Believe those who are seeking the truth. Doubt those who find it. Andre Gide

Tuesday, December 25, 2018

Racial Diversity in the Supply of U.S. Econ PhDs

This post is motivated by Eshe Nelson's column "The Dismal Cost of Economics' Lack of Racial Diversity." I was especially struck by this data -- out of the 539 economics doctorates awarded to U.S. citizens and permanent residents (by U.S. institutions), only 18 of the recipients were African-American.
I thought it would be of some interest to see what the data looks like more broadly over other groups and over a longer period of time. I thank my research assistant, Andrew Spewak, for gathering this data (from the National Science Foundation). 

Let's start with the raw numbers first. The data is aggregated into 5-year bins beginning in 1965 and up to 2014. The orange bars represent the number of econ PhDs awarded to U.S. citizens and permanent residents (by U.S. institutions) over a given 5-year period. The blue bars represent the total number of doctorates awarded.

Seems like the number of econ PhDs awarded to U.S. citizens is on the decline and that this decline has been partially made up by the number of PhDs awarded to foreign students.

Now, let's stick with citizens for the moment and decompose the data across various "racial" categories. The following figure reports the share of econ doctorates earned by various groups.

The most dramatic pattern is the relative decline of PhDs awarded to Whites and the increasing share of degrees awarded to Asians (there is also a noticeable uptick in the "Other" category which includes groups like Native Americans). Blacks and Hispanics have made some gains since the early years, but have since stabilized to about a 5% share.

I now reproduce the picture above, but this time looking at total PhDs awarded.

The relative decline of Whites here is even more evident, as is the increasing share of Asians. It is interesting to note that while the share of Hispanics has increased noticeably by including foreign (non PR) recipients, the same is not true for Blacks. One possibility here is that English-speaking foreign black students may be more likely to target the U.K. over the U.S. and that French-speaking blacks may be more likely to target French-speaking institutions in France or former French colonies, like Quebec. (It would be interesting to examine these statistics for Canadian universities). 

Finally, let's take a look at how the share of PhDs across groups lines up with their share of the total population. Here is what the data looks like for the period 2010-2014. 

While White citizens are over-represented, Whites as a whole are under-represented (relative to the domestic U.S. population). Blacks are significantly under-represented both as citizens and including foreigners. Asians, on the other hand, are significantly over-represented--both as citizens and especially if one includes foreigners. Only the "Other" category seems to be roughly representative of the population.

To conclude, there are some clear racial imbalances here. I think most people would agree that increasing Black and Hispanic representation in the U.S. economics profession is a good idea (for many of the reasons highlighted in Eshe's column). It would also be interesting to see how these patterns have evolved in other countries. 

Sunday, December 23, 2018

Does the Fed have a symmetric inflation target?

It's well-known that the Fed has been undershooting its inflation 2% target every year since 2012 (ironically, the year it formally adopted a 2% inflation target). This has led some to speculate whether 2% is being viewed more as a ceiling, rather than a target, as it is with the ECB. The Fed, however, continues to insist that not only is 2% a target, it is a symmetric target.  But what does this mean, exactly? And how can we judge whether the Fed has a symmetric inflation target or not?

These questions came to me while listening to Jay Powell's recent press conference following the FOMC's decision to follow through with a widely anticipated rate hike. At the 16:15 mark, reporter Binyamin Appelbaum (NY Times) asked Powell the following question:
BA: You're about to undershoot your inflation target for the seventh straight year and you forecast that you're going to undershoot it for the eighth straight year...Can you help us to understand why people would be advocating restrictive monetary policy at a time of persistent inflation undershoots? 
Here is how Powell responded:
JP: Well, we as a committee do not desire inflation undershoots and you're right -- inflation has continued to surprise to the downside -- not by a lot though -- I think we're very close to 2% and, you know, we do believe it's a symmetric goal for us -- symmetric around 2% -- and that's how we're going to look at it. We're not trying to be under 2% -- we're trying to be symmetrically around 2% -- and, you know, I've never said that I feel like we've achieved that goal yet. The only way to achieve inflation symmetrically around 2% is to have inflation symmetrically around 2% -- and we've been close to that but we haven't gotten there yet and we haven't declared victory on that yet. So, that remains to be accomplished. 
While this answer sounded reasonable on some level, it did not satisfy the very next inquisitor, Jeanna Smialek (Bloomberg):
JS: Just following up on Binya's question...I guess if you haven't achieved 2% and you don't see an overshoot -- which would sort of be implied by a symmetrical target -- what's the point of raising rates at all? 
Powell replied to this by making reference to the strength of the economy -- growth well above trend, unemployment falling, inflation moving up to 2%, and a positive forecast. In this context, the rate hike seemed appropriate. Again, a sensible sounding answer -- but did it answer the question actually posed?

As I reflected on this exchange, I felt something amiss. And then it occurred to me that people might be mixing up the notion of a symmetric inflation target with a price-level target.

In her question above, Jeanna suggested that if the Fed has a symmetrical inflation, then we should be expecting an overshoot of inflation. But the intentional overshooting of inflation is not inflation targeting -- it is price-level targeting. With an inflation target, one should be expecting inflation to return to the target--not beyond the target.

This would have been a fine answer to Jeanna's question, but isn't it inconsistent with the earlier reply to Binyamin? In that response, Powell left us with the impression that the FOMC has failed to achieve its symmetric inflation goal -- that success along this dimension would consist of actually observing inflation vary symmetrically around 2%. I'm not sure this is entirely correct.

To my way of thinking, an inflation target means getting people to expect that inflation will eventually return to target (from below, if inflation is presently undershooting, and from above, if inflation is presently overshooting). A symmetric inflation target simply means that the rate at which inflation is expected to return to target is the same whether inflation is presently above or below target. To put it another way, symmetry implies that the FOMC should feel equally bad about inflation being 50bp above or below target. Along the same line, persistent inflation overshoots and overshoots should be equally tolerated (given appropriate conditions).
Should a successful symmetric inflation targeting regime generate inflation rates that average around target? It's hard to see how it would not in the long run and if the shocks hitting the economy are themselves symmetric (this is not so obviously a given, but let me set it aside for now). Does missing the inflation target from below for roughly a decade imply that the FOMC has failed to implement a symmetric inflation targeting regime? Powell's mea culpa above suggests yes. But again, I am not so sure.

As I said above, the success of an inflation targeting regime should be measured by how well inflation expectations are anchored around target. By this measure, the FOMC has managed, in my mind, a reasonable level of success (2015-16 looks weak). The following diagram plots the PCE inflation rate (blue) against expected inflation (TIPS breakevens) five years (red) and ten years (green) out.

In my view, the fact that realized inflation has persistently remained below target does not necessarily imply the absence of a symmetric inflation target. Let's take a look at the FOMC's official view on the matter, originally made public on January 24, 2012 in its Statement of Longer-Run Goals and Monetary Policy Strategy. Let me quote the relevant passage and highlight the key phrases:
The Committee reaffirms its judgment that inflation at the rate of 2 percent, as measured by the annual change in the price index for personal consumption expenditures, is most consistent over the longer run with the Federal Reserve’s statutory mandate. The Committee would be concerned if inflation were running persistently above or below this objective. Communicating this symmetric inflation goal clearly to the public helps keep longer-term inflation expectations firmly anchored, thereby fostering price stability...
It seems clear enough that the real goal here is to keep longer-term inflation expectations anchored at 2%.  The idea is that if inflation expectations are anchored in this manner, then the actual inflation rate today shouldn't matter that much for longer-term plans (like investment decisions). If inflation turns out to be low, you should be expecting it to rise. If it turns out to be high, you should be expecting it to fall. Nowhere does the statement suggest we should be expecting under or over shooting -- a characteristic we would associate with a price-level target. As for the phenomenon of persistent under or over shoots, the statement makes clear that the Committee would be equally (symmetrically) concerned in either case.

If one accepts my definition of symmetric inflation target then, unfortunately, we do not yet have enough data to judge whether the Fed's inflation target is symmetric. The policy was only formally implemented in 2012. Since then we've only observed a persistent undershoot and the conditions leading to these persistent downward surprises. Would the FOMC be equally tolerant of letting inflation surprise to the upside for several years should economic conditions warrant? It seems that we'll have to wait and see.

Thursday, December 6, 2018

Working More for Less

I had an interesting chat with a colleague of mine the other day about the labor market. In the course of conversation, he mentioned that he used to teach a class in labor economics. Naturally, an important lesson included the theory of labor supply. Pretty much the first question asked is how the supply of labor can be expected to change in response to a change in the return to labor (the real wage).

My colleague said that for years he would preface the theoretical discussion with a poll. He would turn to the class and ask them to imagine themselves employed at some job. Then imagine having your wage doubled for a short period of time. How many of you would work more? (The majority of the class would raise their hands.) How many of you would not change your hours worked? (A minority of hands). How many of you would work less? (A sprinkling of hands). At the end of the polling, he'd start teaching a standard theory of labor supply and using it to interpret the poll results (substitution vs. wealth effects).

My colleague administered this poll for over a decade. The results were always the same. (How satisfying.)

Then, one day, for no apparent reason, he decided to mix it up a little bit. Instead of asking the class to imagine an increase in the wage rate, he asked his students to consider a decrease in their wage rate. He was expecting a symmetrically opposite response. To his shock, a majority of the class responded that they would work more. Only a minority replied that they would work less or not change their hours.

Surely, this was an anomaly? But when he repeated the experiment with another class, he got the same result. He mentioned it to a colleague of his, who then ran the same experiment with his class and he too confirmed the result. What was going on here? If true, then employers can apparently get more labor out their workers by lowering their wages?!

The phenomenon here seems related to the evidence of "income targeting" among some groups of workers; see, for example, the classic study of New York taxi drivers by Camerer, Babock, Lowenstein and Thaler (QJE May, 1997). Evidently, inexperienced taxi drivers tend to work less when the return to working is high, and work more when the return to working is low. This behavior doesn't quite square with the phenomenon reported by my colleague. The effect there appeared to be asymmetric: students reported willing working more at a lower wage, but also reported willing working more at a higher wage. In both cases, however, it seems that the existence of some fixed obligation (e.g., monthly food and rent payments) plus no ready access to credit could explain why workers might be willing to work longer hours when the return to work declines.

I'm not sure if these findings shed any light on the state of the labor market today. But it is interesting to speculate. Conventional supply/demand analysis isn't always the best guide. 

Monday, December 3, 2018

Does the Floor System Discourage Bank Lending?

David Beckworth has a new post up suggesting that the Fed's floor system has discouraged bank lending by making interest-bearing reserves a relatively more attractive investment; see here. I've been hearing this story a lot lately, but I can't say it makes a whole lot of sense to me.

Here's how I think about it. Consider the pre-2008 "corridor" system where the Fed targeted the federal funds rate. The effective federal funds rate (FFR) traded between the upper and lower bounds of the corridor--the upper bound given by the discount rate and the lower bound given by the zero interest-on-reserves (IOR) rate. The Fed achieved its target FFR by managing the supply of reserves through open-market operations involving short-term treasury debt.

Consider a given target interest rate equal to (say) 4%. Since the Fed is financing its asset holdings (USTs yielding 4%) with 0% reserves, it is making a profit on the spread, which it remits to the treasury. Another way of looking at this is that the treasury has saved a 4% interest expense on that part of its debt purchased by the Fed (the treasury would have had to find some additional funds to pay for that interest expense had it not been purchased by the Fed).

Now, suppose that the Fed wants to achieve its target interest rate by paying 4% on reserves. The supply of reserves need not change. The yield on USTs need not change. Bank lending need not change. The only thing that changes is that the Fed now incurs an interest expense of 4% on reserves. The Fed's profit in this case go to zero and the remittances to the treasury are reduced accordingly. From the treasury's perspective, it may as well have sold the treasuries bought by the Fed to the private sector instead.

But the question here is why one would think that moving from a corridor system to a floor system with interest-bearing reserves inherently discourages bank lending. It is true that bank lending is discouraged by raising the IOR rate. But is it not discouraged in exactly the same way by an equivalent increase in the FFR? If I am reading the critics correctly (and I may not be), the complaint seems to be more with where the policy rate is set, as opposed to anything inherent in the operating system. If the complaint is that the IOR has been set too high, I'm willing to agree. But I would have had the same complaint had the FFR been set too high under the old corridor system.

Alright, now let's take a look at some of the data presented by David. Here, I replicate his Panel A depicting the evolution of the composition of bank assets.
David wants to direct our attention to the period after 2008 when the Fed flooded the banking system with reserves and started paying a positive IOR rate. The large rise in the orange line since 2008 was due almost entirely to reserves and not other safe assets. This suggests that banks were motivated to hold interest-bearing reserves instead of private-sector interest-bearing assets (loans). He writes:
Something big happened in 2008 that continues to the present that caused banks to allocate more of their portfolios to cash assets and less to loans. While the financial crisis surely was a part of the initial rebalancing, it is hard to attribute what appears to be 10-year structural change to the crisis alone. Instead, it seems more consistent with the critics view that the floor system itself has fundamentally changed bank portfolios allocation.
I think the diagram above is rather misleading since all it shows is portfolio composition and not the level of bank lending. Here's what the picture looks like when we take the same data and deflate it by the GDP instead of bank assets,

According to this picture, bank lending is close to 50% of GDP, not far off its historical average and considerably higher than in the decade following the S&L crisis (1986-1995). Here's what commercial and industrial loans as a ratio of GDP looks like:
It's no surprise that bank lending contracted during and shortly after the crisis. One could even make the argument that paying positive IOR contributed to the contraction. But as I mentioned above, one could have made the same argument had the FFR been kept at 25bp. Again, this criticism has less to do with the operating system than it does with where the policy rate was set. In any case, note that commercial and industrial loans are presently above their pre-crisis levels (as a ratio of GDP). 

To sum up, I do not believe that a floor system inherently discourages bank lending as some critics appear to be arguing. Now that the Fed is paying IOR, reserves are essentially viewed by banks as an alternative form of interest-bearing government debt. New regulations since the crisis have induced banks to load up on safe government assets. But as the following figure shows, this has not come at the expense of private lending.
Banks are lending about as much as they have over the past 50 years (relative to GDP). Bank lending as a ratio of bank assets may be low, but this is because banks are loaded up on safe assets--not because they've cut back on their lending activity.