Inflation is 1.6%: So Let’s Tighten

July 16, 2013Danny Vinik Leave a comment

New CPI numbers are out this morning with headline CPI coming in at 1.8% and core CPI at just 1.6%. The Fed generally uses core CPI (which excludes food and energy prices) when it makes monetary policy as it is less volatile and more indicative of long-run inflation. Last month’s core CPI was 0.2% as was this month’s. On a year-over-year basis, the indicator fell from 1.7% in May to its current 1.6%. Yet, what have markets spent the last month talking about? When the Fed will start to tighten.

This continues to make no sense and has not made any sense for years now.

The Fed has a goal of 2% inflation. When inflation is less than that 2%, the Fed should instill looser monetary policy to raise it. When inflation is below 2% and unemployment is high, this should be a no-brainer. At the very very least, it shouldn’t be talking about when it will instill tighter monetary policy.

If the Fed were really sticking to its goal of 2% inflation, it would overshoot and undershoot it a relatively equal amount as it attempted to hit that target exactly. Instead, the Fed has consistently undershot its goal. Inflation has been below 2% for years now. Meanwhile, unemployment sits at 7.6%. There’s a real human and economic cost to the Fed’s persistent committment to undershooting its 2% target. Its talk over the past month of tapering has already raised mortgage rates. But let’s continue to talk about tightening with inflation coming in under target. That makes perfect sense.

Legislators Are Like Kids

July 15, 2013Danny Vinik Leave a comment

The Senate Finance Committee is determined to take on tax reform, but Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) have chosen a unique way of starting the process: they are asking their colleagues what tax breaks they want, not which ones they want to eliminate. Basically, they are starting from a blank slate and asking lawmakers what they want. The goal was to give Senators the chance to fight for their beloved tax breaks, since few would fight for the removal of favorable tax breaks.

Genu Steuerle of the Tax Policy Center summarized the benefits of the strategy a few weeks ago:

[I]dentifying losers is immensely unpopular among voters, and politicians shy away from it. Worse, they blast those from the other party brave enough to provide details.

But if Baucus sets a revenue target at the beginning of this tax reform exercise, the dynamic shifts—from simply identifying winners and losers to explicit trade-offs. Winners and losers march together. With a blank slate or zero base, every restoration of a tax break requires higher rates (even an alternative tax), especially if there are few or no alternative preferences to sacrifice.

…

But when the burden of proof changes, a lobbyist can appear to be helping his masters simply by saving a subsidy, even if the net benefit is smaller than in the old law. After all, preserving a preference in some form is success relative to a zero baseline.

So, have other Senators stepped forward to support their favorite tax breaks? Not exactly. Senators don’t really understand the process and are worried that supporting one tax break over another will anger certain interests. So far, submissions have been few and far between. Baucus is still convinced that the process will work and a few Senators are working on legislation supporting different tax breaks, but most are hesitant to join on this method of reform.

This reminded me of a passage from Michael Grunwald’s book on the stimulus where he explained the White House’s strategy of not force feeding legislation down Congress’s mouth. Instead, it tried to give them some autonomy over it in hopes of generating greater support and speedier passage. What the Administration found was that Congressmen were eager for guidance:

The cagey approach helped fuel the myth that Obama punted the Recovery Act to Congress. He never submitted a formal draft, and many Hill Democrats grew frustrated with his team’s refusal to nail down exactly what he wanted and what he needed in the bill.

…

As one Senate staffer puts it, most legislators are like kids: They say they want freedom, but deep down they crave guidance. So Democrats who had spent years demanding respect from the White House quickly decided that Obama’s team was too deferential. “People were like: Just tell us what the hell you want!” recalls Tom Perriello, a Virginia Democrat who had just been elected to the House.

Baucus and Hatch’s reform process differs from the Stimulus because the Stimulus didn’t create losers, as tax reform undoubtedly will. But, still, the two legislators should keep this in mind as they continue down this road. Legislators like a coherent direction about not just how the process works, but also what the limits are of their power throughout it. Right now, no one knows how many tax breaks they can or should fight for. They don’t know the likelihood of passage or how their support for different tax breaks will affect them politically. Everything is up in the air and many Senators are too scared to take part.

So Baucus and Hatch should be forewarned: starting from a blank slate sounds like a great idea, but like children suddenly confused by having free reign over their day, Senators are equally bewildered by having free reign over legislation.

Glass-Steagall Returns

July 12, 2013Danny Vinik 3 Comments

Anyone who has studied the financial crisis knows that Glass-Steagall wouldn’t have prevented it. Glass-Steagall was the law that required commercial banks and investment banks to be separate businesses. Basically, investment banks couldn’t gamble with commercial bank deposits. In 1998, Bill Clinton signed the repeal of the law and investment banks began merging with their commercial counterparts.

Except the banks that failed during the financial crisis weren’t combo investment and commercial banks. Lehman Brothers and Bear Stearns were both investment banks. AIG was an insurance company. Countrywide and Washington Mutual were just commercial banks. Undoubtedly, having Glass-Steagall in place would have lessened the damage of the crisis slightly, but it wouldn’t have come close to prevent it.

Now, Senators Elizabeth Warren (D-MA) and John McCain (R-AZ) are out with a bipartisan bill that would reinstate the law. Kevin Drum isn’t impressed:

I’m in favor of smaller banks, and I suppose that splitting up the big universal banks would accomplish that. But either Congress is willing to split up the big banks or it isn’t. If it’s not, then McCain-Warren bill won’t pass. It it is, there are far better ways of doing it.

For my money, I wouldn’t bother at this point. I’d simply mandate higher capital requirements for everyone, and much higher capital requirements for the biggest banks on a sliding scale. That would automatically put pressure on banks to stay smaller, and it would make them safer regardless of their size. It’s a better, simpler way to go.

I think Drum is missing an important point here: reinstating Glass-Steagall has greater name recognition than any other bills. Americans hated the bank bailouts. They still dislike the banks and a number of Congressmen still are concerned with Too Big To Fail. There actually is motivation from both sides to enact a law that would restrict the size of major banks. No legislation is close to passing and bank lobbyists will flood with the capital with both money and threats if anything appears close to passing. But if Congress is going to find a way to pass something, Glass-Steagall is its best shot. That’s for two reasons:

There is public support for reinstituting Glass-Steagall.

1. People have heard of Glass-Steagall. They may not know much about it, but lots of people have vaguely heard the name. They may remember that banks were overjoyed went it was repealed in the late 1990s. They may remember some analysts (wrongly) arguing that Glass-Steagall could have prevented the crisis. It’s not a large mass of people, but it’s a larger group of people than will have heard of any other potential law. Senators Sherrod Brown (D-OH) and David Vitter (R-LA) have also authored a bill designed to combat TBTF – mostly by ramping up capital requirements (as Drum wants). But which potential bill do you think will have greater name recognition? Which would people support more?

2. Intuitively, Glass-Steagall makes sense. Explaining capital requirement is not easy as Matt Yglesias noted earlier this week. But telling banks that they can’t gamble with the money you deposited? Well, that just seems like a no brainer. Congressmen will find it much easier to explain to their constituents the reinstitution of Glass-Steagall than a new law. Banks are going to be up in arms no matter what. A straightforward, simple explanation to voters would help both Democrats and Republicans find the political cover to go against the big banks. Glass-Steagall offers that.

Now, Glass-Steagall isn’t the best way to break up the banks. And it shouldn’t be looked at as a fix to the financial crisis – as noted above, the repeal of Glass-Steagall did not cause the crisis. But it’s the bill with the greatest chance of passing Congress that reduces bank risk and makes the financial system safer. That’s worth doing.

So, I disagree with Drum. I don’t think it is as simple as “either Congress is willing to split up the big banks or it isn’t.” For any two obscure, complicated bills, that would be the case. But Glass-Steagall has two things going for it that others don’t and we would be foolish to throw away those advantages for a slightly better, but ultimately doomed bill.