Of Course Monetary Policy is an Asset Swap -- But that Doesn't Make it Any Less Useful

Nobel Laureate Eugene Fama made waves in the past few days when he called QE a "neutral event". Fama argued that because QE was just the exchange of one kind of interest bearing asset (money that collects IOER) for another (long term treasuries and agency MBS), the policy could have no effect. In my view, his comments were mistaken because they focused on microeconomic intuition and thus ignored the macroeconomic effects of monetary policy.

Fama's main argument was that monetary policy changed character at the zero lower bound. Starting in 2008, the Federal Reserve started paying interest on excess reserves. Once the Fed started to pay IOER, excess reserves held by banks became interest bearing assets. As a result, now when the Fed conducts QE, all it is really doing is taking the private sector's long term bonds and assets and exchanging them for short term (interest bearing) cash. So no new currency makes it into the economy, and as such QE can have no effect.

The set up is correct, but not the conclusion. By ignoring the role of expectations at the zero lower bound, Fama glosses over the real reason why QE matters. Scott Sumner explained this a few weeks ago:

So QE works for very simple reasons. Permanent monetary injections are effective even at the zero bound. QE programs are a signal that central banks would prefer at least slightly faster nominal GDP growth. Slightly faster nominal GDP growth requires that at least a small portion of the currency injection be permanent. So by signaling a preference for slightly faster nominal GDP growth, central banks are implicitly signaling a preference to have at least a small portion of the QE program be permanent (for any given IOR rate). Markets believe the central banks (and why shouldn’t they?) And hence asset prices react to the QE program.

In short, QE is effective because it changes expectations about the future monetary base. Since QE signals an increase in the monetary base in this period and all future periods, it raises expectations about future nominal income and therefore boosts the economy now. Since the short term rate will not be below the interest paid on reserves forever, then the injection of currency has a positive effect on the future price level. This is not a story of wealth effects from appreciating financial assets or a reach for yield due to lower average bond duration. It's not a story of people borrowing as the result of lower interest rates. It's just a simple tale of price expectations and forward looking monetary policy.

Another peculiar argument Fama made was that the Fed's current policy should actually be raising short term interest rates. Because the Fed is introducing more short term debt (in the form of cash) on the market, then short term rates should rise. Analogously, because the Fed is buying up so much long term debt, then the long term rates should fall.

But this misses the underlying macro context. Because the purchase of assets represents a signal about a desired monetary outcome, the result of this "asset swap" is not as neutral as Fama would believe. Moreover, because the Fed has made a commitment to keeping the Fed Funds rate low for an extended period of time, the short rate will not rise. Instead, by expanding the money supply, the Fed keeps short rate low.

Now, if I were a single market participant, the situation would be different. If I individually decided to sell short term debt to buy long term debt, then with sufficiently large quantities I could raise the short term rate and lower the long term rate. But since the Fed controls the printing presses and has the power to pin down the short term rate, this logic does not apply. Instead, if rates did rise, the Fed could just purchase more T-Bills. Even though QE introduces more short term assets into the system, it does not raise the short end of the yield curve.

Furthermore, Fed's purchases of long term treasuries are supposed to raise long rates, not lower them. Since the the long term rate goes up with higher NGDP expectations, then Fed purchases of long term bonds should raise long term rates. And as Michael Darda has repeatedly shown, rates rose during every period of QE. This is just another example of how microeconomic intuition can fail catastrophically in the world of macro. Because Fed purchases have macro level effects on inflation and economic growth, the Fed can actually buy more of an asset and have the price of it go down.

Source: FRED, MKM Partners

If all this seems counter-intuitive, do not blame yourself. Instead, the blame should go to our obsession with interest rates in models of monetary policy. Because monetary policy has historically been implemented through changes in the Fed Funds rate, people have equated monetary policy with interest rate policy. But in truth, interest rates should be seen as reflections of the money supply. So when we say that the Fed is cutting short term rates, what we really mean is that the Fed is expanding the money supply, and as a result, short term rates are falling.

Thinking in these terms will make sure you don't forget about the macroeconomic side of monetary policy. If Fama had said, "IOER means the Fed's printing of money to buy long term bonds has no effect on long term rates and actually raises short term rates", it would have been immediately clear something was off. Why would printing money have an effect on short term rates given that new mass of money can be used to buy T-Bills? Money immediately evokes macro intuition, whereas interest rates focus on micro intuition. As such, focusing on money allows you to guard against simple mistakes.

Thinking in terms of money also makes sure you don't mix causality. Ronald McKinnon argued in a recent WSJ opinion piece that the Fed should raise interest rates will stimulate banks to start lending. If you translate his statement about interest rates into money, it would read "contract the money supply so banks start lending". The first statement appeals to microeconomics, and seems sensible. But even a little thought about the second statement in terms of money immediately reveals the mistake. To stimulate lending, rates will need to fall as the money supply expands. But over time, when interest rates rise, it will be because of the monetary expansion boosting inflation.

Monetary theory is peculiar because it contradicts a lot of basic microeconomic and intuitions. As such, you often see very smart people (Nobel prize winners included) make smart-sounding arguments that are ultimately false. So for as much as I respect the work Professor Fama has done in the field of empirical finance, I disagree with his description of QE. It's not some neutral event, and to think so distracts from the urgent task of monetary reform.
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DeLong offers his comments here.

Edit: 10/31 -- Added QE and long term rates graph from Michael Darda

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Did nominal interest rates fail to spike during the run on the Franc?

Paul Krugman has a new paper investigating the role of currency regimes on the nature of sudden stops, where he argues that a sudden stop would not be contractionary for a country that has a floating exchange rate. The big chunk of the paper is theoretical, but towards the end of the paper, Krugman digs out an interesting case study – France in the 1920s – that helps put his argument into historical perspective.

“The closest one can come to historical situations at all resembling the situation of today’s floating-rate debtors is that of France in the 1920s, which emerged from World War I with a large debt burden that it had great political difficulty dealing with, and did in fact experience a run on the franc.”

“The basic insight is that France grew quite strongly as the franc slid due to loss of confidence […] What actually happened was a sharp fall in the franc, substantial inflation, but no interest rate spike and a quite good performance in terms of real output. Nothing in that story validates the conventional wisdom [about the vulnerability of the United States and other nations to a loss of capital inflows].”

I happened to be particularly interested in that part of the paper, as I’ve recently been trying to understand why nominal interest rates did not spike following the election of the Popular Front in 1936 and the country’s departure from the Gold Standard a few months after. Krugman seemed to point to a similar situation: despite the Franc losing two thirds of its value between 1922 and 1926, he notes that there was “no spike in interest rates”.

Source: Paul Krugman

In fact, Krugman’s diagram shows that “rates actually fell during the first leg of franc depreciation”, which is even more puzzling. After a bit of research, I figured out that Krugman is using the average yield for a portfolio of 180 securities of varying returns from the NBER macro history database (series 13027). One would have to turn to the original sources to understand exactly how that series was constructed, but it strikes me as a choice that would warrant a bit of discussion.

As I show below, the more standard measure of nominal interest rates for that period – the rates of returns calculated on the French consols or rentes – gives a different picture. According to this series, nominal interest rates did increase over this time period. The spike, although seemingly not huge, is an understatement of the increase in nominal interest rates as these returns “are averages of the rates during these troubled times and of the rates that were expected to prevail afterwards, once stability was reached again” (Hautcoeur and Sicsic (1999)).  Assuming a long-term interest rate of 3.75 per cent, Hautcoeur and Sicsic (1999) show that the 2 percentage point spike in the nominal interest rates of the consols that I document in the diagram below correspond to an increase in medium-term nominal interest rates of about 8 percentage points.

Note: Note: The first vertical line indicates the start of the depreciation according to NBER series 14004b. The second vertical line indicates the Poincare stabilization

So nominal interest rates did spike, although clearly not enough to make real interest rates increase. Overall, the Krugman story holds, since he only needs a decrease in real interest rates for the sudden stop to be expansionary. But unless I missed something, that small part of his paper on nominal interest rates needs to be revised.

Jeremie Cohen-Setton (@JCSBruegel) is a PhD candidate in economics at UC Berkeley and an Affiliate Fellow at Bruegel. He specializes in Macroeconomic Policies and Macroeconomic History and worked previously as an economist at HM Treasury and at Goldman Sachs. Jeremie blogs at ecbwatchers.org and is the main author of the blogs review at bruegel.org.

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Eugene Fama explained. Kind of. Part 3: Performance measurement

If we don’t think too much about EMH, but instead view the CAPM and the Fama–French models as models of expected returns, it’s clear that we can use alphas (linear regression intercepts) from these models as a way of managing the performance of investment managers. The return on an investment fund or strategy is just another return and we should be able to use the same models of expected returns to analyze them, so if a mutual fund has positive alpha, we can say that the manager is good and we should invest in him or her, especially if returns are measured after deducting expenses. If alpha is negative, we are dealing with a bad manager and should move funds away. If alpha is zero and/or negative, we might as well invest with a passively managed index fund.

It’s not quite that simple: model alphas are theoretical entities based on population regressions, but in the real world we have to estimate alpha from messy real world data. A common way to estimate alpha is to regress a year of daily excess returns on daily observations of the factors (daily market returns and daily high-minus-low and small-minus-big returns).

Suppose we find a mutual fund that has statistically significant positive alpha based on that year of returns, or even based on the past 10 years of data. What’s to say that the same mutual fund will continue to have positive alpha next year, or the next 10 years? That would only be true if mutual fund alphas are persistent. If they are not persistent, or not persistent enough, it’s all well and good that the fund had positive alpha over the past year, but we can’t use that for anything when deciding when to invest in now.

Hendricks, Patel and Zeckhauser (1993) found some evidence that mutual fund performance is persistent over a one-year time horizon. I’ve mentioned the Carhart momentum factor before; the actual paper where Carhart introduces this result is about the persistence of mutual fund returns. He find that the persistence can be explained by a momentum factor, inspired by previous research on momentum in stock returns.

What exactly do we mean by “can be explained by”? Without the momentum factor, alphas were significant and positive. Adding a momentum factor, that’s no longer true. If we adopt Mark Carhart’s model for evaluating performance managers, we are adopting the value judgment that they should not be rewarded for taking advantage of the known cross sectional factor of momentum.

In the same way, if we dump CAPM and use the Fama–French 3-factor model, we are saying that managers should not be rewarded simply for investing in value stocks or small stocks. Why? The literature offers several different rationales, the simplest being that these are well known risk premia that any idiot could obtain, so we shouldn’t pay investment managers any extra for them. You don’t necessarily have to agree on a reason for value and size premia to share this view.

If we decided to add more factors to the benchmark models, we would be further raising the bar for our investment managers and excluding yet more things that they shouldn’t be rewarded for. Do non-US stocks have a higher expected returns than US stocks? Add an international stock index. Do bonds? Add a bond index. Does real estate have higher returns? Add a real estate index. It becomes more and more difficult to show positive and persistent alpha as we keep on adding more factors; we could add in all the significant principal components of returns for good measure.

Where does Fama himself come down on all this? In a 2010 Journal of Finance paper, a lot of which is about the statistical difficulties of answering the question, Fama and French conclude that very few actively managed funds have abnormal returns that are high enough to outweigh their high fees.

Robert Shiller had an op-ed in the New York Times with this interesting observation:

It’s interesting that Professor Fama is also the intellectual father and major adviser of an investment company that has, by many accounts, been beating the market. The company, Dimensional Fund Advisors, has impressed investors with its performance so much that its assets under management have grown to $296 billion, as of Aug. 31. 

So, how does D.F.A. reconcile the successes with Professor Fama’s efficient-markets theory? 

The D.F.A. Web site refers to the “dimensions” of investing, reflecting the name of the company. First on the list of dimensions are “size” (the stock returns of small companies tend to do better) and “value” (low-priced companies tend to have better returns as well). Indeed, Professor Fama’s work with Kenneth French of the Tuck School of Business at Dartmouth has shown that historically, these dimensions could be used to deliver higher return for investors.

I haven’t actually calculated the alpha of DFA fund returns against the 3-factor and 4-factor models because I am lazy. However, if we take them at their word—that they are simply mimicking the factors rather tha trying to deliver alpha—then by Fama and French’s own standards, we should not expect them to outperform other mutual funds.

(It’s worth looking more closely at that first link. The returns of various DFA funds are compared to benchmarks that capture their investment strategy. For example, DFA US Micro Cap Portfolio (DFSCX), is compared to the 9th and 10th deciles of the CRSP cap-based portfolio indexes, a well constructed family of indexes that is often used by academics.)

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The Republican Brain Dissected

Chris Mooney's The Republican Brain: The Science of WhyThey Deny Science - and Reality argues that conservatives are inherently more biased than liberals due to psychological differences that are likely partly genetic. To some this may seem almost too obvious to be worth stating. For others, particularly for conservatives, the thesis is liable to provoke a strong reaction. Indeed, Mooney described the book as setting a trap for conservatives. Any criticism of the book’s scientific conclusions can be taken as more evidence for the book’s thesis that conservatives are biased and reject science.

The irony here is that Mooney's thesis - conservatives are inherently more biased – itself runs contrary to the views of many social psychologists working in this area. The current de facto position of social psychologists is summed up by University of California-Irvine psychologist and self-described liberal Peter Ditto (who Mooney quotes in the Republican Brain): “When I’m at home, I spend all my time, like a good liberal, yelling at the television set, denouncing Republicans and how biased they are. Then I assume my persona at work and I say, theoretically, it’s really hard to know why there would be a difference.”

Man is a Rationalizing Animal

That’s not to say that The Republican Brainis all wrong about the connection between politics and personality. Psychological research has found connections between a person’s temperament and their political views, with certain personality types inclined towards conservatism and others towards liberalism. For example, self-described conservatives tend to score higher on personality tests in terms of Conscientiousness, which is characterized by high levels of self-discipline, dutifulness, and organization. Self-described liberals, meanwhile, tend to score higher on Openness to Experience, which is characterized by an inclination towards novelty, variety, and creativity. 

The idea that conservatives and liberals tend to have different temperaments is hardly new. You can find hints of the idea in sources ranging from Thomas Sowell's A Conflict of Visions to ordinary political humor. As with any generalization, there will be exceptions; some liberals will be highly conscientious while some conservatives will be highly experiential. Overall we should not be surprised that conservatives tend to be overrepresented in fields that prize conscientiousness (such as business and the military), while liberals are more drawn to experiential areas such as the arts and the academy. 

In addition, there is a great deal of psychological research establishing that, pace Aristotle, man is not only a rational animal but is also a rationalizing animal, particularly when it comes to politics. When confronted with evidence that goes against their pre-existing beliefs, people do not respond by objectively evaluating it. Instead, they tend to respond emotionally, attacking or dismissing contrary views however possible, while credulously accepting any evidence or authorities that seem to support their view. Anyone who has spent time arguing politics on the Internet will not be surprised at this finding.

Again, these are tendencies, not universals. People can rationally assess contrary arguments, it just doesn’t come naturally. The social psychologist Jonathan Haidt, (whose book The Righteous Mindcovers some of the same ground as The Republican Brain but without the partisan overlay) uses the metaphor of a rider sitting atop a giant elephant. The rider is our reason; the elephant, our instincts, emotions, and psychological needs. The rider can move the elephant, but it’s not easy.

Are Conservatives Worse?

Where The Republican Brain departs from Haidt and other social psychologists is in claiming that conservatives are more likely to engage in motivated reasoning in defense of their politics. That’s a much harder case to make, and here Mooney falls short.

Mooney devotes a good part of the book arguing that modern day conservatives are wrong on a whole host of issues ranging from global warming to the effect of Obamacare on the federal deficit. For obvious reasons, these arguments are more likely to appeal to those who share Mooney's liberal politics. 

But even if he were right in every case, this wouldn't be sufficient to justify the claim that conservatives are inherently more biased. To do that, you would have to show conservatives have been more biased and anti-scientific over the whole scope of human history. When one considers left-wing sympathy for pseudo-scientific theories such as Marxist economics, Lysenkoist biology, or Freudian psychoanalysis, there is reason to be skeptical.  

The "asymmetry thesis" also runs contrary to social psychologists' understanding of how motivated reasoning works. Dan Kahan recently summed up this point nicely:

People have a big stake--emotionally and materially--in their standing in affinity groups consisting of individuals of like-minded goals and outlooks. When positions on risks or other policy relevant-facts become symbolically identified with membership in and loyalty to those groups, individuals can thus be expected to engage all manner of information--from empirical data to the credibility of advocates to brute sense impressions--in a manner that aligns their beliefs with the ones that predominate in their group.The kinds of affinity groups that have this sort of significance in people's lives, however, are not confined to "political parties."  People will engage information in a manner that reflects a "myside" bias in connection with their status as students of a particular university and myriad other groups important to their identities.Because these groups aren't either "liberal" or "conservative"--indeed, aren't particularly political at all--it would be odd if this dynamic would manifest itself in an ideologically skewed way in settings in which the relevant groups are ones defined in part by commitment to common political or cultural outlooks.  

To support his thesis, Mooney cites a 2003 meta-analysisof 88 separate surveys comparing personality and political views, conducted by a team of psychologists headed by John Jost of New York University. The Jost study found conservatives were more likely to exhibit dogmatism, intolerance of ambiguity, and general closed-mindedness.

One of the most decisive rejoinders to this cames from Ronald Lindsay, who was also Mooney’s boss (Lindsay is President and CEO of the Center for Inquiry, a non-profit organization that hosted Mooney’s Point of Inquiry podcast). As Lindsay noted, many (though not all) of the underlying studies used in the Jost analysis define conservatism by relying on the “Wilson Patterson Scale,” which categorizes individuals as conservative based on whether they exhibit characteristics such as a “superstitious resistance to science.” Unsurprisingly, if you define someone as conservative if they are anti-science, then it turns out that conservatives tend to be anti-science.    

Mooney’s main argument, though, has to do with the ideological differences in openness to experience. Since liberals are more open to experience, Mooney argues, it stands to reason that they would be more open to contrary points of view, and so will feel less need to use motivated reasoning to swat down evidence that conflicts with their own cherished beliefs.

Failing the Test

It’s an interesting theory, but unfortunately for Mooney, some of the strongest evidence against the theory is set forth in The Republican Brain itself. In the last chapter of The Republican Brain, Mooney describes a study he helped design and carry out along with Everett Young, a psychology post-doc. In the study, students at Louisiana State University were quizzed on their political beliefs as well as their views on a variety of subjects both political (global warming and nuclear power) and non-political (Lady Gaga and Drew Brees). They were then presented with short essays that either supported or criticized their prior views. After reading the essays, the students were asked to rate how persuasive they thought they were, and whether they had changed their minds. [Full disclosure: I went to high school with Drew Brees and think he is a great quarterback.]

Given the human tendency to confirmation bias, one would expect participants not to change their minds much, and to find the essays that supported their views more persuasive than the ones that did not. What set the LSU study apart was that it specifically looked at whether this sort of bias was higher for conservatives on non-political subjects. This is significant, because according to The Republican Brain it is conservatives’ lower openness to experience that is supposedly responsible for their being more biased than liberals. Openness to experience isn't limited to political subjects, so if less openness means more bias, conservatives ought to engage in more motivated reasoning even on subjects that aren’t remotely political.

Mooney clearly intended the study to be his coup de grace, the final, definitive proof that conservatives’ was leading them astray across the broad. There is only one problem. The LSU study failed to find any correlation between political ideology and the tendency to engage in motivated reasoning on non-political subjects. While the book doesn't report findings as to openness, correspondence with Everett Young confirmed that higher openness to experience was not associated with lower motivated reasoning.

If openness to experience doesn’t mean openness to contrary evidence, then Mooney’s whole argument for why conservatives are more biased must fall by the wayside. That, at any rate, is the conclusion his co-author seems to have come to. “My feeling at the conclusion of this study is that motivated reasoning is not a psychological-ideological phenomenon,” says Young. “That is, conservatives and liberals do not differ in their level of motivated reasoning as a result of the inherent psychology that makes them conservative or liberal.”

Admissions like this are devastating to Mooney’s argument. Conservatives criticizing The Republican Brain can be dismissed as utterly predictable. But when Mooney can’t even convince intelligent, liberal-minded folks such as his own co-author or boss (not to mention many liberal social psychologists) that might just be an indication that his arguments aren’t compelling.    

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Miles Kimball and Noah Smith on the fallacy of inborn math ability

Miles and I have a new column out in Quartz, on how the fallacy of genetic determinism is killing Americans' math skills. Some excerpts:

“I’m just not a math person.” 

We hear it all the time. And we’ve had enough. Because we believe that the idea of “math people” is the most self-destructive idea in America today. The truth is, you probably are a math person, and by thinking otherwise, you are possibly hamstringing your own career. Worse, you may be helping to perpetuate a pernicious myth that is harming underprivileged children—the myth of inborn genetic math ability. 

Is math ability genetic? Sure, to some degree...[But for] high school math, inborn talent is just much less important than hard work, preparation, and self-confidence... 

Too many Americans go through life terrified of equations and mathematical symbols. We think what many of them are afraid of is “proving” themselves to be genetically inferior by failing to instantly comprehend the equations (when, of course, in reality, even a math professor would have to read closely). So they recoil from anything that looks like math, protesting: “I’m not a math person.”...We believe that this has to stop. Our view is shared by economist and writer Allison Schrager, who has written two wonderful columns in Quartz (here and here), that echo many of our views... 

We see our country moving away from a culture of hard work toward a culture of belief in genetic determinism. In the debate between “nature vs. nurture,” a critical third element—personal perseverance and effort—seems to have been sidelined. We want to bring it back, and we think that math is the best place to start.

Read the whole thing here!

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On Depressions, the Structure of Production & Fiscal Policy

I came into economics and finance blogging in 2011 a very different economic thinker than I am today. I was convinced (and remain convinced) that we were going through a once-in a generation economic transformation, or more accurately an industrial revolution the shape of which remained uncertain. These ongoing industrial revolutions, of course, cause great upheavals. As Joseph Stiglitz has noted, the Great Depression of the 1930s can be seen as a great displacement of labour in agriculture thanks to technological improvement. Stiglitz, like myself, sees a parallel between today’s slump and that of the 1930s; in the 1930s we were transitioning out of agriculture. We are also in a transitional period today. Since the advent of globalisation, and the growth in automation in the 1970s and 1980s society had begun suffering from falling real wages, and had had to lever up on debt in order to sustain lifestyles and spending habits. The financial sector had taken advantage of this, offering cheapish debt and — morally hazardously — securitising these debts and selling it a greater fool. This was a bomb waiting to explode — because lenders did not have to take responsibility for the fruits of their lending, they could lend to any NINJA, pay the credit rating agencies to grade highly speculative debt as AAA-grade, and sell it to another bank, or a pension fund, or a hedge fund. When the financial crisis blew up, I desired very, very strongly to see the entire corrupt market liquidated. This was an entirely Darwinian wish; financial firms had acted irresponsibly, creating a monstrous system that nobody really understood and they should pay the consequences for their irresponsibility. In liquidation, people would learn a harsh lesson and the economy would be forced to adapt to the new reality. In Hayekian terms, I thought that the structure of production ought to be left alone to adjust.

So I was furious to see the financial sector bailed out and rescued, and I strongly suspected that such medicine would have very harsh negative side effects as the speculators had been rescued instead of learning their lesson the hard way. Maybe the bankers and financiers who got bailed out — and the regulators who were found to be asleep at the wheel — have not learned a lesson. We shall see. Yet, when push came to shove, governments and central banks chose to save the system instead of watching it burn to the ground and given the complexity of the system, and the danger of good businesses being destroyed alongside the speculators and shysters, that is an entirely understandable decision. Certainly, it was also a morally questionable decision — after all, while bankers and financiers get bailed out in an emergency, help for the much poorer fringes of society is much less forthcoming. Yet this is the world in which we live in.

Of course, the world goes on. Banks may not have been disciplined, but the structure of production still must adjust to the new world, albeit in a less brutal and immediate fashion. This has been far from simple. Even though the financial system was saved, economies around the world remained in a depression. In fact, I would define an economic depression in these terms — a depression as opposed to a transitory recession, which relatively quickly self-corrects is a situation in which the structure of production cannot adjust itself back into a pattern of growth, and economic activity becomes permanently lowered. In Britain and the Eurozone we are so far behind our pre-crisis trend that we still as of October 2013 have not grown our way out of the trough yet, let alone caught up with the long term trend line:

The causes of this are multiple and complex. We are in an the midst of an ongoing industrial revolution, a great whirling flourish of creative destruction in which both foreign labour and automation are displacing both manufacturing and increasingly service industries. This creates real ongoing instability. Furthermore there remains the fallout from the crisis — confidence in new job-creating and growth-creating business ventures may have become inherently depressed, as economic expectations drift lower and lower in the context of low growth. Then there is the ongoing trend of government austerity, taking money and jobs out of the economy. Energy prices remain relatively high by historical standards, as we rely on old and increasingly expensive oil-based infrastructure (although I expect energy costs to begin to fall as we transition to newer energy architectures). The private sectors in most Western countries remain in deleveraging mode from a very large private debt overhang from before the crisis, limiting their consumption and investment and paying down debt. These are just some of the possible causes of depressed growth and elevated unemployment that we see.

Governments particularly in Britain and the Eurozone have attempted to fight depressed growth using austerity policies (in the context of expansionary monetary policy). The proponents of austerity theorise that by promising to bring down taxes and spending, they will unleash private sector spending by reducing future expectations of taxes. To me, this has always seemed like a boneheaded and Rube Goldberg-style approach. Simply, the issue of depressed private economic activity is far more complex than future taxation expectations. And aggressive monetary policy has not succeeded in reversing the depression(even if it has probably made the depression less severe). So it has been entirely unsurprising to me to see this approach largely failing. I approach the problem in a far more direct manner. The solution to lowered growth and elevated (and involuntary) unemployment is relatively simple.Eventually someone will start using up the idle resources. This will either be the private sector once it independently gets over its slump in animal spirits, or it will be the government. With such huge volumes of idle capital, interest rates will remain very low until stronger appetite for credit re-emerges. In equilibrium theory, the low cost of credit will by itself start to re-energise borrowing appetite by making more projects potentially profitable. Of course, interest rates are far from the only factor that borrowers take into account when seeking credit, and so it is perfectly plausible that the economy — as it has done — can remain depressed even with very low rates due to deleveraging pressures, low expectations and low confidence, etc. So if the market is ill-suited to taking up the idle resources any time soon — lying as it is in a depressive, irrational strop — the only agent that can do so is the state. The fact of low interest rates allows this to kill two birds with one stone — the state can borrow money (utilising idle capital) to create jobs (utilising idle labour), raising interest rates and bringing down the unemployment rate. And this approach does not require anyone to make accurate predictions about the future. It simply requires a market economy, and a state willing to employ idle resources when they are idle, and to ease off using idle resources when unemployment becomes low and interest rates start to rise.

Many — including probably Hayek himself — would argue that using up idle resources in such a manner will not allow the structure of production to adjust to the new economic reality. The state, Hayek would argue is a poor allocator of capital because it lacks the informational efficiency of the market. I would mostly agree with Hayek’s objection, and note that I favour a predominantly market-based economy. Government interventions should be kept to a necessary minimum. Yet, in a depressionary environment, the structure of production deteriorates as resources lie idle. Unemployed workers lose skills, lose competitive edge and spend and invest less, further depressing the economy. Capital — factories, buildings, amenities, ideas, etc — deteriorates. Young workers may enter the labour force but never find a job. Crime rises, and shady fringe businesses like loan sharks thrive as the unemployed struggle to pay the bills. The social costs of mass unemployment are exceedingly high. The adjustment occurring in a depression is more like a rot. And it is absurd to rot your way to growth. Instead, by lowering unemployment and using up idle capital (preferably in a mix of state-run infrastructure and technology projects, and lending to new businesses) more businesses can be born into existence. Potentially successful new ideas can be tried out, and may find success in the marketplace. The formerly unemployed get to develop skills, habits and ideas, instead of sitting at home all day doing nothing, or hunting for jobs in a scarce and depressed marketplace. And money will go into people’s pockets, spurring investment and consumption, fomenting more new business growth. This, in my view, is the best shot at getting a depressed and rotten structure of production out of the doldrums and back toward strong organic growth. Sooner or later, of course, the private sector will come back and begin to use up resources. But that could be a very, very, very long way away. If we want the structure of production to adjust to the new world and to continue adjusting as the world continues to change, letting huge quantities of resources sitting idle seems like a bad way to do it. Targeted fiscal policy can change that.

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No Country for Timid Men

A screenplay is no place to be timid, tentative, or reserved.

I've read eight spec scripts in the past few days, by unknown writers. Most of the scripts were garbage, two were salvageable (in theory, at least). One of the salvageables was a romantic comedy. The problem with the comedy was that it was good, but not great. I liked it but didn't love it.

Why didn't I love it? First, the scene descriptions were novelistic instead of telegraphic. That's easy to fix. Secondly, the dialog in each scene began "too early," with throwaway lines (the characters greeting each other); too much setup. Again, not hard to fix.

Not so easy to fix is the fact that the humor just wasn't over-the-top. The author fell in love with her characters and thought everything they did was inherently adorable and/or hilarious.

I suggested some touch-ups here and there, but frankly it's the author's job to make it great. All I could do is point out some really obvious areas of potential that were glossed over.

The hero of one script, an adorable nerd (think Forty-Year-Old Virgin), has managed to convince a beautiful woman to accompany him to Hawaii. One scene has him sulking in the bar, alone. The bartender, a burly Hawaiian, finds the hero sulking, sipping at a drink, listening to a ukulele player. He asks our hero something like: "You look like you could use a friend. Want to talk about it?" The hero says "Nah, I'm just going to listen." The bartender: "Talk to me, bro. I have a B.A. in psychology." Mr. Sad Sack says no.

Well, if this is a comedy, I don't like sad bar scenes. My rewrite of this encounter has the bartender saying: "Talk to me, bro. I have a Ph.D. in psychology." Our hero perks up. "What are you doing working here?" Bartender: "Dude. This is where the crazy people are."

Not a knee-slapper, but enough to keep the interest going. It has the ring of truth. People with doctorates sometimes do end up tending bar, in this great economy of ours. And yeah, bars are where the crazies often hang out. In the next scene, when the author has the hero wanting to comfort a young lady nearby who's crying in her beer, the bartender (in the original version of the script) warns our hero off: "Don't do it, man. She a crazy one." The line had zero impact before I gave the man a Ph.D.

At one point, the hero admits to his traveling companion (the beauty-girl) that he was engaged once. He explains that it didn't work out. Boring scene. Not at all in keeping with the character's virginity (or apparent virginity, up to that point). I suggested changing it to him saying: "Actually, I was engaged once. To the Little Mermaid." His partner says: "A cartoon character?" He says: "But it was doomed. She had this, you know, fishy smell."

Again, not exactly a knee-slapper, but the point is, this is a comedy with far too many boring backstory scenes. Why not try to make the boring parts a little more interesting? It's not an option, it's a requirement.

Turns out the heroine was also engaged (and still is) to a Fabio-like muscle dude with a cleft chin. I suggested a line or two of our hero warning her that if she marries Fabio, she's going to wake up looking at a butt-chin about 17,000 times in her life. "And if you smell inside there? There's chin smegma. No, it's true. Chinegma. Chin cheese." Etc.

This comedy's premise is that the main character (the 40-year-old nerd/virgin) has a brain tumor, and he's trying to scratch off items on his decidedly eccentric "bucket list." What the author didn't do is take advantage of the obvious liberty this guy has to do whatever he wants and say whatever he wants to whomever he wants. If he's dying, he's free to go nuts. Right? Instead, he does the most tepid, boring stuff.

It takes courage to write comedy. I told the author, the first thing you have to do is go through the whole script and exaggerate everything you possibly can. When the tattoo artist tells our guy to bring a stick to bite on, that's not good enough. The tattoo artist should tell him to bring a broom handle to bite on, or a baseball bat, or whatever. Think big, think outlandish, magnify things, make them colorful (bigger than life, as we say). We're at the movies. Let's see something fun.

Another comedy script I read suffered from the same problem of too-tameness. Everything was tame when it should have been out-of-control, outlandish. The hero, at one point, robs a bank. His stick-up line: "I know this is going to be a drag for some of you, but this is a stickup."

Huh?

In my mind, I had the guy leaping onto a counter or table, firing a gun in the air, and saying (in Roddy Piper fashion) "Listen up assholes! I'm here to floss my teeth, and kick ass. And I'm all, out, of dental floss!"

Women scream. A man tries to make a phone call.

The hero points his gun at the man's crotch. "I wouldn't try it, Superman, unless you want to be a GODDAM SOPRANO!"

When you're writing for the big screen, you have to be visual (not just talk-talk-talk, which is another common problem with spec scripts) and you have to think big/outlandish. Don't be timid. Leave timidity behind. Write like you mean it. Slay the audience, or die trying.

If you're a screenwriter, novelist, actor, director, agent, or industry person and you'd like to get a sneak peek at my script, "Greeners," write to me (and include your Twitter handle if you have one). My hushmail dot com address is kasthomas. All inquiries kept confidential.

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What Makes a Script Work?

Yesterday I read, and wrote coverage for, four spec scripts by unknown writers. I don't want to go into too much detail about the specifics, but let's just say this: Doing coverage is hard. It's hard under good circumstances. But when the scripts are stinky (as most are) it's actually a punishing experience all the way around.

One script I read was a lighthearted comedy set in Manhattan. The premise was just plain silly. A privately owned publishing house that churns out romance novels (written by people sitting at cubicles!) struggles to remain solvent. A young couple working there tries to save the ailing firm. Hijinks ensue.

Another script involved a card game with a demon-in-disguise. The hero finds a way to chase the demon into the demon's alternate reality, where he must master the rules of the Other World before doing battle with the demon in order to save a sick child whose soul the demon has claimed.

A third script was a substance-abuse comedy a la Cheech and Chong.

All three of these were terrible in various ways.

The least-sucky of the three, the comedy involving the Manhattan "paperback factory," had wooden characters, zero conflict, almost no plot, and for a so-called comedy it had vanishingly few laughs. 

The demon fantasy was mercifully short (88 pages); that's the best thing I can say about it.

The Cheech and Chong epic was dismal, with super-verbose scene descriptions, long speeches, and frequent references to specific song lyrics by specific artists (a no-no).

All three suction-enabled scripts had a few things in common. First, the characters were bland (the opposite of unforgettable) and sounded alike. The publishing-world comedy had no ethnic characters at all (in New York City??) and the characters sounded as if they came out of the same womb and attended the same prep schools. Secondly, the scripts relied far too much on dialog to tell the story. Often, the dialog was horribly stilted. ("My sister, you are a nincompoop" is funny, but for the wrong reasons. The author wasn't trying to be funny.) Most of all, though, the dialog was just incessant, often with "(beat)" inserted to control the rhythm.

The bad scripts had cardboard characters who simply existed, with no backstories, no texture, no complexity, no personality, and minimal (if any) character arc. They were the same lifeless characters at the end of the tale that they were at the beginning.

What you quickly realize when you start reading scripts is that all of the elements of a story play off each other: colorful characters say and do interesting things that both generate conflict and make their response(s) to conflicts all the more interesting. Strange synergies happen. When all the elements are working, they reinforce each other in remarkable ways. Conversely, when you start with flat characters and low stakes, nothing interesting can happen. It's strange how, in a good script, everything tends to work, whereas in a bad script nothing tends to work.

The fourth script I read was a winner. It was a psychological noir thriller in which a 25-year-old cab driver with a 6-year-old sister goes in search of the sociopathic father who ruined their lives. The characters were vivid, the dialog was some of the best I've ever read, the scene construction was crisp, and basically you could tell in the first five pages you were in the hands of an expert. (So yeah, it's true what they say. Ten pages is plenty of time in which to judge the expertise of the writer.)

Now here's the interesting thing. The author of the A+ script made a few boo-boos. He didn't mention until page seven what part of the world the story takes place in (Detroit). On page one, he had a line of dialog that said "Alright, lets go then." I don't know how you feel, but as a professional writer I've always hated the non-word "alright." There's "all right," or there's "okay," but there is (in English) no "alright." Also, "let us" contracts to "let's," not "lets."

The writer used "alright" about 30 times in the script. He also used the f-word way, way, way too much, greatly diminishing its impact. And at the most critical point in the action, he lapsed into passive voice!

And yet, I absolutely loved the script. The level of craft was so undeniably high, the dialog so crisp and believable, the scenes so superbly crafted, the timing and pacing so deft, the plot's twists so unpredictable, the characters so memorable, the ending so poignant, I couldn't help but throw my hands up at the end and go "Yesss!!!"

Bottom line, you can commit a certain number of sins and still get a rave review. But your script better sing. It better do the important stuff so incredibly well that the reviewer is ashamed to give you anything but an A+ grade. That's what happened with the knockout script I read. It kicked major ass. Flaws and all.


If you're a screenwriter, novelist, actor, director, agent, or industry person and you'd like to get a sneak peek at my script, "Greeners," write to me (and include your Twitter handle if you have one). My hushmail dot com address is kasthomas. All inquiries kept confidential.

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The Beggar Maid: Economics and Alice Munro

I can't allow our Nobel-fest to come to a close without a post about Alice Munro. The Canadian recipient of the Nobel Prize in Literature is in some ways a perfect complement to the Fama-Hansen-Shiller trio.

The word economics has its origins in the Greek okionomia, or management of household affairs. Munro's short stories are often categorized as domestic-- which similarly means of or related to the running of a home. Her writing is economic in many senses of the word, in both style and theme. Poverty, desire, selfishness, and self-determination are among the themes she treats with the most skill and nuance.

These themes emerge most notably, perhaps, in "The Beggar Maid," published in 1977, which tells the story of Rose, a college student on scholarship. The title alludes to "King Cophetua and the Beggar Maid," an 1884 painting by Edward Burne-Jones, based on an earlier Elizabethan ballad and a poem by Lord Tennyson. King Cophetua, as you might guess, falls in love with a beggar maid-- or perhaps with the idea of the beggar maid and the beautiful simplicity her poverty represents to him. Munro's story contrasts the romanticization of poverty with the actual experience of poverty.

The story begins, "Patrick Blatchford was in love with Rose." The sentence construction-- with Rose in the passive position--is telling. Rose is given room and board with a female English professor, Dr. Henshawe. Her living situation also arises from her passivity: "She had got to live with Dr. Henshawe by accident." She enrolls in (and despises) an introductory economics course not of her own volition, but because Dr. Henshawe tells her to.

Dr. Henshawe, even before Patrick, romanticizes Rose's poverty; she "liked poor girls, bright girls, but they had to be fairly good- looking girls." Rose satisfies the requirements; she is, so to speak, "working class," although "Before she came to Dr. Henshawe’s, Rose had never heard of the working class." Rose's perception of her family home is altered by her stay with Dr. Henshawe:

"What Dr. Henshawe’s house and Flo’s house did best, in Rose’s opinion, was discredit each other. In Dr. Henshawe’s charming rooms there was always for Rose the raw knowledge of home, an indigestible lump, and at home now her sense of order and modulation elsewhere exposed such embarrassing sad poverty in people who never thought themselves poor. Poverty was not just wretchedness, as Dr. Henshawe seemed to think, it was not just deprivation. It meant having those ugly tube lights and being proud of them. It meant continual talk of money and malicious talk about new things people had bought and whether they were paid for. It meant pride and jealousy flaring over something like the new pair of plastic curtains, imitating lace, that Flo had bought for the front window. That as well as hanging your clothes on nails behind the door and being able to hear every sound from the bathroom. It meant decorating your walls with a number of admonitions, pious and cheerful and mildly bawdy."

One day, in the library, a strange man touches Rose on the leg and then scurries off. "It didn’t seem to her a sexual touch; it was more like a joke, though not at all a friendly one." Rose doesn't particularly want to do anything about it, but she feels the need to tell someone what happened. This is how she comes to meet Patrick, who by chance is studying in a nearby carrel, and how he comes to fall in love with her.

"If she had been trying to make him fall in love with her, there was no better way she could have chosen. He had many chivalric notions, which he pretended to mock, by saying certain words and phrases as if in quotation marks. 'The fair sex,' he would say, and 'damsel in distress.'"

We are told right away about Patrick that "his family was rich." Immediately thereafter comes the following passage, in which he is called poor:

He arrived early to pick Rose up, when they were going to the movies. He wouldn’t knock, he knew he was early. He sat on the step outside Dr. Henshawe’s door. This was in the winter, it was dark out, but there was a little coach lamp beside the door. 

“Oh, Rose! Come and look!” called Dr. Henshawe, in her soft, amused voice, and they looked down together from the dark window of the study. “The poor young man,” said Dr. Henshawe tenderly... She called Patrick poor because he was in love, and perhaps also because he was a male, doomed to push and blunder. Even from up here he looked stubborn and pitiable, determined and dependent, sitting out there in the cold.

Rose does not comprehend at first just how rich Patrick is, and seems to view him with a combination of pity and disgust, especially concerning "that flinching, that lack of faith, that seemed to be revealed in all transactions with Patrick." Notice the use of the word transactions to describe their interactions. The transactional language continues in the following passage, the heart of the story:

"She could not turn Patrick down. She could not do it. It was not the amount of money but the amount of love he offered that she could not ignore; she believed that she felt sorry for him, that she had to help him out. It was as if he had come up to her in a crowd carrying a large, simple, dazzling object — a huge egg, maybe, of solid silver, something of doubtful use and punishing weight — and was offering it to her, in fact thrusting it at her, begging her to take some of the weight of it off him. If she thrust it back, how could he bear it? But that explanation left something out. It left out her own appetite, which was not for wealth but for worship. The size, the weight, the shine, of what he said was love (and she did not doubt him) had to impress her, even though she had never asked for it. It did not seem likely such an offering would come her way again. Patrick himself, though worshipful, did in some oblique way acknowledge her luck."

Whereas economists study commercial transactions that are by necessity and construction mutually beneficial to both parties, here we observe human relational transactions that are at best doubtful, at worst punishing. Patrick becomes the beggar, Rose the king (the object of worship); neither quite knows what they offer or what they receive in return, yet neither is free to decline to transact. We can't help feeling that Patrick and Rose's "transactions" are as violating as the stranger's unwelcome touch of her leg.

Patrick repeatedly tells Rose how "lovely" and "charming" her poverty has made her. He does not understand her experience of poverty, nor she his of tremendous wealth. Then they visit each other's family homes. In preparation for her visit to Patrick's parents' house, "She had sold more blood and bought a fuzzy angora sweater, peach-colored, which was extremely messy and looked like a small-town girl’s idea of dressing up. She always realized things like that as soon as a purchase was made, not before." When she arrives,

"Size was noticeable everywhere and particularly thickness. Thickness of towels and rugs and handles of knives and forks, and silences. There was a terrible amount of luxury and unease."

The trip to visit her stepmother is no better. Actual poverty is not romantic, not beautiful. Afterwards, Patrick says, “'Your real parents can’t have been like that.'” 

"Rose did not like his saying that either, though it was what she believed herself. She saw that he was trying to provide for her a more genteel background, perhaps something like the homes of his poor friends: a few books about, a tea tray, and mended linen, worn good taste; proud, tired, educated people. What a coward he was, she thought angrily, but she knew that she herself was the coward, not knowing any way to be comfortable with her own people or the kitchen or any of it. Years later she would learn how to use it, she would be able to amuse or intimidate right-thinking people at dinner parties with glimpses of her early home. At the moment she felt confusion, misery."

Despite her confusion and misery, Rose agrees to marry Patrick, at which point he gives up his plans to be an academic historian in favor of a lucrative position at his father's company (he previously forswore going into business.) Rose grows ever more miserable until she finally confronts him to call off the wedding, climatically declaring, 

"I don’t have to know what I want to know what I don’t want!"

We believe she has at last taken control of her own destiny. Not long after, though, she spots him in his carrel and has an "barely resistible" temptation to throw herself at him, beg his forgiveness, restore his happiness.

"It was not resistible, after all. She did it."

She neither knows her preferences nor controls her actions. We remember how she hated her economics class, where she probably learned about  homo economicus, the hyper-rational, hyper-calculating representative agent with well-defined preferences. When Jane Smiley presented Munro the Man Booker Prize in 2009, she said, “Millions of readers pick up an Alice Munro story and react with a kind of galvanised self-recognition.” No one wants to recognize herself in homo economicus, the main character of our economics Nobelists (with very mild deviations by Shiller). We want, we believe we want, to be human and distinct, romantic and idealistic. We recognize ourselves in Munro's stories, but it is not a comfortable recognition. Her characters are not exactly homo economicus but neither are they who we want to be. It is not so simple to separate our desires for money, love, sex, worship, power. We can see life "in economic terms" and not, as she describes at the end of the story. The end is told from Rose's perspective many years later, after her ten year marriage to Patrick and eventual divorce.

"When Rose afterward reviewed and talked about this moment in her life...she said that comradely compassion had overcome her, she was not proof against the sight of a bare bent neck. Then she went further into it, and said greed, greed. She said she had run to him and clung to him and overcome his suspicions and kissed and cried and reinstated herself simply because she did not know how to do without his love and his promise to look after her; she was frightened of the world and she had not been able to think up any other plan for herself. When she was seeing life in economic terms, or was with people who did, she said that only middle-class people had choices anyway, that if she had had the price of a train ticket to Toronto her life would have been different. 

Nonsense, she might say later, never mind that, it was really vanity, it was vanity pure and simple, to resurrect him, to bring him back his happiness. To see if she could do that. She could not resist such a test of power."

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