Known Unknowns

Hello,

Welcome to Known Unknowns, a newsletter that embraces ambiguity.

Still no stimulus

Well, GDP dropped 32.9% (annualized!) last quarter, the biggest drop ever since they began to measure quarterly GDP. But this isn’t all that surprising, because we’ve never shut down the economy before, either. The next quarter remains unknown, too, because everything depends on the course of the virus.

What’s extraordinary about Covid-19 is it consistently proves everyone wrong. Whatever you thought would happen in March was wrong. Maybe you thought it wasn’t such a big deal---wrong. Maybe you thought 2 million Americans would die by fall—wrong. Whatever you think will happen this fall and winter is probably wrong too.

I’ve been thinking a lot about how we communicate risk. We depend on our neighbors to make good choices that ultimately impact us all. The government can’t control us, at least not in this country. We need to help people better understand risk and then trust them to make the right choices. But nothing about how we disseminate information through either traditional or social media is consistent with good risk communication. Rather, it either minimizes risk entirely, or tends to overhype tail cases. If you watch the news, you’d think it’s pure chaos, that everything is getting worse and that only a vaccine will end this situation once and for all. But really our best hope is responsible behavior and learning to live with risk. This is not only necessary to manage the virus, but also to get the economy back on track.

Arizona’s trajectory looks somewhat similar to that of New York, and even while not shutting down everything, New York still has many restrictions in place, and the state also has one of the highest unemployment rates. It would be good to know what exactly worked in Arizona, and which policies offered the biggest bang for the buck in terms of the shutdown. And is there a level of risk that we can all live with, or does everything have to be safe and guaranteed?

On a related note, nuance is also lacking in any talk of extending the $600 unemployment insurance enhancement. It officially ended last week, and Congress is still debating what to do about it. Meanwhile, the unemployment rate is at 11.1%—all of those people just got a big pay cut. I’ve read lots of commentary stating that cutting the benefit will send the economy off a cliff, but 5 out of 6 recipients are getting more from UI than they had previously earned while working. I’m not sure why many households require more income now than they had before the pandemic hit. It’s no wonder that saving is up.

Listen, I get it. Unemployment benefits normally replace 30 to 50% of income, and we definitely should top that up—after all, there are lots of numbers between $0 and $600. And it may be too much to ask states to ensure that everyone’s benefit is less than 100% of their working pay, so a flat amount makes sense. But it doesn’t need to be $600.

Yes, I’ve read the studies that insist that small businesses owners who complain that they can’t get people to return to work is strictly anecdotal, and that we should ignore them. And I agree: the lack of jobs is the biggest problem. But hopefully the economy will start some recovery this fall, and a $600 benefit could be a serious obstacle standing in the way of this happening. Small business owners have had such a rough time, so why are we making it harder for them by increasing their labor costs? The CBO estimates the extra $600 will boost the economy in 2020. But they also expect it will slow the recovery. They project extending it through January will mean lower GDP and employment in 2021.

We have no idea what the fall will bring. We need an unemployment benefit that allows from some flexibility for the economy to recover, while providing people some certainty. And committing to $600 until who knows when (because it's never a good time to cut pay), is not it.


The problem with no harm

The big tech CEOs testified before Congress last week, and I keep seeing legal scholars looking for ways to justify breaking up big tech, even if they can’t prove that big tech causes economic harm. Why would you want to break up a company if it doesn’t pose harm?

Yes, I know that some critics see big tech’s sheer size as problematic. But why is big necessarily bad? It could be that in a more global/tech economy, large companies are necessary in order to scale and compete. That could be why all industries are dominated by large, more productive firms. It could be a market failing, or simply just a structural change to the economy.

A more legitimate concern is a lack of competition, but I’m not entirely sure that there’s harm there, either. In principle, there is no problem with small firms innovating and being bought by bigger firms that have the means to scale up their technology and improve their product with more data. What supposedly keeps big tech big are its networks, which ultimately create a natural monopoly. But networks are not that durable—they aren’t like power grids. People are fickle, and are happy to jump to a new technology when it comes along. For example, does anyone under 25 use Facebook anymore?

To be sure, there are lots of problems with big tech, including some dodgy use of data, as well as platforms like Amazon, the App Store, and Google prioritizing their products. Hate speech and conspiracy theories are widely shared, and there’s certainly scope for regulation here. But breaking up big tech doesn’t actually solve any of these problems. Breaking up big firms worked in the old economy, with traditional monopolies. But now we live a new world, and that calls for new solutions.

The Fed needs more theorists

There was also a Fed rate decision last week, which—as expected—entailed no change. The FT has a nice discussion about how low rates are now our new normal, even if the economy bounces back, because the neutral monetary policy sets rates at the natural interest rate, which is now lower.

The FT doesn’t know why it’s lower. It could be demographics or more global trade, which increases the demand for a handful of low-risk assets. I wish more economists were theorists, because understanding why the risk-free rate is low and whether or not it will survive de-globalization is important. Pure empirical work isn’t enough. We need a better understanding of what’s moving markets and changing the financial system.

The FT makes a great point regarding how the Fed really can’t control the natural interest rate, so it’s odd that some commenters and Fed governors are pushing for yield curve control. If the Fed can’t manage short-term rates, how would it expect to control long-term rates? It’s never been able to before because long-term rates are set in the market. It seems that yield curve control would require Fed bond buying like we’ve never seen for a very long time. How can Fed independence exist under such circumstances?

It’s like we just can’t seem to live with risk anymore. We’re waiting on a vaccine to take COVID-19 risk to 0, and we also expect the Fed to buy enough bonds to fix the economy. Maybe instead we should just accept that these tools reduce risk, but that we also have to act responsibly and learn to live with ambiguity.

In other news

Anti-racism starts with financial literacy. Knowledge is power.
Don’t trust those private equity returns. I’m looking at you, public pension funds.

Until next time Pension Geeks!

Allison