Relevant and even prescient commentary on news, politics and the economy.

Will North Korea Explode After Biden Becomes President?

Will North Korea Explode After Biden Becomes President?

 This is what was forecast in a column in the Washington Post by Victor Cha. He sees a combination of economic collapse, a massive spread of Covid-19, and a standard desire when a new US president to enter the office to be behind a possible outbreak of military assertiveness, possibly exacerbated by a much more serious collapse of the DPRK economy and society.  I suspect this is overdone, but there are definitely some major problems going on there, with much of the new attention on this coming out publicly as a result of a major address by Kim Jong Un at the 8th (only?) Korean Workers’ Party Congress, where he openly admits failures to meet Five Year Plan targets for almost everything and calls for a massive tightening of policy with a reassertion of stricter state control of the economy.

I have double checked this by checking on the North Korean Economy Watch blog, which has an extensive report on Kim’s speech, and also seems to avoid the hysterical edge that Cha takes, although with the departure of his pal, Trump, along with all his internal problems, I can imagine Kim may well be tempted to stir up some sort of trouble.  Anyway, some details.

Indeed, targets for almost everything have not been met, ag production, manufacturing, and more.  The one manufacturing sector that seems to be holding up, and was described as “the core industrial sector,” something I have not see claimed before, is the chemical industry. Apparently it is doing so well there is almost no use for some of its output, although what is useful is going to be fertilizer and other inputs to agriculture.

Trump on his own terms

David Hopkins has an interesting take on the failure of Trump’s presidency:

Regardless of these challenges, the general verdict on Trump among historians and political scientists, reporters and commentators, and most of the Washington political community (including, at least privately, many Republicans) is guaranteed to range from disappointment and mockery to outright declarations that he was the worst president in American history. And there is little reason to expect that the information yet to emerge about the internal operations of the Trump administration will improve his reputation in the future. Instead, it’s far more likely that there are stories still to be told about the events of the last four years that history will find just as damning as today’s public knowledge.

Trump’s defenders will respond that the scholars and journalists who claim the authority to write this history are fatally corrupted by hostile bias. It’s certainly true that these are collectively left-leaning professions, and that the Trump presidency treated both of these groups as political opponents from its earliest days. So what if we tried for a moment to give Trump the benefit of the doubt by attempting to evaluate his presidency as much as possible on its own terms? Did Trump succeed in achieving what he wanted to do, even if it wasn’t what others wanted him to do?

Recommended.

Covid Vaccination one dose or 2 II

There is evidence from Israel that one dose of the Pfizer vaccine is less effective than was suggested by the few person-days of evidence in the phase III trials. In Israel  “over 12,400 have people tested positive for coronavirus after receiving vaccine shots” Israeli health officials estimate that one shot is about 50% effective after 14 days . The control group is not matched, it’s not a randomized trial, but it is evidence that the second dose provides benefits on the order of the benefits of the first and is evidence against my proposal to delay the second dose.

Debt and Taxes II

This is an extended post on the caveat to debt and taxes 1. It is joint work with Brad DeLong and Barbara Annicchiarico. The point is that, in his Presidential Address, Olivier Blanchard notes that the argument that higher debt causes increased welfare is weaker than the argument that it is feasible.

The Treasury can afford to increase debt D_t just by just giving bonds away and can pay interest and principal without ever raising taxes so long as the safe rate of interest which it has to pay is lower than the trend rate of growth of GDP. In that case it is possible to just roll over the debt forever and the debt (including the additional debt) shrinks to insignificance as a share of GDP.

Following Blanchard we assume zero trend growth and an economy which reaches a steady state. This really just simplifies notation a bit. Also Blanchard works with Rf_t which is 1 plust the safe rate of interest, so bonds mature in one period and pay Rf_t times the amount invested. In contrast investing in productive capital K_t gives a risky return R_t (includng the capital one still has so the ordinary notation is return r = R-1).

The time subscripts are there because, in general, both the safe and the risky return depend on D_t and K_t. This is a major nuisance and I will present a super absurdly simple example (due to Brad) here in which the state is constant.

The model is an overlapping generations model — the young work and get a wage W_t. They consume C_t^y and buy the bonds D_t and the capital K_t from the old. The old get capital income and also sell their bonds and capital to the young. They consume all of that so C_t^o = Rf_tD_t+R_K_t

Importantly, there is a technology shock which makes W_t and R_t stochastic. This is a crazy assumption, which is absolutely standard when one wants to put risk into a macro model and also wants to keep it super simple. The point is that bonds are safe and that ownership of capital (stock) is risky.

The way to make the model absurdly simple involves two steps. First assume that the policy is to increase D and to keep it at the new high level. If Rf_t<1 this involves an additional gift of D(1-Rf) to the young each period. Increased debt finances an increase in this universal basic income so long as Rf_t<1. The point of this is to keep things simple. It is not needed for the increase in debt to help all generations not just the first who get the windfall gift (see below).

Then the key extreme very convenient assumption just for a simple example.

Agents choose C_t^y to maximiz

1) C_t^y + beta ln(C_{t+1}^o)

The extreme extraordinary assumption is that utility is linear in consumption when young, so young people are risk neutral. The assumption that utility is logarithmic in consumption when old is fairly conventional but it is not innocent either. Together they make everything simple, because it means that people always save beta

so

2) K_{t+1}+D_{t+1} = beta

Then the assumption that the state keeps Debt constant implies that capital is constant.

This implies that Rf and E(R) and the stochastic distribution of R are all constant and everything is simple.

After the jump I will discuss other cases. Here I just note that the extreme assumptions don’t just make all the math simple. They actually matter, because constant Rf_t gaurantees that it stays below 1. In general (and certainly for independent technology shocks) Rf_t is sometimes greater than 1. I will put all this off to the after the jump appendix.

The super simple model shows three beneficial effects of increased debt. First there is the gift to the old at the time D is increased, second there is the gift of (1-Rf) to the young each period. Third debt causes higher Rf which is nice for the citizens so long as the new higher Rf is less than 1.

There is, however, a fourth effect which alarmed Blanchard. In the olg model debt crowds out capital. In the super simple model

3) K=beta-D

The reduction in K causes lower wages W_t and higher returns R_t (still with time subscripts because both depend on the technology shock).

This transfer from the young to the old is risky and it reduces expected welfare so long as the steady state risky rate is greater than 1. In the super simple model that means it reduces expected welfare s long as E(R) >1 when K = beta. Blanchard shows this at some length.

I am now going to do some algebra. I am going to set population + labor supply to 1 just to simplify notation.

With constant returns to scale, perfect competition implies

4) W_t + R_t K = Y_t

taking the derivative with respect to K

5) d W_t/dK + (dR_t/dK)K + R_t=R_t

so

6) d W_t/dK = – (dR_t/dK)K

7) K+D=Beta so dK/dD=-1 so

8) d W_t/dD = – (dR_t/dD)K

Now consider the following policy. D is increased by a small amount deltaD and a small tax on capital income of Tau is introduced so that

9) (1-tau)(R_t + deltaD dR_t/dD) = R_t

That is the tax is calculated so that the after tax income from ownership of risky capital of the old is unchanged.

The revenues tau(R_t + deltaD dR_t/dD)K are given to the workers. Equation 8 implies that their income is unchanged. The tax and transfer policy eliminates the fourth effect of incrased D.

This means that the policy of increasing debt and eliminating the effect on wages and the return on capital by taxing capital income and giving the proceeds to workers makes every generation better off and is a Pareto improvement.

In general in public economics a reform is said to increase efficiency if it is possible to combine the reform with taxes and transfers such that everyone is better off. So in the simple model, the standard use of the term implies that issuing debt and giving the proceeds to citizens would increase efficiency.

This is a very standard analysis of the absolutely standard model used to analyze the welfare effects of public debt. The conclusion really shouldn’t be controversial (but it will be).

Tennessee’s Block Grant Is Approved by H.H.S.

Restoring Medicaid,” What happens when states switch to Block Grants? I came across a NYT article citing Seema Verma’s approval of the Tennessee’s Block Grant recently. The Tennessee Block Grant is mentioned in section ” Revoke The Block Grant Initiative” of my post Restoring Medicaid.

What Are Block Grants?

Government funded normal Medicaid has established rules for coverage and benefits. In an exchange for greater freedom offered to states and an open-ended payment commitment, states pay a share of Medicaid. Using the Block Grant initiative and capped federal funding , states can decide what services to provide.

If the Block Grant spending is less, Tennessee can keep 55% of any savings. Savings can be used for anything related to healthcare and not just Medicaid. If the spending increases beyond the Cap, Tennessee makes up the difference. Program limitations can change to allow the spending cap to grow if enrollment increases such as what is happening during the Pandemic.

Medicaid pays for a wide variety of pharmaceuticals and pays the lowest price “today” of any pharmaceutical purchase in the United States. Under a Block Grant, Tennessee negotiates the drug pricing. One danger is if a drug is too expensive, Tennessee can reject covering it in its formulary.

Why Can Block Grants Be Bad?

Good news (industrial production) and bad news (retail sales)

Good news (industrial production) and bad news (retail sales)

This morning’s two reports on industrial production and retail sales for December were a case of good news and bad news.


Let’s do the good news first. Industrial production, the King of Coincident Indicators, rose 1.6% in December. The manufacturing component rose by 1.0%. Needless to say, these are strong positive numbers. As a result, overall production is only -3.3% below its February level, while manufacturing is only down -2.4% since February:



Manufacturing has consistently been one of the biggest bright spots in the economy ever since April. 


Now on to the bad news.

Debt and Taxes I

There might be such a thing as a free lunch.

There will soon be a Democrat in the White House and Republicans will soon rediscover their hatred of deficits (which were no problem when they were cutting taxes on firms and rich individuals). We are going to read a lot of arguments about irresponsibly burdening our children with debt (which ignore the fact that they will also inherit most of the bonds). We will be reminded that sooner or later we will have to pay.

I am not sure if Milton Friedman will be quoted saying “to spend is to tax”. There will be arguments about how deficit spending creates the illusion of wealth (as consumer/investors we forget that we owe the money as well as owning the bonds just as citizens we forget that we are (most of) the creditors as well as the owners of the indebted Federal Government). There will be arguments about how we can pay now or pay later and it will be more costly if we pay later.

All of this is based on the assumption that the Federal Government’s intertemporal budget constraint is binding. Arguments that you can’t get more now without having less later are arguments about a binding budget constraint. The argument that an increase in spending must be financed by increased taxes in the present or in the future of the same present value is the argument that the intertemporal budget constraint is binding (in fact it is a better explanation of the concept than “the intertemporal budget constraint is binding” the two statements are equivalent and “increased spending … increased taxes …” is written in plain English).

It is true that in standard models, the intertemporal budget constraint is binding (this is called the transversality condition just to type more big words). This is a condition for *optimality* — an aspect of the solution to an intertemporal optimization problem. It is not a given or an assumption about the problem agents face. This is embarrassingly simple. In standard models, you can’t get something for nothing, because if you were in a situation in which you could get something for nothing, then you made a mistake not getting it, and it is assumed that you didn’t make a mistake.

When discussing fiscal policy, Friedman et al assumed that it is optimal while criticizing it as suboptimal. This is a plain contradiction and simple error. All of the discussion of fiscal policy which is used to rule out more deficit spending now assumes that policy is optimal which rules out any change by assumption.

This is not a quibble. The condition for a binding intertemporal budget constraint is that r>n that the interest rate the Treasury must pay is greater than the trend growth of GDP. if r<n then debt can be rolled over forever with new bonds sold to pay interest and principle on the old bonds. The debt to GDP ratio shrinks to zero if r<n and debt is rolled over. This is how the USA handled World War II debt. The US did not pay it off by running primary surpluses. The USA rolled the debt over until it was small and then elected Reagan and began the modern era of huge deficits.

The relevant r in the inequality is the interest rate the Treasury pays on it’s debt. This is always much lower than many other interest rates and has historically usually been very very low. It is now exceedingly low, and it has been extremely low since 2008. It was also very low until the 70s and, when corrected for inflation, remained very low until Reagan and Volcker began working with each other.

This is well known to economists. A masterful explanation and empirical demonstration was given as an American Economic Association Presidential address by OJ Blanchard in 2019 . Read it if you doubt my claims (also if you don’t — it is very good).

For a while after 2008, it was assumed that this was temporary and things would return to normal (normal meaning as they were from 1980 to 2000 but never were before 1980 nor have been after 2000). Many economists now agree that this is the new normal (same as the old normal and different from the situation of extremely loose fiscal policy combined with extremely tight monetary policy).

Importantly this is *not* entirely a forecast. The yield on 30 year inflation indexed bonds is currently -0.24% — the US Federal Government can borrow for 30 years paying a negative real interest rate. Pessimists think that the trend of real GDP growth has fallen to 2% a year (from 3% historically). But it is definitely growth not shrinking.

It is true that investors might change their minds and interest rates might shoot up. If the US financed it’s spending with 30 inflation indexed bonds, this would not be a problem for the Treasury for 30 years. Investors who bought the bonds would lose money, but the Treasury would still have to pay the same coupons and face value. There is even a discussion of introducing extremely long duration bonds — 50 year bonds to lock in interest rates longer or even consols (bonds which last forever and pay a constant interest rate — obviously a multiple of the CPI because the old 19th century nominal consols are silly collectors’ items now))..

But basically the main hugely important point is that there is every reason to think that the US Federal Government can get something for nothing, because it has a slack intertemporal budget constraint.

Failing to take advantage of that would be failing to solve an intertemporal optimization problem. It is one of the few (very difficult) ways to fail my Macroeconomics course.

Caveat after the jump

“insurrections, treason, and the pardon power”

The Federalist Papers #74 on insurrections, treason, and the pardon power: an argument that such pardons would be invalid as “arising in a case of impeachment”

The Insurrectionists from January 6 are already asking Trump for pardons. Probably the only thing that would hold him back from doing so is his innate selfishness: what would be the benefit to *him*?

The thought that Trump could issue Got Out of Jail Free cards to the very people he incited to riot is mind boggling.

But it’s at least possible that he might not have the right to do so. 

Article III, Section 2 of the Constitution provides that “The President … shall have the power to grant] reprieves and pardons for offenses against the United States, EXCEPT IN CASES OF IMPEACHMENT.” 

That last bit isn’t just my emphasis. It’s also the emphasis placed on the quote in the discussion of the President’s pardoning power in The Federalist No. 74, which also discusses the right of the President to issue pardons in the cases of sedition and treason. Below is the entirety of the relevant discussion: 

Desirable Incentive Effects of Income Taxation III

This is the third post in a series. I will discuss advantages of income taxation different from the obvious advantage that taking from people with high income hurts them less than taking from people with low income. Here again, I will assume that, in equilibrium, income tax is returned to the people who pay it as a lump sum. I do this to focus on the incentive effects of income taxation.

The first two posts are here and here.

In standard models, these effects are undesirable and amount to a deadweight loss which is second order in the tax rate. However, the standard models rely on standard assumptions which are completely implausible. They are used, because it is guessed that the policy implications don’t depend on the absurd assumptions. The policy implications always, in fact, follow from the assumptions.

In this post, for the third and last time, I will relax the assumption that people are 100% purely selfish and care only about their own consumption and leisure. Instead I will assume that people maximize the sum of their pleasure from consumption and leisure plus a constant far less than one times other people’s pleasure from consumption and leisure.