Known Unknowns

A false choice


Welcome to Known Unknowns, a newsletter about the risk of ignoring what we know.

We are doomed to forget the past

I wrote a review on Nicholas Wapshott’s book about the Samuelson/Friedman rivalry. It was a good read and timely. It feels like we are reliving many of the same policy mistakes we made in the 1970s. Inflations is up because of supply shocks; the Fed is insisting it will go away if we ignore it and also justifying ignoring it even if it doesn’t go away.

My latest Bloomberg column explores why we may not be doomed to repeat the 1970s. It is not because I put so much faith in policy. There have been structural changes to the economy that make prices less likely to spiral out of control. Most of them have to do with trade and technology. We get more stuff from abroad and can observe prices across different sellers on the Internet. Both of these factors exert deflationary pressure – or they do 98% of the time. But I also wonder if there’s a tail case where they can cause inflation to spiral upward. If trade shuts down, then we’ll have more severe shortages, since our economy has become more dependent on trade. Online platforms can also mean a bigger population of buyers for a small amount of goods. I don’t think we’ll get into those tail cases for long. But it is worth thinking about.

The biggest reason to fear higher inflation is if expectations become unanchored, and that’s a serious risk – and the Fed is playing with fire when it comes to its credibility. Though it may not have much choice, since Powell would be replaced if he gave off the slightest whiff of a hawkish tendency. So much for independence. I would not be surprised if there’s more price volatility, more uncertainty, and 3% to 4% inflation in our future. Which is not a trivial increase compared with what we are used to.

Anyhow, back to Nicholas’ book. It is a great time to read about how the Philips curve broke down and economists learned that the trade-off between inflation and unemployment was actually a false choice. If you think you can exploit the Philips curve to lower unemployment, you just get stagflation.

Expectations matter – and so does appreciating the limits of monetary policy.

And make new mistakes

I have a many thoughts and feelings about the $3.5 trillion budget. I could get behind some of the expansions to our entitlement state. As I’ve argued before, it could use some revising, and many people are falling through the cracks.

But the actual substance of the bill feels like an after-thought. It is not enough to offer child-having tax refunds, housing, childcare, pre-K, community college, electric cars for the upper-middle class, tax cuts for the upper-middle class, and much more. How you structure these benefits really matters – not only in terms of expense but also in terms of the incentives they create for work, marry, and take risks.

Getting those things right helps us pay for benefits because they support growth. I am not sure what’s more ludicrous: the idea we can expand entitlements to this extent and only extremely rich people will need to pay for it or the hardened belief that people don’t respond to incentives. I think the flaw here is the belief that economic growth is inherently zero sum. It follows from that assumption that incentives don’t matter because growth only happens if one person loses and another gains. Therefore, we can choose our winners and losers without any loss of prosperity.

I reject this proposition. The evidence is overwhelming growth, and innovation is how we prosper. It is not zero sum. Yes, there is scope for redistribution, but how you do it really matters. In this bill, content and structure are getting almost no attention. Even if I don’t agree that all these programs are worth our tax dollars, they all deserve better. Universal pre-k can be valuable or much worse for kids depending on how you implement it. The plan to subsidize childcare will increase prices. If we want cheaper, better care we could reform licensing requirements instead. But it feels like such details are besides the point. And big universal benefits are not as popular as you might think, especially when people have to pay for them.

What really bothers me is long-term care. I can get behind paying home health aids more (though forcing them to unionize is unwise, and it will be bad for many undocumented workers), and even an expansion of Medicaid can be justified. But it also feels like policy-makers have put very little thought into how we’ll pay for an increasingly old, sick population that needs care. The latest proposal appears to be inching toward universal LTC: It offers care to more people and does more to crowd out the private market.

Maybe before we do that, we should have a conversation if we want a universal long-term-care program. I don’t because that it means little choice in your care and its quality. I wouldn’t want that for my family or myself. But reasonable people can disagree.

I’d prefer reforming Medicaid while we are at it. Get people off waitlists, pay home aid workers more, but also not totally crowd out the long-term-care insurance market. We need to reform and strengthen asset limits. Private insurance isn’t viable now. But it can be. I think the ideal long-term-care solution is a combination of private and public options.

I bet many of you didn’t even know long-term care was in the budget. Blink and you’ll miss the actual provisions in our largest entitlement expansion in decades. This is all stuff that deserves careful thought and debate. For Obamacare, we had debates and townhalls – where are they now?

I have a feeling the budget will be pared back, and it seems LTC will be first on the chopping block because we’d rather spend the money on electric car subsidies and restoring the full SALT deduction. But this problem is not going way.

In other news

I recorded a podcast with Zvi Bodie and Robert Lerman. We discussed how I became an economist and how I got here. It’s a great series; they are excellent interviewers and have spoken to economists I’ve long admired.

Until next time, Pension Geeks!