killers, according to the consensus, follow a "free floating template ... to resolve their rage and express their sense of personal grandiosity." There is also evidence of "suicide contagion effect" that gets attention in the media. In 1984 there were a series of suicides in the subway system in Vienna, Austria. Suicide researchers concluded that sensational reporting in the media and glorification of suicides might be the cause of the three-year epidemic. Researchers convinced media to change the coverage "by minimizing details and photos, avoiding language and simplistic explanations of motives, moving the stories from the front page and keeping the word 'suicide' out of the headlines." Subway suicides immediately dropped by 75 percent. 

These findings pose a conflict between freedom of press and media in the U.S. and elsewhere, and the public good. Psychologists' findings demonstrate that sensational coverage in media on mass killings, romanticizing killers, motives that sometimes evoke sympathy among the general public, may inadvertently bring about other potential killers who have gripes against the government, institutions, laws and regulations, and public in general. The media, motivated by aspirations to provide information to the public, can incite some potential mass killers to come out of the shadows. This effect of the media reporting on mass killers is similar to what psychologists call the "priming effect."
Nobel laureate, Daniel Kahneman, explains in his book, "Thinking Fast and Slow," that priming effect occurs when ideas influence actions. In the recent

report by state investigators on Newtown mass murders, killer Adam Lanza supposedly "became obsessed with the 1999 Columbine High bloodbath and other such mass killings ... " Thus, the extensive coverage of mass murders primed Lanza, already suffering from behavioral and mental problems, to commit murders of his mother and 26 school children and adults in Newtown, Conn. His mother, who purchased guns for him and took him for shooting practices, further facilitated his actions.

Entertainment media also contributes to the priming effect in the name of entertainment. For the society as a whole, sensational and graphic media reporting of mass killings and killers is akin to the moral hazard problem, which economists point out in markets and in many policy actions. Simply, moral hazard arises when a beneficial action by one party may incite the receiving party to engage in behaviors that tend to negate the benefits.
The problem of moral hazard or of "hidden action" was first studied in the insurance industry, where policyholders may engage in actions unobservable to insurance companies. For example, a homeowner who buys fire insurance, covering full replacement cost of home and its contents, lacks the incentive to take precautionary measures to reduce fire danger. Hence, lack of precautions increase fire likelihood, increasing cost of insurances.

Another example is the bail-out of banks and financial institutions during the recent severe recession. To critics, bail-out poses moral hazard problems because it incentivizes them to engage in hard-to-observe risky behavior, hence, posing threats to the financial system.

Similarly, media coverage of mass killers poses a moral hazard problem. Mass killers, primed by thrilling and vivid coverage in media, negate benefits of information to the public. What is the responsibility of free media to prevent such mass killings and promote the public good? I am sure responsible media is as concerned about killings as are others. However, in light of psychological evidence, media's right to exercise freedom of press in reporting massacres, could incite unobserved killers at the margin to commit mass killings to gain notoriety.

The priming effect of mentally unstable people becomes more acute with availability of high-powered weapons with high capacity magazines. Such weapon systems mutually support mass killing instincts of mentally unstable people who have gripes against society and institutions.

The value of the free press is unquestionable. However, given emerging psychological evidence, the exercise of freedom responsibly for the public good, is also precious.

Mathur is former chairmen and professor of economics and now professor emeritus, Department of Economics, Cleveland State University, Cleveland, Ohio. His articles also appear in blogonomics.blogs.com. He also writes blogs for Standard-Examiner at http://blog.standard.net/economics,etc.