What would Alan do?

There has been a lot of talk lately about whether the Fed will continue raising interest rates or pause for a while. I don't know the answer, but here is one way to think about it.

About five years ago, I wrote a paper on monetary policy in the 1990s. I estimated the following simple formula for setting the federal funds rate:

Federal funds rate = 8.5 + 1.4 (Core inflation - Unemployment).

Here "core inflation" is the CPI inflation rate over the previous 12 months excluding food and energy, and "unemployment" is the seasonally-adjusted unemployment rate. The parameters in this formula were chosen to offer the best fit for data from the 1990s.

Right now, core inflation is 2.4 percent, and unemployment is 4.6 percent. This formula says the federal funds rate should be set at 5.42 percent--just 17 basis point above the current target of 5.25 percent.

So we now seem to be very close to the rate that Alan Greenspan would have set under these conditions.

Set your TiVo!

I am scheduled to be a guest on Kudlow & Company today. CNBC at 5 pm EST.

Update: I believe the show will be repeated Monday and/or Tuesday, when Larry is on vacation.

Mishkin to the Fed

President Bush nominated Frederic Mishkin to the Federal Reserve today--another great appointment. It always warms my heart to see a textbook author make good.

On Energy Independence

A reader emails me a question about "energy independence."

Professor Mankiw,

Because I graduated from Harvard in '05, I took Ec 10 from Marty (although I did have the pleasure of using your excellent textbook). I've been a dedicated reader of your blog ever since I discovered it this spring. Anyway, on to the question.

I'm working in DC right now, and everywhere you turn there is a politician advocating for "energy independence." What's more, both parties seem to have adopted the mantra, and I have not yet heard a serious voice denouncing the call to "end our addiction on foreign oil."

Am I crazy to think that "energy independence" makes absolutely zero sense and is instead a political canard to appease protectionists on the left and isolationists on the right?

I'm pretty sure that Marty gave a spirited lecture about the virtues of free trade and decried examples to the contrary like China's push for food "self-sufficiency."

How is "energy independence" any different?

[name withheld]

The reader is correct that "energy independence" is a bipartisan mantra. George Bush in his 2003 State of the Union address said, "Our third goal is to promote energy independence for our country." John Kerry in a 2004 campaign ad said, "It's time to make energy independence a national priority."

Does this make any sense? Consider this passage:

"One of my policy goals will be to shut down LNG facilities and to stop building new ones. These facilities make it easier for American to buy cheap natural gas from abroad. Americans may enjoy the lower prices, but these facilities keep us dependent on foreign suppliers. It is better to produce all our energy domestically, even if it means consuming less and paying higher prices."

Would either Bush or Kerry insert such a passage into a speech? Of course not.

If we could wave a magic wand and costlessly reduce the need for imported energy, that would be great. Calls for energy independence are usually followed by magic-wand-like claims about what conservation, technology, etc. are likely to produce. But politicians rarely suggest that Americans make significant economic sacrifice for purposes of energy independence. The rhetoric is usually hollow.

This is, in my view, fortunate. Hollow rhetoric is less worrisome than substantive, misguided rhetoric. Another word for "independence" is "autarky." While gasoline taxes can be justified as a policy to deal with externalities, "energy autarky" is not in itself a desirable goal.

Update: Econbrowser estimates what the price of oil would be under energy independence.

Define "Hack"

Mark Thoma calls our attention to an old column from Paul Krugman that contains these words of wisdom:

How can you tell the hacks from the serious analysts?... if a person, or especially an organization, always sings the same tune, watch out. Real experts, you see, tend to have views that are not entirely one-sided.

I couldn't agree more.

Define "Rich"

From Hal Varian's column in yesterday's NY Times:

After a detailed examination of the financial circumstances of people close to retirement, two economists, Stephen F. Venti of Dartmouth and David A. Wise of Harvard, concluded that the primary reason for differences in retirement assets was differences in propensities to save. It is not unusual to see low-income households with high savings rates holding more financial assets at retirement than high-income households who saved a smaller fraction of their income.

People often use the term "rich" as if the word had an unambiguous meaning. Venti and Wise show that high-income people and wealthy people are frequently different people.

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On Arthur Burns

The conventional wisdom is that Arthur Burns was a failure as a central banker. The mysterious knzn, however, questions whether this assessment is right:

for the 12 months ending in February 1970, when Burns began his chairmanship, the CPI inflation rate was 6.3%. For the 12 months ending January 1978, when Burns ended his chairmanship, the rate was 6.7%. On balance, that hardly looks to me like letting inflation get out of hand.....it looks like Johnson�s influence on Martin deserves as much blame for the subsequent high inflation rates as does Nixon�s influence on Burns.

An intriguing suggestion, but I don't think we can revive Burns's reputation quite so easily.

While Burns was dealt a particularly difficult hand to play (OPEC shocks, productivity slowdown), inflation was not nearly as well contained as these numbers suggest. Recall that the Fed influences the inflation rate with a lag. Let's suppose that lag is one year, which I believe is roughly consistent with econometric studies. The story then looks very different. By this reckoning, Burns inherited an inflation rate of 5.0 percent (during his first year in office) and left his successor an inflation rate of 9.3 percent (during the year after Burns left office). Not a happy legacy for a central banker.

Wages and Work Hours

Here is an intriguing fact from a new NBER study:

In 1983, the most poorly paid 20 percent of workers were more likely to put in long work hours than the top paid 20 percent. By 2002, the best-paid 20 percent were twice as likely to work long hours as the bottom 20 percent.

That is, wages and hours worked went from being negatively correlated to being positively correlated. This may be an important piece of the puzzle of rising income inequality.

Credos of the Left and Right

From Barbara Ehrenreich:

Yeah, I'm talking "class war" as a solution to poverty and rising inequality. But remember, the working class didn't start this war.

From Jeff Taylor:

Nothing is more dangerous than a lunatic with government letterhead.

Wessel on the Fiscal Challenge

In today's Wall Street Journal, David Wessel hits the nail on the head (as he often does):

the political reality is that a Republican president can hope to restrain spending on Social Security, Medicare and Medicaid only if he can bring some Democrats along. And the only way to bring Democrats along is to put taxes on the table -- maybe not increasing tax rates, but raising revenues by simplifying the tax code, closing loopholes, targeting corporate subsidies, broadening the tax base or whatever brings in more money.

Let's take aim at the state-and-local tax deduction, the mortgage-interest deduction, and the exclusion of employer-provided health insurance. (And have I mentioned gasoline taxes lately?) But let's keep tax rates low.

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