Economist Robert Hall of Stanford University talks with EconTalk host Russ Roberts about the current state of the U.S. economy and what we know and don't know about the recovery from the Great Recession. Much of the conversation focuses on the choices facing the Federal Reserve and the policy instruments the Fed has available. The conversation includes a discussion of Hall's experience as chair of the National Bureau of Economic Research Committee on Business Cycle Dating.
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Readings and Links related to this podcast episode
Related Readings
HIDE READINGS
This week's guest:
Robert Hall's Home page
This week's focus:
"The Anatomy of Stagnation in a Modern Economy," by Robert E. Hall. Hoover Institution and Department of Economics, Stanford University and National Bureau of Economic Research. May 13, 2016. PDF file.
Additional ideas and people mentioned in this podcast episode:
Benefit incentives and behaviors after the Great Recession:
Mulligan on Redistribution, Unemployment, and the Labor Market. EconTalk. December 2012.Autor on Disability. EconTalk. April 2012.
Erik Hurst on Work, Play, and the Dynamics of U.S. Labor Markets. EconTalk. November 2016.
Productivity, by Alexander J. Field. Concise Encyclopedia of Economics.
"The Economy's Hidden Problem: We're Out of Big Ideas," by Greg Ip. Wall Street Journal. December 20, 2016.
"What Determines Productivity?," by Chad Syverson. Journal of Economic Literature, 2011. PDF file.
"Measuring Economic Policy Uncertainty," by Scott R. Baker, Nicholas A. Bloom, Steven J. Davis. Quarterly Journal of Economics, July 2016.
"Benefits of Competition and Indicators of Market Power." Council of Economic Advisers. Whitehouse.gov, April 2016. PDF file.
Excess reserves, Federal Reserve interest paid to banks
David Beckworth on Money, Monetary Policy, and the Great Recession. EconTalk. May 2016. Excess reserves, discussion and links.
Sumner on Money and the Fed. EconTalk. January 2012. Excess reserves, Federal Reserve paying interest to banks to hold excess reserves.
Stimulating the economy and multipliers:
"The Financial Accelerator in a Quantitative Business Cycle Framework," by Ben Bernanke, Mark Gertler, Simon Gilchrist. NBER Working Paper No. 6455. March 1998.
Government Spending Multipliers in Good Times and in Bad: Evidence from U.S. Historical Data," by Valerie A. Ramey and Sarah Zubairy. 2011. PDF file.
Ramey on Stimulus and Multipliers. EconTalk. October 2011.
The dating of business cycle peaks, troughs, and recoveries:
The NBER's Business Cycle Dating Committee.
Recessions, by Geoffrey H. Moore. Concise Encyclopedia of Economics.
A few more readings and background resources:
Total Factor Productivity Report. Federal Reserve Bank of San Francisco.
Unemployment, by Lawrence H. Summers. Concise Encyclopedia of Economics.
"Notes on the Current State of Empirical Macroeconomics," by Robert E. Hall. June 1976.
"Macroeconomic Effects from Government Purchases and Taxes," by Robert J. Barro, Charles J. Redlick. NBER Working Paper No. 15369, September 2009.
Saltwater and Freshwater Economics. Wikipedia.
Milton Friedman. Biography. Concise Encyclopedia of Economics.
A few more EconTalk podcast episodes:
Alberto Alesina on Fiscal Policy and Austerity. EconTalk. April 2016.
Stagnation
Cowen on the Great Stagnation. EconTalk. February 2011.
Joel Mokyr on Growth, Innovation, and Stagnation. EconTalk. November 2013.
Highlights
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Podcast Episode Highlights
HIDE HIGHLIGHTS
0:33
Intro. [Recording date: December 8, 2016.]
Russ Roberts: Before introducing today's guest, I want to encourage listeners to go to econtalk.org--you'll find a link there [in the upper left corner] to vote for your favorite episodes from 2016 and give us some additional feedback. Thank you so much.
0:51
Russ Roberts: Now, on to today's guest, who is Robert Hall.... I want to start by discussing a recent paper of yours that we'll link to, "The Anatomy of Stagnation in a Modern Economy." And I'm going to read the opening paragraph. It's pretty blunt and dramatic.
In the years following the global financial crisis of 2008, many modern, advanced economies suffered stagnation. Unemployment rose sharply and declined slowly, output fell substantially, and growth remained substandard even eight years later. Investment in plant, equipment, software, and research and development languished. Productivity grew well below its historical rate. Monetary and fiscal measures to offset these developments were aggressive, but were only partially successful. This paper studies these events as they occurred in the
single largest advanced economy, that of the USA.
A lot of people have argued that, while fiscal and monetary policy were only partially successful, that's simply because they just weren't aggressive enough. Do you agree?
Robert Hall: Well, first of all, with respect to monetary policy, the standard policy of lowering interest rates was done about as aggressively as possible. Maybe not quite, but pretty close. With respect to fiscal policy, really a lot happened; but it happened mainly because of what are called the automatic stabilizers. Discretionary fiscal policy, as in previous contractions, was not politically feasible, it turned out. So, I think I'd probably agree that in some ideal world more would have been done on the fiscal side.
Russ Roberts: So, when you look at the Stimulus Package of the early days of the Obama Administration, which was, I don't know, what ended up being about $800 billion--why was that not a significant amount?
Robert Hall: Well, first of all, a large amount of that money went to state and local governments. And rather than expanding their fiscal effects, a lot of them, a lot of the governments used them to pay off debt. Understandably. If you stare at the National Income Accounts on the government purchases of state and local governments, you don't see any sign whatsoever. In fact, you see a contraction. So, calling it $800 billion is a bit of a myth, in terms of what was actually delivered as stimulus to the economy.
Russ Roberts: And another good chunk of it was tax rebate, that just--it's interesting to me. There's this myth that it was all these shovel-ready infrastructure projects. I don't particularly think that would have been a good idea or successful. But it's not what we did.
Robert Hall: I think that's right. If you look at the National Income and Product Accounts, at the category that would include these supposedly shovel-ready projects, you just don't see any expansion. Remember that most of that type of spending is done by state and local governments, not by the Federal government. So, the fact that [?] the Federal government couldn't articulate a change in what the other government units were doing came through very clearly. But, all research of every contraction assumes that the same thing happens. So, this is not really a surprise.
Russ Roberts: When you say, "the same thing," what do you mean?
Robert Hall: I mean, the Federal government would like to expand the economy by inducing state and local governments to spend more. But they don't have the tools to do it--at least, they have neither the political will nor the tools to make it happen. So, there's a long literature, as long as I've been an economist, which is a long time, that shows that discretionary policy aimed at increasing government purchases like infrastructure just don't work. Or, if they do work, they don't start stimulating the economy until it no longer needs it. There's some work that shows this. It's actually perverse, because it takes so long to get spending cranked up; if it ever does, it's when the economy is back into a boom condition.
5:33
Russ Roberts: So, what do you see as the set of factors that explains the mediocrity of this recovery, the fact that, as you say, eight years into it, into the recovery, we see very little recovery or improvement in investment? In the labor market, a lot of people have suggested it's been very disappointing. Even though unemployment is low, employment, labor force participation is low. What do you think explains it?
Robert Hall: Well, the two big factors you just mentioned, one of them, labor force participation totally unexpectedly fell several percentage points--at least 3 percentage points. More than you'd expect, even given the deep recession. So that's one factor. Even more important is simply the slowdown in productivity growth. We had productivity growth, but at much lower rates. And that's just fundamental to the amount of output. You know, I've studied the labor market pretty carefully, and I'm convinced--and other papers that I've written recently make the argument that the labor market is really is back to absolutely normal conditions. The unemployment rate of 4.6% is well below the long-run average of 5.9% for unemployment. Key factors like how long it takes an employer to fill a job--it takes longer than it ever has before to fill a typical job. That's a sign of a tight labor market. So, at this point, we can't say that there's a lingering effect in the labor market. But there are other lingering effects, which are--to quantify them, that paper you mentioned.
7:19
Russ Roberts: What do you think of the work of Casey Mulligan, who has been a guest on the program talking about the impact of changes in various welfare programs and their implicit marginal tax rates that have discouraged workers?
Robert Hall: Well, I think, philosophically, I agree with a lot of the points you've made, which is that we've created a system where people become dependent on programs, lose their benefits so aggressively that they become trapped. It just doesn't make sense to enter the labor market even though it's back to normal because of losing benefits. And there was a big expansion of benefits which has not completely gone back to normal, as a result. Casey's numbers are in some ways hard to interpret. I wouldn't want to endorse--certainly, the theme of his book, which was the entire recession was caused by it--does not square with anything I looked at. What I see is that about 8 million people suddenly lost their jobs, mostly in the late Fall of 2008 and the first half of 2009. And that was a major factor. Working that off was actually a--very time-consuming. And there's no way that it makes sense to say that those people only lost their jobs because there was an increase in benefits and they quit their jobs. We know they didn't quit their jobs. So, that part of it, I could--in my analysis, overblown. But the need for reform of benefit programs--Disability probably the most important one--is very acute. And there's just agreement across the board on economists, that point.
Russ Roberts: Related to that: Do you see the long secular decline--secular meaning over time--decline over time in prime age male labor force participation to be explained in part or in large part by that expansion of Disability opportunities? Or is something else going on? Is it people's skills--people are worried that, you know, these remaining factory workers, a lot of whom will not find good alternatives and are not returning to the labor market in the normal way?
Robert Hall: You know, it's a combination of all the things you mentioned. Probably some more. First of all, among men, it's a very long-term phenomenon.
Russ Roberts: Yeah.
Robert Hall: Labor force participation was much higher in 1950. And then it's--among men--and it's declined, a pretty smooth trend. Whereas the situation for women is quite different. There was a big increase in participation among women; and then, about 10 to 15 years ago that changed and you see some decline in participation by women. But, you know, work has become less common. And particularly work among young people--and most [?] factors that about--in the year 2000, not that long ago, about half of all teenagers at any given time were working. Today, less than 25%. So there's been a decline in half of the fraction of teenagers who are employed. That's the most extreme number. But you see the same thing among the 20- to 24-year olds. And you see it among older men, especially. And that's very tied in with evidence about the declining health moves[?] age groups, and the absorption by the Disability. Which there was bulge[?] of people going on to Disability, which has not reversed itself--going on Disability is pretty much a trap, in the sense that relatively few people make that decision and are qualified than exit.
Russ Roberts: We had Erik Hurst on recently talking about the--you mentioned teenagers. He found in his work with some co-authors, I think it's 21-30-year-olds who were non-schooled, I think 18% did not work in the previous year, compared to 8--I can't remember the time frame but it's a short time frame, and a lot of these folks are living at home.
Robert Hall: Playing video games.
Russ Roberts: Yep. That's what he says. I'm not sure it's--
Robert Hall: I followed the progress of that paper in detail.
Russ Roberts: I'm a little bit skeptical. Let's move to--or at least that video games are driving the change, which is what he's--I'm sure it's some of the [?].
12:05
Russ Roberts: Let's go to productivity growth, which you said is sort of the crux of the matter. A lot of people have argued recently, or at least a lot of prominent people have argued recently that the reason investment is down and productivity is down is because we've figured out all the interesting and productive things to invest in. What's your view on that hypothesis? And if you disagree, what do you look for to think about it?
Robert Hall: Yes. So, Greg Ip had an article in yesterday's Wall Street Journal. It's such a tired old story. And, you know, we have surges in productivity. There was productivity pessimism, say, around 1990, similar to what there is today. And a similar thing--all the good ideas have already been implanted[?]. And then the Internet came along and gave this very remarkable, or things like it.
Russ Roberts: Well, 'That was the last one! That was it. There was one left. We found it.'
Robert Hall: Okay. I gave a talk recently to a popular audience about computer vision and the changes that it makes. And for one example, I showed in the video the way trash used to be collected from households. Which, you'd have a truck with a team of 3 guys, 2 of whom rode outside and jumped off--
Russ Roberts: Yep--
Robert Hall: and emptied a trash bin and then pushed a button; and the thing went up; and then they would go to the next house. Today, the trash in most places, certainly where I live, is picked up by a truck that has 1 guy. And he barely stops. And then computer vision takes over. It spots your trash bin, wherever it is; reaches over. It adjusts for any mistakes the driver made, flips the trash--at least 3 times more quickly than the guys can do it. So, they have a 3-fold reduction in the number of people, from 3 to 1. And you have a tripling of the speed. So, the productivity of collecting trash has gone up by a factor of 9. And that's just scratching the surface of what computer vision can do. You know, the excitement about computer vision today is mainly a self-driving car, but there's so many other places. And it's a very, very intensive area of work by computer scientists. There's many, many tech startups right now whose main mission is to improve computer vision, and the improvements that have been made in the last few years are just stunning. So, I, you know, I don't try to forecast; but I think this productivity pessimism--I emphasize productivity uncertainty. Episodes like we've had recently, of a slowdown in, say, over a 6-year period, have been common. There's nothing statistically surprising about it. And they've typically been followed by productivity growth going to normal or even above normal. So, we have waves of productivity pessimism, and we have waves of productivity optimism. And that's what I've seen. And I've been watching this for quite a while.
Russ Roberts: Well, your remark about the trash pickup reminds me, not--at my current weight level [?]--to stand near the curb as the trucks go by. Could be mistaken. They are still getting some of the bugs out, I'm sure. I wouldn't want to be picked up by mistake.
15:44
Russ Roberts: But it's an example of where technology is being applied. And it may or may not be showing up in the data. What do you think of this argument that, say, in GDP (Gross Domestic Product), so many of the pleasures of life of the last 10 years are not very monetized, and we are not measuring a lot of the gains correctly in the National Income Accounts?
Robert Hall: Okay. Well, Chad Syverson, Chicago, has written a very interesting paper. We're[?] giving I think what started out as a kind of a neutral evaluation at that point. And he showed, using various arguments that sort of put it in a prelimit[?], that upper limit is pretty limited. The idea that we're somehow missing some huge benefits. Of course we are--
Russ Roberts: But we always have--
Robert Hall: but, you know, for example, the whole revolution in photography is not captured at all in our data. They still collect only--they base statistics on the assumption that people are using film and sending it off to be developed. And I wouldn't know where to go with film to be developed.
Russ Roberts: Right; I've spent $100 for software program to develop on my computer. It's a one-time payment. They upgrade it every once in a while. But I take 10,000 photographs on my computer--I have about 10,000. And it's glorious.
Robert Hall: I do exactly the same thing, probably the same software. Exactly.
Russ Roberts: And it's not being measured. Certainly my pleasure from it is not being measured. Certainly the pleasure I get from not having to re-take--only take 12 pictures and worry I got the right ones that I can take 1000 is just wonderful.
Robert Hall: Yeah. Exactly. So that's a very concrete example. But I think it's fair to say, when you look at what the economy produces and what we consume, there's just an awfully large number of things where we know nothing much has changed. Like the generation of electricity. Or building houses is a great example. It's a very large budget share; it's a growing budget share for housing in the United States. And, houses are being built today with exactly the same technology virtually as they were 100 years ago. It's a very big sector, much bigger than any of the ones that people are excited about, like photography, but it's not one where productivity growth has occurred. You have to get realistic. If you stare at the numbers for what we make, it's an awful lot of totally boring stuff where you know there's not much change in productivity going on or even possible.
Russ Roberts: So, when you say you're not a pessimist or an optimist, that you are a realist, the way I'd describe it, the fact that the last 8 years have been so disappointing--you're saying that's just a standard kind of slowdown that happens in the data now and then? And not to be worried about it?
Robert Hall: Well, I don't know--I hesitate to say that it's 'just,' because I've received a lot of study--like John Fernald, at the San Francisco Fed has been kind of the highly knowledgeable expert on that point, and he's written a number of papers there that everybody should read who is interested in this subject. But, it seems like there was this period of rapid adoption of revolutionary information processing technology, and that's somewhat slowed down oddly because there are so many places that you deal with every day that could be immensely improved. Like the airline that I fly that I won't name has a ridiculously bad website, a notoriously bad website. And if they could just hire the right people, who are numerous, especially in Silicon Valley, to write a decent website it would be a huge step forward for all of us. So it just hasn't happened. And we sit there waiting--every single time you enter anything it does a whole page load. Nobody writes websites that way today. That's just pathetic. That's the website of 1995. Twenty years ago.
Russ Roberts: Well, the cost of revamping that website, the time it would take and the--I guess they don't think those 3 seconds for that re-load, which are annoying to us, are going to be that valuable. And they don't think they can capture that monetary gain, maybe. I don't know.
Robert Hall: But it's odd because the companies that grew up with the web, especially Amazon--why doesn't Amazon start an airline? It seems to me that would just be perfect.
Russ Roberts: Well, they're close. They are really close, actually.
Robert Hall: It wouldn't surprise me, if they did.
Russ Roberts: Nor I.
21:12
Russ Roberts: One thing you haven't mentioned that we haven't talked about yet is interest rates. And one of the things that people have noticed--it's funny, it's been going on for decades but we just sort of noticed it, at least some of us have, at least some people just started writing about it--they've been falling for a very, very long time, through both good times and bad times.
Robert Hall: Well, that shows that you're younger than I am.
Russ Roberts: I don't know about that.
Robert Hall: In the first half of my career, they went up.
Russ Roberts: Well, that's true.
Robert Hall: They reached a spectacular peak, around 1981. And then it's been down from there.
Russ Roberts: But that's a long time--
Robert Hall: Of course, a lot of that--we are talking about nominal interest rates, though they were boosted a lot in the 1970s by growing inflation. They don't [?] monetary policy that further increased, just a double-whammy of high interest rates. And then we got back to normal, during the 1980s. But then other things took over: We got inflation down, so that was no longer an important factor; but there were other things which resolved into declines in real interest rates. It's normally that case that--first of all, interest rates are global. This phenomenon all over the world. And world economic growth has slowed recently. It's not just the United States, but China, for example--a big factor is China. So, the decline in growth is one thing. And there's others. I've just written a paper on this--you're invited to read, of course.
Russ Roberts: Yeah; we'll put a link up to it. But isn't that just the flip side of this concern that--this slowing of growth is the flip side of--I'll just say it's a puzzle. Normally after a recession, certainly a recession of the size we had in 2008, certainly the worldwide nature of it, it would be followed by a very brisk and dramatically recovery. We haven't seen that. Growth seems sluggish. What do we think is going on? People ask me; I just say 'I don't know.' It's easy for me. But 'I have no idea,' is my answer.
Robert Hall: I know something.
Russ Roberts: Well, tell me what you know.
Robert Hall: Okay. So, what I do know is that the labor market has behaved very much the way that it has historically. There was nothing very surprising about what happened in the labor market, once you come to grips with the fact that it was a very large shock. So, in terms of immediate job loss, it was by a considerable margin the worst.
Russ Roberts: In a long time.
Robert Hall: Yes, well, yeah, over the period since we measured unemployment, which started in 1948. So, that triggered this normally, fairly long period in which unemployment gradually declines. But that's always been true. People always get excited about it because recessions don't happen very often. For example, most reporters who are reporting on the Great Recession were not reporters when the previous recession occurred in 2001.
Russ Roberts: Correct.
Robert Hall: But, if you take--if you look--here are the numbers on job destruction. There were 8 million jobs destroyed, as I mentioned before in late 2008 and early 2009. There were about 5 million jobs destroyed in the 2001 recession. Which was actually a pretty bad recession from the job-destruction point of view.
Russ Roberts: Mild enough [?]
Robert Hall: Other things--it was followed--so, the reason that--so, we had what amounts to, structurally, a pretty normal recession/recovery, except that it was really bad. So, it was just scaled up. But, qualitatively it was all the same things would have happened previous recession. The thing that makes everybody think that recovery was slow is not what we should be calling a recovery at all. It's what happens to productivity. Productivity doesn't systematically do one thing or another over the business cycle. Here, we had low productivity growth at the same time that we had a normally-structured recovery from a very bad shock. But the combination gave an extended period, going up to today, of disappointing results. As of today, all the disappointment comes from things that are not related to recovery. The recovery is complete. But we are not where we'd like to be because productivity growth has been bad. And also because we have a legacy of not having formed much capital since 2007. And that's really hurting, too. And that was another of the big factors in the paper that you started the discussion with.
Russ Roberts: And to summarize that: So, that's a nice way to think about it, right? Low capital formation and low productivity; and of course in a way they are almost saying the same thing. They are certainly related.
Robert Hall: No, not the way--if we are talking about what economists call 'total factor productivity.'
Russ Roberts: Explain.
Robert Hall: So, it's the--normally the economy grows faster than you'd expect, given the fact that normally employment is rising and capital is rising. But output rises even more than you expect. And that's what's called a 'residual.' And the residual is also called 'total factor productivity'. The 'total factor' means that it's considering and giving credit to all factors, capital and labor, and not just labor. So, when you talk about total factor productivity it's already allowing--in this case it's allowing for the fact that--
Russ Roberts: [?] or less--
Robert Hall: capital formation had been very weak. By some measures it's back to normal today. It's very tricky to figure out what the right measure is. But there's still a legacy of capital that would have been formed if we hadn't had a severe recession which wasn't. And that's a nontrivial part of the total.
27:40
Russ Roberts: So, a lot of people want to blame a lack of investment on uncertainty of various kinds--policy uncertainty. We just had a 2-term President who came in and overhauled the health care sector and financial regulation, two significant parts of the U.S. economy, and overhauled the ways where the impact of it wasn't clear for a while. I think the legislation is still somewhat incomplete, even today.
Robert Hall: There's a question of whether it's viable, the premiums are going up so rapidly that nonviability is definitely an issue.
Russ Roberts: So, a lot of people, certainly on this program, who share my free market views have, you know, said, 'Well, of course the economy is lousy, or investment is lousy. It's because there's a lot of uncertainty.' My thought is: I'd love for that to be true, for my biases. But there's always a lot of uncertainty. Now we have a President who is really uncertain: what policies will be put in place. We'll see what is going to happen.
Robert Hall: Surely there is more uncertainty now than ever before--
Russ Roberts: Than ever.
Robert Hall: But the stock market loves it. So, it's a--I'm very familiar with that literature and I certainly respect the people who have worked on it. But, the connection they--getting a direct sort of causal connection has proven to be elusive and then in the literature, what is true is that--actually, 9/11, which my colleague has worked on, is actually a very interesting test of that proposition. In fact it was the first thing that Bloom looked at. And what happened there was there was clearly an enormous rise in uncertainty after 9/11. There was a brief period of diminished spending, investment and consumption spending. And then, you know, people looked around and said, 'I guess not.' And it occurred toward the end of a recession. And the economy behaved quite normally after that; and then we had a pretty good expansion through the end of 2007. So that was kind of a laboratory for that idea. It shows that the idea is valid; but on the other hand, the effect of what was kind of a transforming experience for many of us, on the economy was remarkably small just after a few months. By the way, there's another hypothesis floating around. The Council of Economic Advisers has a paper on its website questioning this idea that there's been a substantial increase in market power--
Russ Roberts: Yeah, I saw that--
Robert Hall: in this economy, and that translates directly into bad news on several fronts, including capital formation: Market power functions like a tax to discourage economic activity. I don't know if it's true. So far, as market power is one of the topics I worked on 30 years ago, and found it remarkably elusive to measure. And I don't--I think there's kind of a presumptive case in favor of it; there has been some increase in concentration. But I think it's going to be an area of research. I think that the policy uncertainty research has sort of done everything they can do--and they've done a lot and I think they've convinced some people, perhaps not me. But I think this market power hypothesis is going to get a lot of attention as another thing that's holding back, and maybe even holding back productivity. Now, to me it's a somewhat more promising idea.
31:39
Russ Roberts: Let's shift gears to monetary policy. I ask my guests, and I get asked a lot by my friends, why the Fed, why banks are holding excess reserves in the magnitude that they are at the Fed. And I get asked this question--it's usually a related question, which is, 'If the Fed was so aggressive, why didn't we have inflation? And does that mean that Milton Friedman and others were wrong?' And then people respond, 'No, because the banks are holding the money. And when the money goes out in the economy it will cause inflation.' And yet--I have not heard a good theory for why the banks are holding onto massive amounts of excess reserves rather than investing them. This is related somewhat to our previous discussion. So, what are your thoughts on these issues?
Robert Hall: Okay. Well, first of all, the first question is easy to answer. The banking system as a whole has no choice about the level of reserves. It's completely dictated by the Federal Reserve. If one bank decides to invest its reserves, the reserve just land at another bank. It's a sealed system [?]. There's a lot of misunderstanding of this point, but it's absolutely central to understanding monetary policy to understand that banks collectively have no choice whatsoever about their holding of reserves. It is completely determined on Constitution Avenue [i.e., the Board of Governors of the Federal Reserve--Econlib Ed.] So that's the first point to make.
Russ Roberts: You want to explain that? So, the normal way that this story gets told is that the Fed intervened in 2008, 2009, I think even kept going--quantitative easing of various kinds. And they bought a lot of assets that banks held, both government Treasuries as well as mortgage-backed securities. And they paid for those by crediting those banks on the balance sheets that they have at the Fed, with reserves that they could then lend out.
Robert Hall: Yeah, you know a more instructive way to say it: They borrowed the funds from the commercial banks and used the proceeds to buy bonds. Because a lot of people don't understand that the process that you just described is simply borrowing in the capital market. The Fed greatly expanded the national debt by issuing what are Federal obligations, borrowing--which are reserves. It's as simple as that. It's just a bank. It gets funds from one source and it uses them to buy securities of a different type.
Russ Roberts: And so the expansion? The so-called [?] where did it come from? Just--that's electronic magic.
Robert Hall: No, it's just as you described it. It's a conscious thing that the Federal Open Market Committee directs, [?] like to say, the Trading Desk to start buying stuff. Every time they start buying stuff, every time they buy stuff, as you pointed out, they do it because they have this automatic right to borrow from the banking system by creating more reserves. So they write a check, so to speak, which is increasing reserves. And they use it to buy bonds.
Russ Roberts: But you are suggesting that the banks, which have statutory limits--minimums--of what they have to hold at the Fed, now hold, because of those actions, they have much larger amounts on the Fed balance sheet. And if they try to lend those out to, say, homeowners and home purchasers, they can't do that--they can't change that, net?
Robert Hall: The system can't. Any one bank can. So, one bank can say, 'Oh, we don't like what they are getting today which is 50 basis points, 1/2 of 1%'--
Russ Roberts: That's the interest that the Fed is paying them for holding them there.
Robert Hall: Exactly. Right. And they look around; and that's completely safe; and they say, 'What can we get on other safe investments?' Well, less than that. Okay. So, they have absolutely no incentive, given the current state of the money market to do anything. Now, suppose that--
Russ Roberts: That's a separate point. That's a good point. I was going to get to that. But that's not the main point. Keep going.
Robert Hall: Okay. But then if you ask, 'What would happen if Alan Blinder,' who has been very vocal in The Wall Street Journal on this, and others, including me, but not so much in print, said, 'Well, that's a silly policy. Let's change the 50 basis points to 0.' Then banks would look around and they'd say, 'Ah! Now I'd really like to invest.' And so they would start, as you were saying. It's, 'I'm not getting the market return from reserves any more. I'll try to get rid of them.' But every time they try to get rid of them--which they do aggressively. But the reserves always land at some other bank. If you buy something--if you make a loan, then the funds are deposited in someone else's bank account; and that means that the corresponding reserves are moved to that person's bank. There's nothing the system can do. One of the anomalies here is that, for crazy reasons which I won't go into and don't fully understand myself but I know that my colleagues do--a lot of the banks that--the reserves under certain circumstances can be held by foreign banks, like Deutsche Bank in particular. So, Deutsche Bank, at one time--I don't know if it's true now--was actually the single largest bank holder of excess reserves. And they were harvesting money from the American taxpayers because the Federal Reserve for completely unexplained reasons was paying more than the market rate. This paying excess--being over the market rate--went into effect in October of 2008. At exactly the wrong time. Blinder just sputters; and he's a very middle-of-the-road kind of a guy. He's not political. Just economics.
38:02
Russ Roberts: Well, it's a mystery to me, too. When I--that was my next question, which is: there are two ways to ask the question, which is: One, the question is why the Fed started paying interest on reserves. The standard economist's answer is--and I know you've written a paper on it recently and you're going to be talking about it shortly--is: It was new way, it was a new instrument for the Fed to use in effecting monetary policy. For those of us who might not be economists, who might be political scientists or just everyday people, it looks like a way to take care of the banks through a tough time when they had very troubled balance sheets. Economists don't like to give that answer. Most of them. What's your explanation? In October of 2008, what were they thinking? What were either the economic ideas or the political forces that made that happen?
Robert Hall: Hard to say. Again, I'm not the--I somewhat stay away from that because--I never thought that, during the time especially when it was 25 basis points that it was the most important policy issue that some people do, like Alan Blinder did. I don't think we have a good answer to that. I think everyone is puzzled. Everyone applauded the Fed using the rate they pay on reserves as an instrument: in fact, certainly my feeling is that it should be the instrument of monetary policy. But if you asked then what I thought the rate should be, I would have said it should be negative. For example, the European Central Bank currently pays -40 basis points. There's actually a big difference. Obviously Europe needs to be stimulated more than the United States today, but even today, the 50 basis points they are paying, quite a bit more than they should. And they know that because they've actually created a new kind of reserves, the RRP. This is technical stuff; but they recognize it so fully that they've actually got two kinds of reserves now, and they pay the right interest rate, which is currently 25 basis points, on this new kind of reserves. We're going to, I think, gradually see a swing toward a more reasonable use of this policy instrument, phasing out old-fashioned reserves and then using these new kind of reserves.
Russ Roberts: Well, let me ask one more question to capture this idea that the amount of reserves is fixed at the Fed and they in fact just move it around. So, if real interest rates, real productivity in the economy grow to, say, 2, 3%, historical levels while the Fed continue to pay a half a percent--
Robert Hall: Oh, well, that would be a big surprise.
Russ Roberts: Right. Well, if that happened, walk me through the chain as banks then tried to get rid of their reserves. What would happen?
Robert Hall: So, an individual could say, 'Wow. I can now make a lot more money lending out, even adjusting for risk. For one thing, the interest rates you are talking about would apply to Treasury Bonds, and then there--
Russ Roberts: [?] and then 5 or 6% with riskier things.
Robert Hall: Okay. But let's say there's a safe interest rate to 50--to 1/2 of 1 percent, the Fed is paying. And if you go to the Treasury and buy a Treasury Bill, which is equally safe and is short term, and you get, say, 3%--well, it's a no-brainer to spend your reserves to buy Treasury bills from somebody. But then what happens? That person puts it in the bank and then that bank is saddled with excess reserves. Okay. So, the way we used to teach, why monetary policy can expand the economy, was the same logic: that if there were reserves around which banks regarded as hot potatoes and wanted to get rid of them, then as they all collectively started lending more that would expand the economy. That was the basic theory of why boosting the quantity of reserves, which was traditional monetary policy--this is Milton Friedman monetary policy--
Russ Roberts: That's the way I was taught--
Robert Hall: Quantity of money.
Russ Roberts: Yeah, not interest rates, not that it makes investment look more attractive. Just, yeah, print money; spend it.
Robert Hall: But that whole mentality was developed during a time when reserves received zero interest. So, everything was based on the quantity of reserves: if the Fed increased the quantity of reserves it would put hot potatoes in the hands of banks; they would try to lend it out; that would expand the economy. As the economy expanded, then we'd settle into a new equilibrium where the quantity of reserves was what the banks needed to use and the expansion would stop. Today, we need to re-map that into thinking about what happens if you change the interest rate that's paid on reserves. And then the corresponding thing to increasing the quantity of reserves is to lower the interest rate; that low interest rate makes reserves hot potatoes; that expands the economy. So, you are describing a situation that would be intensely expansionary.
Russ Roberts: Correct.
Robert Hall: Way more than I think anyone would choose.
44:05
Russ Roberts: Well, the only thing I'm confused about--it's probably more than one thing--is that, I thought you were going to say, as they tried to acquire those Treasuries, that demand is going to push the return on those back down, and make it hard for those interest rates--I'm wondering what the interest rate the Fed pays on reserves, how that affects the real interest rate in the economy and the rest of the economy.
Robert Hall: Well, it's very persuasive. That is, it simply has to be the case that Treasury Bills, which are essentially the same thing as reserves--they are safe obligations of the Federal government--they can't pay a return that's very different.
Russ Roberts: Correct.
Robert Hall: So, all kinds of things happen, as you were saying. But you are starting from a point where the Fed would never be. They would never be in a situation where market interest rates were that different from what they had chosen to pay on reserves in the new regime, because, remember that with $3 trillion dollars of reserves outstanding, they have to make those attractive enough. The stresses that would be caused in the situation you are describing would be--the economy would practically explode because of this difference. So, what you'd see is the Fed would never get into that situation. They would be inching up, just as they did; and what they're going to do next week [note: episode recorded December 8, 2016--Econlib Ed.] is probably add another 25 basis points, because they see market rates rising and they say, 'What matters to us is the difference between what we pay on reserves and market rates and we have to keep that differential fairly small because we've got $3 trillion dollars of reserves out there.' In contrast to the days when there were $17 billion dollars of reserves, where they have a kind of a free hand and in fact in those days didn't pay any interest on reserves and sometimes had a very large differential. But $3 trillion is a very different number from $17 billion.
46:13
Russ Roberts: So, what's the significance of that $3 trillion? Is it irrelevant? Is it important?
Robert Hall: It's a huge piece of the Federal debt.
Russ Roberts: I guess that's the right way to think about it.
Robert Hall: It would create what economists call a disequilibrium if the identical components of the debt paid different interest rates.
Russ Roberts: But don't people think--but that's a little bit--the Treasuries aside. Like you say, let's say those are just the same thing. Out in the real world there's some level of productivity that normally would be driving interest rates. I think what people are worried about is whether this $3 trillion, 3 point whatever-it-is in the Fed's books, is somehow affecting the real economy. You are saying it's no different from any other debt that the government runs.
Robert Hall: Well, no, it could be because the Fed does have a choice about what interest rate to pay. They do have that choice. I believe that what we'll see, and what we are seeing, and what we will see next week, is they'll track the rise in interest rates and keep the interest rate on reserves, in their case, a little bit above market rates. Blinder and I would say, we got that wrong: it should be a little bit below. But to the extent that they start switching reserves, which they could do at any time, from old-fashioned reserves to the modern reserves which pay a lower interest rate, 25 basis points less, then that would be a sign that they were reducing the subsidy that Blinder and others have been upset about. But I want to emphasize that's not a huge deal. This doesn't compare to some of the important policy decisions that are going to have to be made in our nation's capital soon, which is: Can we possibly finance our government?
Russ Roberts: Well, we're going to save that for another episode. But just to make sure I understand this: A lot of people say, 'Well, when are we going to get back to normal?' So, you are saying that it's not so unnormal to have $3 trillion compared to $17 billion, because it's just a different form of government debt?
Robert Hall: Absolutely. This question, when Bernanke started expanding the portfolio, very early in that process he put an essay on the Fed's website with sort of a speech that he'd given, which said, 'Look, we have two things we can do when normalization occurs. We could either keep the rate we pay on reserves at a low level and reduce our sales back to $17 billion of reserves. That's Strategy One; that's a completely viable strategy. Or, Strategy Two is we can pay market rates on reserves and we can continue to have trillions. And either one of those works fine. Don't worry: we've got two. We've got belt and suspenders.' And he's right. And, you know, Yellen has continued to make the same point as often as necessary. But [?] this idea that there was some kind of inflationary [?]--they've got two ways to prevent it from happening.
Russ Roberts: Yeah. I'm just not sure about the political economy there; and I'm not sure the political economy of having fiscal policy, the way you've described it, centered in the Central Bank rather than in the Congress--there's less accountability. I don't know.
Robert Hall: Yeah. Yeah. I'm not going to argue [?].
49:50
Russ Roberts: Okay. Well, let's turn--I'm fascinated by the NBER (National Bureau of Economic Research) dating business cycle--business cycle dating. 'I'm fascinated' is a bit strong. But I'm very interested in it. So I want to turn to that now. As far as I understand from the web, you've been the Chair of that committee since 1978, when it started--the official, of course they are dating for other recessions and booms, healthy times--that economists have created, and the NBER has created. But since 1978, you've been the Chair of this committee that decides when did a recession start; when did it end. [More to come, 50:28]