Time's up for time change

And inflation targeting and Social Security denialism too

Photo by Luis Cortes on Unsplash

Hello,

Welcome to Known Unknowns, a newsletter that believes in math, weighing trade-offs, and ending our barbaric time-keeping traditions.

Pension Geeks’ ears are bleeding

It does not take much to make a Pension Geek happy. We just like to value liabilities (using a market discount rate, of course) and compare them to assets. We are happier when they match. But if they don’t match (almost always a shortfall), we get concerned. It is just math. Pension shortfalls aren’t good; retirees are counting on their pensions. If the money isn’t there, they face benefits cuts, or someone else must pay up for them. And sorting it out tends to be disruptive and unnecessary because pension shortfalls are something we can see coming years in advance—and the problem only gets worse with time. Pension Geeks aren’t that special; we can’t see the future—we just are comfortable with numbers.

But this world is not for us. Somehow math has become political—especially when it is applied to Social Security—with both parties denying that the numbers don’t add up and pushing policies that won’t work. I wrote for Bloomberg about why lifting the cap or applying the 12.4% payroll tax to income above $160,000 (or $400,000) won’t be sufficient. First, it only covers 75% of the shortfall.

Apply the tax to investment income, too, you say? I suppose that’s a solution, but then Social Security is longer a universal pension scheme. And besides, I can’t believe it needs saying, but these are very large tax increases. If you make $250,000, that’s more than $11,000 a year in taxes, just on your wage income! Maybe if it saves Social Security, it is worth it. But we have other things to pay for. If we add up all the tax-the-rich proposals, we only get $10 trillion of revenue (assuming these taxes can be collected, which is doubtful when you have 70%+ tax brackets), while we are running an $18+ trillion deficit over the next ten years.

I feel like I am becoming a professional defend-the-rich-from-taxes-that-I-will-never-be-rich-enough-to-pay-myself advocate. But my genuine concern is that the math does not add up, and it is bad tax policy. It is dishonest to tell people that they can have an enormous middle-class welfare state and that they won’t have to pay for it. The fact is that the rich only have so much money, and you can only tax them so much. The truth is that we will all end up paying more—unless Paul Krugman’s forecast that life expectancy will continue to fall pans out. But I think we have better alternatives.

Losing my monetary policy religion

This is a weird economy. The job market just keeps on keeping on, and inflation is falling, but not by much—even as energy prices fall and supply chain issues are worked out. The inflation cat is out of the bag. The Fed keeps increasing rates, but it does not seem to be having much effect.

I’ve been thinking about things I have changed my mind about in the last few years. Three come to mind:

1.     Drug legalization. I used to be for it, but we clearly don’t have the wherewithal to regulate drugs and their sales in a sensible way—just go to Washington Square Park to see what I mean.

2.     Open borders (as a policy, I never supported not enforcing the immigration policies we have). I still think we should take more immigrants, especially economic migrants, but while open borders may be good for the economy, they are a disaster politically.

3.     Inflation targeting is effective and the best monetary policy.

The third one may be the hardest for me to let go of. Like most economists my age, I was raised on inflation targeting. It was my economic religion. The idea was that it is all about expectations, and if we set reasonable expectations, we could have low, stable inflation—and the best of discretion and rules. It all made sense at the time.

But then we adopted a 2% target, and the inflation rate has since been everything but 2%. And I anticipate the Fed will be in a bind soon. It will face a decent or good labor market and 3% or 4% inflation. That’s a pretty healthy economy. There’s nothing wrong with 3% or 4%, except it is not the 2% target. It may seem like Fed policy is not doing much now, but if it decides to go nuclear, inflation will fall, and there will be pain. But it may not be worth the cost. Will it really bring on a recession and job loss just to maintain the credibility of its target? That will be a tough sell.

But if it doesn’t get inflation to 2%, what does that target mean anymore? And if targeting works through credibility, it seems like it doesn’t work at all. Maybe the Fed never had any credibility to begin with. Right now, the Fed is trying smallish hikes and tough talk. If targeting and credibility worked as policy tools, you’d think that talk would be more effective.

But letting go of targeting requires a big rethink of monetary policy. I am starting to wonder if there is just a natural rate of inflation (based on supply, demand, and productivity), and the best the Fed can do is keep inflation stable around that rate—sort of like unemployment.

Hedging life

I wrote a long feature in City Journal about what I learned about risk management from the pandemic. It is a pity. We went into the pandemic with so much knowledge compared to the past, not only about vaccines and airborne viruses but also about risk management. Good risk management means accepting that you can’t eliminate risk, but you can apply a logical, transparent, and consistent framework to make the world less risky. Much of it is about communication but also weighing costs and benefits. We had the tools to make a bad situation less bad.

Instead, I was required by New York State to order a hot dog with a cocktail as a COVID-19 precaution. It felt like we retreated to superstition, even in the age of science.

In other news

Finally, this pointless and costly biannual ritual may be a thing of the past.

I spoke to Robert Inman about state and municipal finances. The federal debt ceiling gets all the attention, but what’s going on at the state level probably matters more to your daily life.

Until next time, Pension Geeks!

Allison