An Economic and Security Policy Blueprint for America

A timely new policy book, Blueprint for America, edited by George P. Shultz, is being released today online for the first time. The release coincides with the start of platform writing by Republicans this week and Democrats the following week, and then by national political conventions and the general Presidential campaign.  But the book is purposely meant to be non-partisan as ten contributors with experience in economics, national security, finance, health care, energy, and education join Shultz in laying out novel and practical reforms for governing as well as for campaigning during the election.Shultz_Blueprint_cover

In my view, the book is worth a serious look because it endeavors to bring a greater focus to economic and security policies than we have seen in the campaign. It candidly describes and diagnoses the serious economic and security problems America now faces, and it offers solutions to those problems.  Importantly it combines practical ideas on economics and national security, stressing the importance of getting back to long-term strategic thinking with the goal of improving people’s lives.

The book consists of 12 chapters (all online here)

  • The Domestic Landscape by Michael J. Boskin
  • Entitlements and the Budget by John F. Cogan
  • A Blueprint for Tax Reform by Michael J. Boskin
  • Transformational Health Care Reform by Scott W. Atlas
  • Reforming Regulation by Michael J. Boskin
  • National and International Monetary Reform by John B. Taylor
  • A Blueprint for Effective Financial Reform by John H. Cochrane
  • Education and the Nation’s Future by Eric A. Hanushek
  • Trade and Immigration by John H. Cochrane
  • Restoring Our National Security by James O. Ellis Jr., James N. Mattis, and Kori Schake
  • Redefining Energy Security by James O. Ellis Jr.
  • Diplomacy in a Time of Transition by James E. Goodby

cleverly interspersed with four insightful essays by George Shultz on why out-of-control entitlement spending is a problem, on human resources, on a world awash in change, and on the art and practice of governance. Shultz reflects on his time as secretary of state in these essays, writing that “I worry about the sorry state of the world and my instinct is to say something constructive about the problems.”  A good way to get into the book is to read Shultz’s poignant essays first, and then go on to study the reform proposals in individual pieces.  Here is a quick overview of some of those proposals.

Michael Boskin starts off by documenting the need for general government reform asking, for example, why we have “forty-six job-training programs, sprawling over nine government agencies.” He also considers the need for tax reform, demonstrating why lowering rates and broadening the base will raise growth and create simplicity, and for regulatory reform, proposing an overall regulatory budget cap and a requirement stating that an old regulation of comparable cost must be removed for every new regulation imposed, as a means of balancing of benefits and costs.

John Cogan offers proposals to reform social security and other entitlements arguing that “returning the welfare system to the states is long overdue.” Addressing impediments to reform he notes that “discussions about welfare are too often ideological.” He shows that “reformers are incorrectly cast as heartless people who are unwilling to help the less fortunate. State governments are erroneously cast as uncaring entities…. An effective welfare reform… improves the actual outcomes for the targeted citizens. Welfare reform should be judged on such results.”

Scott Atlas proposes a novel six-part health care reform plan that “restores the original purpose of health insurance: to protect against the risk of significant and unexpected health care costs.” He shows how the Affordable Care Act “has made private insurance less affordable and pushed health insurance reform in the wrong direction. It has furthered the erroneous view that insurance should subsidize the entire gamut of medical services, including routine medical care.” In contrast he shows that his plan “enhances the availability and affordability of twenty-first century medical care for all Americans, ensures continued innovation, and reduces health care costs by trillions of dollars over the decade.”

Rick Hanushek gives a comprehensive overview of the problems in K-12 education and then delves into the role of the federal government versus state and local governments. He puts forth the important principle that “The federal government is in the best position to specify what needs to be produced, but it is quite unprepared to direct what 100,000 schools should do to accomplish this. The states should be given the ‘how’ role.”

John Cochrane offers reforms to deal with financial crises and the too-big-to-fail problem including a novel proposal for equity-financed run-free banks. He also makes a refreshingly unabashed case for free trade backed up by history and basic economics, and he shows the rule of law and immigration benefit America.

In an essay on monetary policy I make the case for a proposal for domestic monetary reform that has already been written into legislation passed by the House of Representatives, and I show how this reform can be extended to create a rules-based international monetary system.

The book then shifts to national security policy with a thoughtful chapter by James Ellis, James Mattis and Kori Shacke that proposes several key strategic reforms. They argue that the current approach to developing a National Security Strategy is too unfocused: “Rather than cataloguing every interest, strategy should consist of decision rules that allow for application to events as they unfold,” a statement that would equally apply to economic policy proposals in the book.  They also emphasize that America needs a “strategy of security and solvency, showing that “economics are integral to military power. In fact, they are dispositive: no country has ever long retained its military power when its economic foundation faltered.” This is also theme that is echoed through the book.  Stressing the need for alliances they argue that a strategy which America adopts “must, foremost, be ally-friendly,” suggesting a simple guide that “those countries that are not against us are for us.”

James Ellis then reviews energy policy. He describes how dramatically circumstances have changed for US energy policy, noting that “The US energy situation today is by almost all accounts better than it has been for decades.” He documents that in 2014, “just 16 percent of our country’s net petroleum use was imported from OPEC. That is now less than 6 percent of our total energy consumption, putting OPEC behind the total energy supplied by, for example, the state of Pennsylvania (7 percent) and just ahead of Colorado (4 percent).” Nevertheless, he argues that energy policy still has problems to deal with including the need to reduce carbon emissions and maintain a diversified portfolio of energy supply.

In the chapter on diplomacy, James Goodby summarizes an interview with George Shultz on governance of foreign policy in the state department, and offers proposals for a range of reforms, including better training and a greater focus on improving the foreign services.

In the concluding essay of the book, George Shultz puts these proposals into perspective observing that the American people have dealt with similar problems in the past and arguing that they can deal with today’s problems if they work at it, reminding us that “democracy is not a spectator sport.”

Posted in Budget & Debt, Financial Crisis, Fiscal Policy and Reforms, International Economics, Monetary Policy, Regulatory Policy

Now is the Time for “Chapter 14” Bankruptcy Reform

Yesterday a “Chapter 14” bankruptcy reform passed the House of Representatives as Title XI (The Financial Institution Bankruptcy Act) of the Appropriations Bill on Financial Services and General Government.  This is a very promising development. The reform would largely end the problem of too-big-to-fail by making it feasible for a large failing financial firm to actually fail and go through bankruptcy under clear rules without systemic spillovers, thereby greatly reducing the likelihood of government bailouts.  The fact that this reform is largely nonpartisan and is part of a passed appropriations bill greatly increases the chance of it becoming law soon, maybe even before the election or at least in this congress. That is the conclusion on the Wall Street Journal in this report.

Much of the research and legal work on this proposal has been conducted by the Resolution Project at Stanford’s Hoover Institution under the direction of Ken Scott, who unfortunately passed away last month. Ken founded and was the driving force behind the Resolution Project which consisted of legal scholars, economists and market practitioners from around the US and the UK. The goal of the Resolution Project was to design legal and economic reforms to prevent bailouts and spillovers of failed financial institutions. Under Ken’s leadership, the Resolution Project—it began work in 2009—developed the “Chapter 14” bankruptcy reform. In a short span of time he edited three books on this subject, Ending Government Bailouts as We Know Them (2010), with me and George Shultz; Bankruptcy Not Bailouts: A Special Chapter 14 (2012) with me, and Making Failure Feasible: How Bankruptcy Reform Can End Too Big To Fail (2015) with Tom Jackson and me.   Without Ken’s dedication, rigorous thinking, insistence on excellence and genuine good-nature, these scholarly and practical contributions would have been impossible. The research has been bolstered by many opeds, blogs and congressional testimony.  The idea has been out there, debated and written into law. It is time to make it the law of the land.

Posted in Financial Crisis, Regulatory Policy

Debt Explosion Still Looks Like July 4th Fireworks

Six years ago, on July 4, 2010, in a post on this blog, I plotted the CBO’s projection of the ratio of federal debt to GDP because it reminded me so much of the Fourth of July fireworks. What does it look like now?

The most recent CBO long term projection was made in June of last year (CBO is later than normal this year).  For some reason, however, the CBO no longer reports debt levels higher than 250% of GDP, as it did in the past, though it does publish estimates of the primary deficit (the difference between revenues and non-interest spending) under its alternative fiscal scenario through 2089. So I use those estimates and calculate the debt levels assuming that the interest rate remains at the levels forecast by CBO.  test

 

As you can see from the figure, the fireworks explosion is still there, and it looks just the same! Clearly this future debt picture is not sustainable.  A fiscal consolidation—a reduction in the primary deficit—is needed if the debt explosion is to be avoided. That the debt is projected to grow relatively slowly as a share of GDP for the next 5 or 6 years has led to complacency, but the longer the fiscal consolidation is postponed the harder it will be to carry out without disruptions.

The decrease in the debt to GDP ratio in the late 1990s was largely due to a decline in defense spending as a share of GDP coupled with strong economic growth. The increase in recent years is due to the weak economy—the recession of 2007-2009 and the slow recovery.  The projected increase in future years is mainly due to the rapid growth of entitlement spending compared to GDP

Posted in Budget & Debt

Whither Economic Freedom Post-Brexit?

As events are turning out, the Brexit decision is providing an opening to revive a trend toward economic freedom and thus stronger economic growth. But will the UK leadership and their counterparts in the EU and the US take that opening?  That depends in part on whether they understand the economic benefits.

A good way to see this is to look at the following chart of recent trends in economic freedom. The index combines well-known measures of regulatory burdens and openness to international trade along with the rule of law and the scope of government, gathered together by the Heritage Foundation. econfreeNote that throughout the past two decades the UK has been well above the EU average of economic freedom. So it is not surprising that the UK economy has grown nearly 1 percent points faster than the EU as a whole and with an unemployment rate only ½ as high.

The chart also shows that the EU score rose and started to catch up to the UK during the period from 1995 to 2005, but unfortunately economic freedom has not kept that pace with that improvement in the past ten years, and that the UK has even declined.

This is where the opportunity lies: The hope is that by escaping the difficult political, and at times very bureaucratic, constraints of Brussels—which have made regulatory reform difficult—the UK will be able to get back to and surpass the level of economic freedom it has achieved in the past. Even with the possibility of a costly transition, the long term gains in income and employment would be substantial.

This will, of course, take a good deal of leadership in the UK and an embracing of the principles of–and practical ways to implement–economic freedom. It is promising that the recently declared, and already front-runner, for Prime Minister, Theresa May, has pledged to carry out a successful exit strategy without the strings of the EU, even though she was against Brexit.  It is also promising that UK Independence Party leader, Nigel Farage, suggested to the European Parliament this week that “Why don’t we just be pragmatic, sensible, grown-up, realistic and let’s cut between us a sensible, tariff-free deal.”

The danger, however, is that the EU will not be accommodating to the international trade part economic freedom—which includes free trade in goods and in services and open capital markets.  This attitude runs the risk of going in the wrong direction: pulling down the index of economic freedom—which factors in the degree of market openness—to the detriment of all Europeans.  Already there have been calls by some EU leaders to reject a continuation of open trade in goods, services, and capital between the UK and EU, unless the UK agrees to such concessions on immigration, a clear way to kill a mutually beneficial trade deal. There is also a danger that another UK ally—the United States—will turn protectionist and refuse to enter into a trade deal with the UK, which would also pull down the index of economic freedom. So the direction that economic freedom takes following Brexit now depends on the economic leadership in the UK, the EU and the US.

Posted in International Economics, Regulatory Policy

Solid Economic Support for Sensible Financial Reforms

Economic research, including work in the 1970s on time inconsistency, has long provided a rationale for central bank independence in conducting monetary policy. Indeed, the research encouraged the spread of central bank independence and inflation targeting around the world in the 1990s.

But the rationale for the independence of other activities at central banks, including many financial regulatory activities, is much weaker. At the least one needs to establish a clear connection between monetary policy actions and regulatory actions to justify placing these activities in an independent central bank.

When central banks drift away from monetary policy and go into other areas, their actions bypass the checks and balances so important in a democracy, and this can lead directly or indirectly to poor economic performance.  For example, the Consumer Financial Protection Bureau—with oversight of such activities as payday loans that have little or no connection to monetary policy—is located in the Fed with no appropriation role for Congress.

A sensible reform to deal with this problem would be to require congressional appropriation of funds for regulatory and supervisory activity within the Fed leaving the monetary policy function to be independent and funded by Fed earnings. The Fed already distinguishes between regulatory/supervisory activities and monetary activities in its internal accounting so this would be a reform that could readily be carried out in practice.

The Financial CHOICE Act outlined two weeks ago by House Financial Services Committee Chair Jeb Hensarling includes such a reform. The act has other reforms with good economic rationale: It would encourage banks to have more capital by offering them in return relief from complex regulations which slowdown the economy. It would restore the regular constitutional role of the Congress by requiring congressional approval of major financial regulations based on cost-benefit analysis. It would reform the bankruptcy code with a new chapter to prevent bailouts and financial spillovers of failed financial firms. And it would require the Fed to report on its strategy for monetary policy.

In general, the act emphasizes the use of incentives and market mechanisms operating through the rule of law to raise economic growth. A number of economic experts with a great deal of research and policy experience over many years have signed on to a statement supporting the proposed legislation, including Michael Bordo, Michael Boskin, Charles Calomiris, John Cochrane, John Cogan, Steven Davis, Marvin Goodfriend, Lars Peter Hansen, Robert Heller, Peter Ireland, Jerry Jordan, Robert Lucas, Allan Meltzer, Bennett McCallum, Lee Ohanian, Athanasios Orphanides, William Poole, Edward Prescott, Thomas Saving, George Shultz, John Snow, John Taylor, Daniel Thornton, and Peter Wallison.

Posted in Monetary Policy, Regulatory Policy

Rules Are Green and Discretion Is Red in the Monetary Game

Raghuram Rajan, Governor of the Reserve Bank of India, is calling for a reform of the international monetary system.  He has been calling attention to problems in the system for a while, and now he is looking for a solution.  In his March 21 Project Syndicate article “New Rules for the Monetary Game,” he argues that “what we need are monetary rules that prevent a central bank’s domestic mandate from trumping a country’s international responsibility.”  The details are laid out in a paper with his colleague, Prachi Mishra.

Raghu has a particular idea in mind.  He suggests that the international community assign colors (green, red, and orange, like traffic lights) in this way: “policies with few adverse spillovers should be rated ‘green’…and policies that should be avoided at all times would be ‘red,’” and in-between policies would be ‘orange’.  He then suggests that economists at central banks, at international financial institutions, and in academia get started with the classification based on economic models and data.

I have been writing about the merits of a proposal for “A Rules-Based Cooperatively Managed International Monetary System for the Future” for some time and with some recognition by Central Banking Publications; it’s already based on economic models and data. In fact, a lot of research and experience over the past several decades shows that rules-based monetary policies lead to better performance nationally and globally. So the proposal is pretty straightforward:  An international agreement on a rules-based system would be built on clear descriptions and commitments to monetary policy rules in each country.  So let’s color rules- based policies green, and discretionary policies red (with Raghu’s orange for monetary policies that are in the transition or normalization phase), and get on with implementing the proposal.

 

Posted in International Economics, Monetary Policy

New Test Finds No Impact of QE on Long-Term Interest Rate

The Fed’s stated purpose of quantitative easing (QE) was to lower long-term interest rates, and many papers have endeavored to test empirically whether it achieved that purpose. Some, such as the paper by Gagnon, Raskin, Remache, and Sack, have looked at the impact of QE announcements, finding the intended impact. Others have questioned estimates based on announcement effects because they may miss reversals that come after the initial effect; a paper by Stroebel and Taylor has instead looked at the direct cumulative effects of bond purchases during QE1, controlling for various risks, and they do not find a significant impact.

A recent study by Ansgar Belke, Daniel Gros and Thomas Osowski takes a whole new approach by controlling for global effects on long-term interest rates. They focus on QE1 and they find no significant impact. The paper was presented yesterday by Ansgar Belke at the Conference on Macroeconomic Analysis and International Finance in Crete, where I was the discussant

The basic idea is explained simply at the start of the paper using the following chart of the 10-year US Treasury rate along with comparable rates in Europe.

QE test graph

“Eyeball econometrics” reveals a lot of co-movement in these rates, which raises basic questions about the finding that changes in the US rate were due to QE. In fact, while the authors show that the US 10-year Treasury rate fell by 1.1 percentage points around the time of QE1—leading to the view that QE had the intended effects—it turns out that the long-term rate in the Euro area (measured by long-term German bonds) came down by about the same amount.  Using rigorous statistical techniques, the authors find that QE1 has no significant effect on the long-term relationship between the interest rate differential and the exchange rate.  Here they use co-integrated time series models with residual tests for structural breaks—modern versions of Chow tests.

This finding also raises doubts about some of the rationales for the effect of QE, including portfolio balance arguments, which would not be expected to have such large global effects.   To be sure, it could be that QE1 had the signaling effect that short-term policy rates in the US would be lower for longer, and thereby signaled the same for the ECB policy rate assuming some kind of policy contagion.  If so, term structure models might suggest co-movements in long-term rates in Europe.

Their model also includes the exchange rate, which will enable them or others to use the approach to examine exchange rate effects in other periods and countries, and perhaps estimate the effect of QE by the Bank of Japan and the ECB in 2012-2015, which eyeball econometrics suggest led to depreciation of the yen and then the euro.

Posted in International Economics, Monetary Policy