May 17, 2009
The Conflict in Modern Conservatism Once Again-Becker
Posner and I decided to post again this week on the conservative movement because of the great interest in our discussion last week. I will try to respond to some of the thoughtful comments and criticisms, and clarify some of my claims.
I claimed in that post that the current Republican Party is trying to incorporate two inconsistent sets of beliefs: one is the support of competition and generally freer markets, and the other is the advocacy of interventionist policies on various social issues, such as gays in military, stem cell research, or in international affairs. Both these positions are often linked together as "conservative", but they involve contradictory views of government. I argued for a consistent conservative position that supports individual choices, and opposes big government. To be sure, government intervention may be required when individuals make decisions that impose sizable external costs (or benefits) on others that are not incorporated into their decisions. On this approach, however, the harmful (or beneficial) effects on others must be considerable before government actions would be justified because governments are generally so inefficient.
A blog by the excellent development economist William Easterly
(http://blogs.nyu.edu/fas/dri/aidwatch/2009/05/confused_american_liberals_and.html) suggests a different definition of conservative beliefs, as do some of those who posted on our blog. Easterly argues that the true definition of a conservative is someone who respects traditions and existing institutions, and who wants to limit change. Although that is a common definition of the essence of conservatism, I do not believe it is a consistent or sensible one. I do agree that considerable respect for what has survived and thrived in the past is warranted, and my anti-big government conservative would certainly respect institutions that have performed well for a long time. However, conditions do change, sometimes in crucial ways, and a sensible conservative philosophy would recognize the necessity of changing one's views when this happens, even when that goes against venerable traditions.
To take one example, until the latter part of 19th century, married women in England were not allowed to own personal property, including money, in their own name, Even though they had a long history in England and many other countries, such laws were discriminatory and undesirable. Note that some other countries, notably Islamic countries, did not have such laws. Another example: laws against divorce may have made sense in an environment where women did not work and had many children since women would have faced serious financial difficulties if their husbands divorced them (I say "may have" because laws might have protected women's rights to financial support if divorce had been allowed). For these reasons the great philosopher, David Hume, who was a strong supporter of freedom of choice, argued for laws against divorce. However, anti-divorce laws make little sense in the modern world when many married women work to earn a living, and they have few children. Therefore, a true conservative that generally opposes government involvement in private decisions would fully support laws that make divorce quite easy to obtain by both men and women.
Many comments on my discussion centered on the issue of abortion, and that is an especially difficult issue for someone who believes in individual rights. For there is an obvious conflict between the rights of women to control their bodies and their motherhood, and the rights of fetuses that might be far enough along in their development to be considered human beings. This is a very prominent example of the general difficulty of determining where to draw the line when the rights of children conflict with the rights of their parents. I do not claim to have a definitive resolution of this conflict in the case of abortion, or in some other parent-child conflicts. But I come down on the side of women's rights to make decisions about their body, except in very late term abortions where fetuses can survive outside a woman's body, and therefore can be considered real children.
Abortions often allow women to have children at later dates when they are better prepared emotionally and in other ways to have children. In effect, abortions in these cases would allow women to substitute children who would be born later, and would be better taken care of, for the fetuses that are aborted now. That seems to me to be a tradeoff worth making. Moreover, laws banning abortion would be difficult to enforce against wealthy women since they would be able to get abortions illegally under reasonably good conditions, including by going abroad. Poor women who want abortions would suffer the most from enforcement of an anti-abortion law, as they are the ones who mainly suffer from laws against the use of drugs and many other types of laws.
Conservatives are not isolationists on international affairs since they recognize that the interests of a country like the US are affected by what happens in other countries. This is clear in Reagan's successful efforts to wear down the Soviet Union during the Cold War, or in more contemporary efforts to anticipate terrorist attacks planned in other countries. However, just as with the use of government powers on purely domestic issues, conservatives would recognize that governmental foreign actions are usually very inefficient (as in conducting wars), and are often driven by special interests. A conservative philosophy would limit governmental international interventions to cases where the risks from not taking actions are very large, and the interventions reasonably straightforward.
Posted by Gary Becker at 7:59 PM | Comments (22) | TrackBack (0)
Conservatism II--Posner's Comment
My post last week on the decline of the conservative movement in the United States received more than 200 comments. Many of them were very thoughtful, and many others were very shrill.
It is apparent that global warming, abortion, and guns, in approximately that order, arouse particular emotions among many passionate self-described conservatives. About the first of these three issues, I wish to clarify my position briefly. I do not think there is much doubt that carbon emissions generated by human activities increase the amount of carbon dioxide in the atmosphere and by doing so raise surface temperatures. How much they raise them and with what consequences remain uncertain. I merely think that the risk of catastrophic global warming is sufficiently great to warrant more vigorous remedial efforts than have been attempted thus far by the United States.
About abortion, my personal position is the same as Becker's. I will add only that I think the legality of abortion should be determined by legislatures rather than by courts. I think Roe v. Wade was a mistaken decision, though probably one that we shall have to live with.
Similarly, I think private gun ownership should be a matter for legislative determination, rather than judicial. The Second Amendment is unclear about whether there is a right to own guns for personal self-defense or hunting, and I don't think delving into eighteenth-century documents argued to bear on the meaning of the amendment is a sensible way of doing constitutional law in the twenty-first century.
Some commenters seem to believe that because I am critical of the current conservative movement, I must be a liberal--maybe even a left-wing Democrat. To those commenters, disbelief in global warming, in the regulation of gun ownership, and in the criminalization of early as well as late abortions is a litmus test of "true" conservatism. There are, in fact, multiple conservatisms, as Becker and I have emphasized. Like Becker, I believe in limited government and so do not support government activities that cannot be justified convincingly by reference to considerations of economic prosperity, basic individual liberties, or domestic or national security. I do not favor the curtailment of individual liberties on the basis of religious beliefs, nostalgia for the "good old days," or traditional social beliefs (such as distaste for racial minorities or homosexuals) that cannot be related to economic, libertarian, or security values. One of Reagan's great political achievements was to unite the diverse conservatisms in a single political movement that managed to gain the support of a majority of the American people.
That unity has now dissolved, and it will require skillful political entrepreneurship plus overreaching by liberal politicians (or the kind of left-wing extremism that marred the late 1960s and early 1970s) to restore it.
The ideological division within the conservative movement has been compounded by a decline in intellectual and managerial competence--a tendency to substitute will for intelligence ("I believe it so it must be so"). Some commenters note the intellectual and ethical failings of liberals, and they are right to do so. But it is only at the Right, at present, that anti-intellectualism is embraced and extolled.
Posted by Richard Posner at 5:43 PM | Comments (17) | TrackBack (0)
May 10, 2009
Is the Conservative Movement Losing Steam? Posner
I sense intellectual deterioration of the once-vital conservative movement in the United States. As I shall explain, this may be a testament to its success.
Until the late 1960s (when I was in my late twenties), I was barely conscious of the existence of a conservative movement. It was obscure and marginal, symbolized by figures like Barry Goldwater (slaughtered by Lyndon Johnson in the 1964 presidential election), Ayn Rand, Russell Kirk, and William Buckley--figures who had no appeal for me. More powerful conservative thinkers, such as Milton Friedman and Friedrich Hayek, and other distinguished conservative economists, such as George Stigler, were on the scene, but were not well known outside the economics profession.
The domestic disorder of the late 1960s, the excesses of Johnson's "Great Society," significant advances in the economics of antitrust and regulation, the "stagflation" of the 1970s, and the belief (which turned out to be mistaken) that the Soviet Union was winning the Cold War--all these developments stimulated the growth of a varied and vibrant conservative movement, which finally achieved electoral success with the election of Ronald Reagan in 1981. The movement included the free-market economics associated with the "Chicago School" (and therefore deregulation, privatization, monetarism, low taxes, and a rejection of Keynesian macroeconomics), "neoconservatism" in the sense of a strong military and a rejection of liberal internationalism, and cultural conservatism, involving respect for traditional values, resistance to feminism and affirmative action, and a tough line on crime.
The end of the Cold War, the collapse of the Soviet Union, the surge of prosperity worldwide that marked the global triumph of capitalism, the essentially conservative policies, especially in economics, of the Clinton administration, and finally the election and early years of the Bush Administration, marked the apogee of the conservative movement. But there were signs that it had not only already peaked, but was beginning to decline. Leading conservative intellectual figures grew old and died (Friedman, Hayek, Jeanne Kirkpatrick, Buckley, etc.) and others as they aged became silent or less active (such as Robert Bork, Irving Kristol, and Gertrude Himmelfarb), and their successors lacked equivalent public prominence, as conservatism grew strident and populist.
By the end of the Clinton administration, I was content to celebrate the triumph of conservatism as I understood it, and had no desire for other than incremental changes in the economic and social structure of the United States. I saw no need for the estate tax to be abolished, marginal personal-income tax rates further reduced, the government shrunk, pragmatism in constitutional law jettisoned in favor of "originalism," the rights of gun owners enlarged, our military posture strengthened, the rise of homosexual rights resisted, or the role of religion in the public sphere expanded. All these became causes embraced by the new conservatism that crested with the reelection of Bush in 2004.
My theme is the intellectual decline of conservatism, and it is notable that the policies of the new conservatism are powered largely by emotion and religion and have for the most part weak intellectual groundings. That the policies are weak in conception, have largely failed in execution, and are political flops is therefore unsurprising. The major blows to conservatism, culminating in the election and programs of Obama, have been fourfold: the failure of military force to achieve U.S. foreign policy objectives; the inanity of trying to substitute will for intellect, as in the denial of global warming, the use of religious criteria in the selection of public officials, the neglect of management and expertise in government; a continued preoccupation with abortion; and fiscal incontinence in the form of massive budget deficits, the Medicare drug plan, excessive foreign borrowing, and asset-price inflation.
By the fall of 2008, the face of the Republican Party had become Sarah Palin and Joe the Plumber. Conservative intellectuals had no party.
And then came the financial crash last September and the ensuing depression. These unanticipated and shocking events have exposed significant analytical weaknesses in core beliefs of conservative economists concerning the business cycle and the macroeconomy generally. Friedmanite monetarism and the efficient-market theory of finance have taken some sharp hits, and there is renewed respect for the macroeconomic thought of John Maynard Kenyes, a conservatives' bête noire.
There are signs and portents of liberal excess in the policies and plans of the new administration. There will thus be plenty of targets for informed conservative critique. At this writing, however, the conservative movement is at its lowest ebb since 1964. But with this cardinal difference: the movement has so far succeeded in shifting the center of American politics and social thought that it can rest, for at least a little while, on its laurels.
Posted by Richard Posner at 2:32 PM | Comments (215) | TrackBack (10)
The Serious Conflict in the Modern Conservative Movement-Becker
The roots of conservatism go back to philosophers of the 17 and 18th centuries, such as John Locke, David Hume, and Adam Smith. They opposed big government, and favored private decision-making, primarily because they argued that individuals were generally better able to protect their interests than could government officials tied down by bureaucracy and special interests. They claimed further that making decisions for oneself and suffering the consequences were usually good for people, even when these decisions led to bad outcomes, because learning from one's own mistakes helps improve future choices.
Modern conservatism is only partly built on these roots. Its support of competition and private markets, and hostility to sizable regulations, is a direct descendant of the classical liberal views, as espoused for example in Smith's Wealth of Nations. Competition and markets puts faith in the power of individuals and firms to satisfy their own and society's wants better than when governments manage firms and whole industries. To such conservatives, the present US government's management of the American auto industry is an invitation to disaster for that industry. It would be much better to have allowed GM and Chrysler several months ago to be reorganized through bankruptcy proceedings. Classical conservatism would recognize that the intervention of the Fed and Treasury in the finance sector may be necessary, given the crisis in that sector, but classical conservatives would look for this involvement to end as soon as possible.
The other pillars of modern conservatism are aggressive foreign policy to promote democracy in other countries, and government actions to further various social goals, such as fewer abortions or outlawing gay "marriage". These views fit less comfortably in the conservative tradition that is hostile to big government and skeptical about the use of government power to override individual decisions. Classical conservatives would argue that governments are no more effective at interventions internationally or on social issues than they are on economic matters. So governments should usually not get involved in such issues, except when its intervention has enough benefits to compensate for governmental inefficiency and ineffectiveness. This usually is not the case.
A political party, like the Republican Party, may encompass both economic conservatives, and social and international conservatives, even though the philosophies behind each type are inconsistent with each other. The reason is that for parties to compete at the national level, or in other large political arenas, they have to put together coalitions of groups with different interests, such as different types of conservatives, or market interventionists with laissez faire internationalists. However, even large parties are generally stronger and more coherent when different factions share most of the same philosophy. The Democratic Party is now fairly well united in the belief that governments frequently do better than private decision makers in both the economic and social spheres.
Similarly, the Republican Party under the leadership of Eisenhower and Reagan had a more consistent classical conservative philosophy of supporting private markets in the economy, little military involvement in other countries, and even little interference in social arrangements. Neither Eisenhower nor Reagan was particularly religious, and they did not have strong views about gays or abortion rights. The shift in the attitudes of the Republican Party toward more interventionist views on social issues, and to some extent also on military involvement to create more democratic governments in other countries, has created this crisis in conservatism. Better stated, it has created this crisis in the conservatism of the Republican Party.
I believe that the best way to restore the consistency and attractiveness of the conservative movement is for modern conservatism to return to its roots of skepticism toward governmental actions. This involves confidence in the capacity of individuals to make decisions not only in their own interests, but also usually in the interests of society at large. Such a shift in attitudes would require more flexible approaches toward hot button issues like gays in the military, gay marriage, abortions, cell stem research, and toward many other issues of this type. It will not be easy for the Republican Party to emerge from the doldrums if it cannot embrace such a consistently skeptical view of government.
Posted by Gary Becker at 10:11 AM | Comments (47) | TrackBack (2)
May 5, 2009
Announcement-Posner
My book A Failure of Capitalism: The Crisis of '08 and the Descent into Depression was published a couple of weeks ago, but it had been completed on February 2. In order to bring the book up to date, reflecting events since then and also some fresh thinking and reading on my part, I have decided to do some update blogging of the book under the auspices of the Atlantic Monthly, which hosts a number of blogs. The address of my Atlantic blog is http://correspondents.theatlantic.com/richard_posner/. The entries are, as in the Becker-Posner blog, in reverse chronological order. The first two entries have now been posted.
I will not be using any material from the Becker-Posner blog in the Atlantic blog (the name of which is A Failure of Capitalism), or vice versa. My blogging with Professor Becker will therefore be unaffected.
Posted by Richard Posner at 10:09 PM | Comments (24) | TrackBack (0)
May 3, 2009
Some Economics of Flu Pandemics-Becker
Every century or so, a major flu pandemic (an epidemic with a global impact) occurs. The last one, the Great Pandemic of 1918-19, infected many hundreds of millions of people, and killed about 50-100 million men and women worldwide. The Asian flu of 1957 is estimated to have killed 2 million people, and the pandemic of 1968 killed over 1 million persons. Various false alarms have also occurred, such as the swine flu outbreak in 1976 in the US, where over 40 million persons received flu vaccinations, and 30 persons died from the vaccinations, while few died from the flu itself. Is this swine flu scare the "big one" that has come almost 100 years after the Great Pandemic? If so, what would be its economic cost?
So far, less than 1,000 persons worldwide are confirmed to have swine flu -they are mainly persons under age 16- and the death rate is a few percent of those contracting the disease. However, it is still too early to be confident that the effects of this swine flu will be mild or moderate since flu pandemics, including the Great Pandemic, often go through phases, where the first phase is rather moderate, and the next phases are much more devastating. Whatever the course of this flu outbreak, health officials are confident that before long a major pandemic will strike that could wreak devastation throughout the world.
Note that flu pandemics involve a huge " externality" because infected individuals have limited incentives to consider the likelihood of infecting others when deciding how much contact to have with other individuals. This externality justifies a significant public health involvement in trying to control the spread of flu during a pandemic.
Consider the cost of a modern flu pandemic with the impact of the Great Pandemic. Fifty million deaths in 1918-19 constituted about 2.8% of the world population at that time. Since world population has grown twofold since then, a flu pandemic at this time that killed 2.8% of all people would take about 150 million lives. This is a staggering number. It can be converted into an equally staggering monetary value by using findings on what people are willing to pay to avoid fatal health and other risks- what economists call the statistical value of life. It is estimated that this statistical value of life for a typical young adult in the United States is about $5 million. This means that a young person would be willing to pay about $500 for a decrease of 1/10,000 in the probability of dying at each age, and $1000 for a decrease in the probability of dying of 1/1,000.
To get a monetary value of the aggregate cost of another such great pandemic, we assume that the comparable statistical values of life in other countries equal $5 million times the ratio of the per capita incomes to the US per capita income. For example, the statistical value of life for a typical young person in a country with half the per capita income of the US would be $2.5 million. Then if we assume that the same percent of the population would die from such a pandemic in all countries, the total cost of a pandemic equal in severity to the Great Pandemic would be over $100 trillion. This is such a huge amount that it is hard to visualize. It dwarfs in magnitude the effects of such a pandemic on world GDP, the economic effects that are usually calculated.
A study published in the science magazine Lancet in December 2006 by Murray, et al estimates that a modern pandemic of equal virulence to the Spanish flu that caused the Great Pandemic would kill not 150 million persons, but about 60 million people. They also claim that these deaths would be very much concentrated in poorer countries. Using Murray, et al's calculations to adjust my estimate of what people of the world would be willing to pay to avoid such a pandemic would reduce the estimate from $110 trillion to about $20 trillion.
The number of deaths from such a virulent flu might well be proportionately less than that caused by the Spanish flu because of important developments in the world health care system. On the one hand, the explosion in world population since 1919, the growth of cities at the expense of the countryside, and the development of air travel that led to much greater movement of persons across national boundaries imply that the spread of flu among people has become a lot easier. Offsetting these changes are others that make it a lot easier to contain the spread and severity of flu pandemic. Public health officials can more quickly isolate and identify the genetic composition of different flu strains than they could during the Great Pandemic. Officials of different countries are also in much greater contact with each other, and can collaborate to partly quarantine the epicenters of future pandemics.
Perhaps the most important development in recent decades that would save lives during a future pandemic are vaccines and antiviral drugs, such as Tamiflu. Vaccines might be produced quickly enough to inoculate huge numbers against new flu strains, even highly virulent strains. When taken early enough, the antivirals can greatly moderate the course of an illness and speedup recovery. The US and the European Union apparently have large enough stocks of antivirals to treat about 16% of their populations-the US supply covers about 50 million persons- while Japan has even large drug supplies relative to its population. The poorer countries of Africa and elsewhere are the least prepared to fight a major pandemic.
Of course, new flu strains may emerge that cannot be treated by the known antivirals. And bioterrorists may be able to produce and spread highly deadly viruses of all kinds. At the same time, however, drug companies are better prepared than even a few years ago to ramp up production of old drugs, and to develop additional drugs to fight new flu strains and other viruses that are not treatable by present drugs.
I have indicated that the vast majority of people are willing to pay a lot to gain protection against deadly flu viruses. This is why it would be desirable to greatly increase the stockpile of drugs and vaccines even if the probability of another pandemic were low, and its nature not known. For example, the expected worldwide cost in terms of willingness to pay to avoid the risk of another great pandemic that had a one in hundred probability of occurring during the next twenty years would be approximately 1/100 x $20 trillion, or about $200 billion. This cost would justify sizable increases in world spending on antiviral drug and flu vaccines.
Posted by Gary Becker at 4:50 PM | Comments (20) | TrackBack (0)
The Economics of the Flu Epidemic--Posner
As Becker points out, the potential costs of a lethal pandemic are astronomical. The Spanish flu epidemic of 1918-1919 killed tens of millions of people, and because of the extreme mutability of the flu virus it is entirely possible that an equally lethal strain may re-emerge. True, the death rate would probably be significantly lower today because of improvements in medical care, but it might not be. The new virus might be even more lethal, or more people might be infected; in either event as many or even more people might die.
The mutability of the virus can make existing flu vaccines completely ineffectual. Because the virus is airborne and has an infectious incubation period of several days (that is, a period in which a carrier of the virus is asymptomatic but infectious), a large number of people can be infected before the disease is even discovered and measures for preventing its further spread implemented. International air travel can spread the disease throughout the world in almost no time.
The interesting economic issue, besides the costs inflicted by the disease, stressed by Becker, is the optimal response to the danger of a lethal flu pandemic. Ideally one would like to be able to calculate the expected cost of the pandemic and compare that with the cost and efficacy of the possible preventive and remedial efforts. The expected cost would be the cost inflicted by the pandemic discounted (multiplied) by the probability that, in the absence of preventive measures, that cost would be incurred. Unfortunately, that probability cannot be estimated. But since we experienced such a pandemic less than a year ago, the probability cannot be considered trivial. Since the potential cost if such a pandemic does occur is so enormous, efforts at prevention or mitigation deserve serious consideration.
If, following the Lancet estimate discussed by Becker, we guess that a repetition of the 1918-1919 pandemic would inflict a total cost worldwide of $20 trillion (this estimate excludes the narrowly economic costs, but they would probably be lower, in part because thinning out populations can raise per capita incomes, especially if the very young and the very old, and poor people in overpopulated countries, are the principal victims), and if we indulge a further guess that there is a 1 percent annual probability of such an event, the annual expected cost would be $600 billion. Of course this would not imply that the world should spend $600 billion a year on trying to prevent, or reduce the costs of, a lethal flu epidemic. Costs and benefits have to be compared at the margin. The marginal benefit of additional expenditures on preventing or alleviating the costs of a flu academic is probably zero after a few billion dollars of expenditure. Indeed, it could be negative, because large expansions in the number of research personnel working on vaccines against lethal airborne diseases increase the number of people who have the skills required for bioterrorism--a concern to which I return later in this comment.
On the prevention side, the most important measures are (1) global early warning systems and (2) the development of very broad-spectrum flu vaccines, that is, vaccines that provide protection against possible mutant forms of the virus. Neither of these preventive approaches are terribly expensive. Of course, one could spend unlimited amounts of money on vaccine research, but this would be inconsistent with the marginal principle: the returns to additional resources on developing a vaccine that would protect people against all possible mutations of the flu virus probably diminish rapidly. Crash programs have limited efficacy in solving deep scientific puzzles.
On the response or remediation side, expansion of hospital facilities and arrangements for large-scale quarantining should be considered, although here the costs are likely to become prohibitive quite rapidly. For example, there are fewer than one million hospital beds in the United States; imagine how much it would cost to expand this number tenfold in order to be prepared for a major epidemic--yet even a tenfold increase would accommodate only about 3 percent of the U.S. population.
Analysis is complicated and the prospects darkened by the threat of bioterrorism. The flu virus, like the smallbox virus, lends itself to weaponization; both viruses are airborne and have significant infectious incubation periods. Smallpox is more lethal than any known flu virus, including the 1918¬¬-1919 virus, the death rate (as distinct from number of deaths) fron which was very low. But increasing the lethality of a virus, and also modifying it to make existing vaccines ineffectual against it, are well within the current state of scientific knowledge, and require only modest technical skills and inexpensive manufacturing facilities.
Optimal responses to pandemics, whether natural pandemics or ones contrived by terrorists, are complicated not only by diminishing returns, but also by the multiplicity of catastrophic threats. Even if multiplying the number of hospital beds tenfold could be a justified measure in preparation for a possible lethal flu epidemic, it would be immensely costly and this would as a practical matter preclude financing measures directed against other catastrophic possiblities, which include abrupt global warming, asteroid strikes, biodiversity depletion, nuclear terrorism, and (as we have become acutely aware) global depressions. We need an overall "catastrophe budget" that would match expenditures to the net expected benefits of particular measures targeted at particular catastrophic threats.
Posted by Richard Posner at 3:01 PM | Comments (6) | TrackBack (1)
April 26, 2009
Is the Federal Reserve Losing Its Independence? Posner
Even in a democracy, it is believed that certain government functions should be placed beyond the control of democratic politics. The usual example is the judiciary (though most state judges in the United States are elected, this is a considerable anomaly). But another example is the central bank, which in the case of the United States is the Federal Reserve. A central bank has considerable, often decisive, influence over short-term interest rates, and, through them, over long-run interest rates as well. Typically (and to oversimplify), a central bank reduces short-term interest rates by buying short-term government securities, which pumps cash into the economy when the cash is deposited in bank accounts and then withdrawn and spent. Interest is the price that people or firms demand to part with cash--the more cash there is in the economy, the lower that price will be. In addition, by increasing the demand for these securities, the purchase increases their price, which in turn reduces their yield--the interest that they command. The central bank increases short-term interest rates by the reverse operation--selling short-term government securities, which sucks cash out of the economy, since the central bank can retire the cash rather than having to spend it.
Long-term rates tend to follow the path of short, both because of substitutability and because the more cash the banks have to lend, and so the less they have to pay for the capital that they lend, the lower the interest rates at which they will lend, including lending long term, because competition will tend to keep the spread between the banks' borrowing and lending costs from increasing just because their borrowing costs are falling.
The reason for making the central bank politically independent is that the bank's power over interest rates could be abused for political ends. Suppose the economy, though not in recession, is somewhat sluggish, and the government, perhaps because an election is looming, wants to juice it up. So it orders the central bank to reduce interest rates by buying government securities, thus pumping money into the economy. Reduced interest rates will stimulate lending, borrowing, and therefore economic activity, but the increase in the money supply can (since the economy is merely sluggish, and not in recession) create inflation. Very low interest rates in the early 2000s in the United States caused asset-price inflation, with destructive consequences, as we know.
Inflation can have other political objectives besides stimulating the economy in order to improve a government's popularity. It is a method of taxation. Suppliers are required by law to accept the official currency in payment of debts, so government can buy goods and services just by issuing money to its employees and other suppliers without having to raise the money by borrowing or by (explicit) taxation. The suppliers will respond by raising prices, but if the government refuses to pay (for example, refuses to raise wages), then the suppliers, to the extent dependent on the government for business (or employment), will have to accept the cheapened money.
In addition, inflation can be used to benefit some groups in society at the expense of others. Inflation benefits debtors, when debt is not indexed for inflation, and hurts creditors. A strongly pro-creditor central bank might even engender deflation, which would mean that debtors would be repaying their debts in dollars worth more in purchasing power than when they took out their loans. A central bank might do that (reduce the money supply, so that the purchasing power of a given quantity of money increases) in order to strengthen its currency, which would enable the country to buy imports more cheaply and increase the return on its foreign investments. (That was the ground on which Britain deflated by returning to the gold standard after having gone off it in World War I. That was a government decision; there was no independent central bank.)
Since the harms of inflation are now widely recognized, a central bank that focuses on limiting inflation will be reasonably popular; and since the value of its being independent of political influences so that it will limit inflation (and deflation) will be recognized, its independence will not be challenged. But the independence of the central bank in the United States, as in other countries, is not guaranteed by the Constitution, as the independence of the federal judiciary is. It is a matter of statute, and Congress could eliminate or reduce the Federal Reserve's independence from the normal political process at any time. Its independence is therefore legally precarious.
That is part of the reason why the modern Federal Reserve has focused on controlling inflation, and, specifically, why it did not prick the housing bubble of the early 2000s, as it could have done at any time by pushing up interest rates, until the bubble got completely out of hand in 2006 and 2007. Had it pricked the bubble earlier, precipitating a fall in housing prices with consequent defaults and foreclosures, at a time when it was unclear that the run up in housing prices was a bubble, it would have been blamed for causing a recession, because proof of a bubble is difficult.
But in retrospect the hit that the Federal Reserve would have taken by pricking the bubble would have done less damage to its prospects for continued independence than the current depression, and the Fed's response, may be doing. Had the Fed merely pushed down interest rates when it became apparent last summer that the economy was sliding into a recession or worse, it would have been doing something that it was expected to do: the converse of raising interest rates to prevent inflation is lowering interest rates to prevent recession, and this is consistent with stabilization, which is part of the Fed's explicit statutory mandate. The Fed did lower the federal funds (overnight bank lending) interest rate, which has become the conventional way in which it influences interest rates. That rate is now virtually zero, yet the reduction has not done the trick. The reason is that the impairment of the banks' capital (because of their heavy involvement in home mortgage lending) has discouraged the banks from lending, since lending is risky. And so the fact that they can borrow from one another at essentially a zero rate of interest to meet loan demands has not incited them to lend in amounts necessary to maintain economic activity at a normal level.
The Fed in some desperation therefore began last fall lending substantial sums to banks in an effort to increase their safe capital to a point at which they would increase their lending by relaxing their credit standards and reducing interest rates on their loans. The Fed also began buying up private debt (as distinct from government securities), for example credit card debt, in the hope that the sellers of the debt would use the cash they received for their debt from the Fed to issue more debt, that is, to lend more. It even has begun buying long-term private and public (Treasury) debt.
The dangers to the Federal Reserve's independence that are created by such activities are twofold. First, the scale of the Fed's intervention is so great as to create a serious risk of a future inflation, albeit a risk that, at present, the bond markets (judging from long-term interest rates) do not consider large. The Fed in the last year has expanded the supply of money by about a trillion dollars, and is intending to expand it further. In principle, it can reverse the expansion process by selling Treasury securities (and the other debt that it has bought) and retiring the cash it receives from the sale. The problem is that a sudden large withdrawal of cash from the economy could cause interest rates to spike, bringing on a recession, as when the Fed reduced the money supply in 1979-1982 to break the 1970s inflation, which was getting out of hand (it reached 15 percent in 1979). A gradual withdrawal might be too slow to prevent inflation.
It is true that when the Fed buys short-term debt, such as credit-card debt, the transaction unwinds naturally in a short time: the debt is paid by the debtors, and the cash received from them can be retired. But this assumes that the debt is paid in full, which it may not be, and that the Fed does not immediately buy more short-term debt, and perhaps feel obliged to continue doing so, because the market has become dependent on its participation. And the Fed as I said is buying long-term as well as short-term debt, and that does not unwind automatically in the short term; it can be sold but it might be sold at a loss, depleting the Fed's balance sheet and leaving excess cash in the economy to create inflation.
If the Fed's actions precipitate inflation or have other untoward consequences, there is likely to be a political backlash against the Fed. We live at present in a blame culture, and really the Fed is lucky that so far most of the public's and the Congress's and the media's ire has been directed at the bankers rather than at Greenspan or Bernanke.
Second, and perhaps more ominous, the types of intervention that the Fed is now engaged in can create an impression of politicization of financial policy or even of impropriety. If the Fed merely issues an offer to buy some specified quantity of Treasury bills, or an offer to sell some specified quantity of those bills, it is not picking and choosing among companies or industries. But if it decides, or participates in deciding, whether Bank X should be allowed to fail while Bank Y receives a huge bailout, or when it uses its position as a bank's creditor to alter its management or influence its business decisions, it invites accusations of favoritism or worse. (Or when it decides to buy one type of private debt rather than another.) The latest portent is the allegation that Bernanke, the Fed's chairman, participated with Henry Paulson, the then Secretary of the Treasury, in pressuring Bank of America last December not only to go through with its planned purchase of Merrill Lynch but also to conceal Merrill Lynch's immense losses from Bank of America's shareholders. I have no idea whether the allegation is true; but that it should be made at all is an example of the political danger to the Federal Reserve if it becomes involved in the operation of individual banks.
I am not suggesting that the Federal Reserve is wrong to take radical measures to combat a depression. The Fed's "easy money" monetary policy may have warded off a deflationary spiral, which would have been disastrous (there is still a mild deflation--the Consumer Price Index for example is below what it was a year ago--and it could still get worse). And the Fed's bank bailouts may well have limited the decline in lending touched off by the near collapse of the banking industry last September. I merely contend that such measures pose greater threats to the Fed's political independence than would early intervention to prick the housing bubble and by doing so perhaps have prevented the grave economic situation in which the nation finds itself.
Posted by Richard Posner at 8:53 PM | Comments (58) | TrackBack (0)
Central Banks Cannot Easily Maintain their Independence- Becker
Most richer nations nowadays, and many developing nations, have "independent" central banks, such as the European Central Bank and the Federal Reserve Bank. "Independence" cannot be precisely defined, but it is supposed to indicate that the central bank of a country has the freedom to make decisions which the government, represented by the Treasury in the United States, does not like. The purpose of independence is to allow monetary policy to be decided independently of fiscal policy, although obviously even independent banks and governments may respond in consistent ways to broad economic events, such as the present recession.
The motivation for having an independent central bank is the many occasions in the past when subservient central banks accommodated the government's desire to spend more without raising additional taxes. Central banks accommodate fiscal authorities essentially by buying government securities that help finance government spending. In return for receiving government debt, a central bank would either directly print additional currency that governments can spend, or it would create reserves in commercial banks that lead to an expansion of bank deposits and monetary aggregates, such as M1. Either way, inflation would result from this monetization of the government debt, often severe inflation and even hyperinflation. Hostility to rapid inflation led to the political support behind giving central banks much greater independence from fiscal authorities.
The history of the Federal Reserve's transition in and out of independence is illuminating (see Allan Meltzer's book, A History of the Federal Reserve, 2003). The Fed fully and enthusiastically compromised its independence from the Treasury during World War II. It bought large quantities of government debt to help the government finance the large wartime deficit. Inflation from the resulting big expansion of the money supply was suppressed through wage and price controls. This inflation became open after removal of these controls at the end of the war.
For a half dozen years after that war was over, President Truman and the Treasury pressured then much more reluctant Fed officials into maintaining the Fed's subservience. Eventually, however, the Fed regained its independence in the famous Accord reached in March 1951. Nevertheless, the Vietnam War, the Great Society Program, and the reinstitution of wage and price controls by Richard Nixon in the early 1970s led to later erosions of the Fed's independence.
Even during normal times, central banks, whatever their nominal independence, are under strong pressure to accommodate expansionist fiscal policy, especially as elections approach. During extraordinary times, whether in peacetime or during wars, this pressure usually becomes too powerful to resist. So the rather complete bending of the Fed to the Treasury's wishes during the present worldwide recession is not surprising. Still, that does not make it right, and I have some doubts about the Federal Reserve's recent behavior.
One concern is the somewhat arbitrary choices the Fed made about which banks to bailout and which ones to close or merge into other banks. This added significantly to the enormous uncertainty already prevalent in financial markets. I am also worried about the Fed's support of the huge federal deficits generated by the sharp expansion in federal spending. I understand such actions are necessary to help governments fight wars, but why help finance so much spending during this recession, particularly spending that has dubious stimulating potential? One example is the almost $800 billion so-called stimulus package that will do little to stimulate the economy, but will greatly raise long term government spending in directions desired by the President and Congress (see the posts on January 11 of this year). Another example of dubious government spending that the Fed seems willing to help finance is the ill thought out Treasury plan for hedge funds and other financial institutions to buy toxic bank assets (see the criticism of this plan in my posts on March 29 and 31).
The huge increase in bank reserves is a major consequence of the Fed's monetization of the government's large spending programs. Reserves went from about $8 billion in early Fall to around $800 billion, or a hundred fold increase in only 6 months. The recession rather than the wage and price controls imposed during prior periods is keeping inflation suppressed at present. Once the economy begins to recover, the inflationary risks will be enormous. In order to soak up these reserves, the Fed would have to sell large quantities of its government securities back to the private sector. These sales would put downward pressure on security prices- that is, upward pressure on interest rates- that will slow the economy's expansion at that time. For this reason, any government in power then, whether Democratic or Republican, will vigorously resist such Fed actions.
Hence it is not obvious that the Fed will be able to conduct these sales sufficiently smoothly to prevent either a recession or a serious bout of inflation. These are not pressing concerns when a serious recession is the immediate problem, but they will become major challenges down the road.
Posted by Gary Becker at 3:55 PM | Comments (5) | TrackBack (0)
April 19, 2009
Repayment of Tarp Bank Loans-Becker
Six months ago essentially all large American banks and many smaller ones received loans from the federal government to help shore up their capital base as they tried to weather the financial storm. Some banks would likely have failed during the severe strains in the capital market last September and October were it not for these loans. This past week, however, the two strongest large banks, Goldman Sachs and JPMorgan Chase, indicated that they wanted to, and were able to, repay their loans. Should they be allowed to do so?
It appears that not all banks wanted to take government loans in October, but some large banks were apparently "forced" to as part of the TARP loan program devised by then Secretary of the Treasury Henry Paulson. According to some accounts, the government exercised this pressure in order to avoid disclosing which banks were the weakest and needed these loans to survive.
This explanation of the government's behavior is strange since generally participants in financial markets do not have an excess of information about the financial viability of different banks, but rather they do not have enough information. It is wrongheaded for the government to try to mislead markets about which banks are weak. Indeed, the purpose of disclosure requirements mandated for banks and other companies is to raise the degree of public information available about different companies in order to assist participants to make wiser decisions. In any case, most firms and individuals active in financial markets already had a fair idea of which banks were stronger and which ones were weaker.
Many of the banks worse fears about the strings attached to these loans have been realized. The resulting government intervention in bank managerial decisions include the well-publicized restrictions on bonuses and other pay to executives, restrictions on banks' ability to hire foreigners, and frequent demands to appear before Congressional committees to justify what they are doing. Less onerous interventions include Congressional and the media's opposition to banks holding expensive golf and other outings, bank use of private planes, and meetings at luxurious resorts. Goldman, JPMorgan, and other banks want to repay their government loans primarily to eliminate these and potentially other government restrictions on managerial decisions. I see no compelling reason why they should be prevented from repaying their loans.
One argument made against allowing them to repay is the same one used to justify requiring the relatively strong banks to take the loans in the first place; namely, that the weaker banks would be exposed if the stronger banks repaid at this time. However, they are already exposed since the major participants in financial markets already know that banks such as Goldman and JPMorgan are much stronger than say Citi and Bank of America.
A more sophisticated version of this argument is that if the strong banks were allowed to repay now, the weak banks would also try to repay, and thereby become still weaken, since they do not want to appear weaker than their competitors. However, weak banks are unlikely to try to repay if that would so further weaken them that they would soon require even larger government bailouts before long. Moreover, repayment by strong banks would be a good motivator if it gave weaker banks stronger incentive to get into a financial position whereby they too could repay without damaging their viability.
Another argument advanced against allowing any repayment at this time is that this would weaken the capital position of repaying banks (even those that claim to have enough capital to repay). Yet especially the stronger banks would not want to repay the Tarp loans if that means that before long they have to ask the government for additional loans. Goldman has raised an additional $5 billion in equity to help finance their repayment, and the company has reduced its assets to 14 times its capital compared to 26 times at the end of 2007. JPMorgan claims to be able to repay their loan without having to raise any more capital.
In any case, the Treasury is soon releasing results of the stress tests they have given to all major banks. We will then have better information to determine if the banks that want to repay now can comfortably pass these tests. I am confident that these banks will rank quite high, which would help explain why they are eager to repay.
If Goldman and JPMorgan were simply allowed to repay their TARP loans, they would still have the sizable benefits of the Temporary Lending Government authority (TLGP) that provides FDIC guarantees on bonds issued by covered banks. These guarantees stem from Goldman 's conversion into a bank holding company last fall-JPMorgan was already such a company. Goldman has borrowed about $28 billion under TLGP. This would be the right time to start reducing these guarantees for Goldman and JPMorgan as a condition for these banks being allowed to reduce government controls over their decisions.
Posted by Gary Becker at 6:19 PM | Comments (43) | TrackBack (0)
