What’s Wrong With the Model?

I think that Joseph C. Sternberg misses some very important factors in his latest Wall Street Journal column critiquing the Federal Reserve:

Jerome Powell owes us an explanation. The Federal Reserve chairman this week confirmed what investors already had guessed: Surprisingly persistent inflation is dissuading the Fed from cutting its short-term policy rate as soon and perhaps as quickly as Wall Street had hoped.

It’s the right call. The Fed committed its worst error in 40 years when it acted far too slowly to tame inflation following the pandemic. Its institutional credibility—on which hangs a lot in a fiat-money system—now depends on Mr. Powell’s success in suppressing that inflation.

The problem is that the central bank keeps making new versions of the same old mistake, granted with a better policy outcome this time around. It’s still getting its inflation forecasts badly wrong and then acting on those forecasts in ways that exacerbate confusion in markets and the broader economy.

concluding:

While we wait, Mr. Powell needs to make policy today. What to do? Note here that one of the things that makes the Fed’s broken economic models so embarrassing is that the central bank keeps talking about them. Predictions are central to the Fed’s forward guidance—the press conferences, wordy policy statements and quarterly dot plots about future interest rates by which the Fed seeks to guide financial markets. Were it not for all this forward guidance, we wouldn’t know what the central bank’s models have been erroneously predicting in recent years.

Mr. Powell increasingly acts as if he understands this. One of his achievements over the past year has been to convince markets that concrete new data points such as the recent inflation uptick matter more to the Fed than the often bogus projections spit out by its computers. Yet the Powell Fed still relies on forward guidance to an unhealthy degree, a legacy of the Ben Bernanke and Janet Yellen eras. To adapt the old saw, perhaps if you don’t have something right to say, don’t say anything.

The first factor is that unlike the situation in, say, the early 1980s, monetary policy and fiscal policy are working at cross-purposes. That’s not unusual—it’s almost always the case. What was unusual is that in the 1980s that was not the case. The second factor is closely related to that one: the markets expected and expect a spending spree, i.e. monetary and fiscal policy will continue to work at cross-purposes.

The third factor is how different circumstances are now than they were in the 1980s, so different that I’m not sure how anyone could realistically expect Fed actions to have the same effects in the same timeframe as they did then. Just to cite one example of the differences in 1980 there were 192 banks with assets over $1 billion and more than 12,000 with assets less than $100 million. Now there are 250 with assets of $6 billion or more and about 4,500 banks in total. Banking has seen enormous consolidation over the last 40 years.

That isn’t the only difference. In 1980 the ratio of debt to GDP was about 30%; now it’s around 120%. Empirically, that has been demonstrated to make a significant difference in an economy’s performance. What effect does that level of debt overhang have on the Federal Reserve’s ability to control inflation with interest rates? We can guess but we don’t really know.

The last factor I want to mention is that inflation is a lagging indicator. Here’s a graph of the M2 money supply over time:


M0 is money in circulation plus commercial bank reserve balances. From the Richmond Federal Reserve:

M1 is defined as the sum of currency in circulation, demand deposits at commercial banks, and other liquid deposits; it is often referred to as “narrow money.” M2 is everything included in M1 plus savings accounts, time deposits (under $100,000), and retail money market funds. M3 is everything in M2 plus larger time deposits and institutional money market funds. (Because the cost of estimating M3 was thought to outweigh its value, the Fed stopped reporting it in 2006.)

What do you see when you look at the graph above keeping in mind that inflation is a lagging indicator? I conclude that the inflation that began to show up in the first quarter of 2021 was probably a consequence of the spending in excess of aggregate product in 2020. And we kept spending in excess of the increase in aggregate product. We’re still doing it.

I could go on listing factors. It’s a wonder that the Fed’s models reflect the behavior of the real economy at all.

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You and Whose Army?

In an op-ed in the Washington Post Michael O’Hanlon considers the question I asked earlier this week—what would it take for Ukraine to win in its war with Russia? He proposes a counter-offensive consisting of what is essentially a “human wave attack” against a particular point (unspecified) in the Russian lines. I have no basis for assessing the prudence of such a course of action in the absence of air superiority, something not considered by Mr. O’Hanlon, either. Here’s his analysis:

Popular lore notwithstanding, an offense does not need a 3-to-1 advantage in manpower or equipment across a whole military theater to have a good chance of success. But when attacking a prepared defense head-on, that kind of superiority is probably needed in the place where the army attempts to break through.

At or near this vicinity, Russia could be expected to have 40,000 to 50,000 troops within weapons range, or able to get there within a few hours — about 10 percent of the half a million troops it now has stationed along its 600-mile front line. To give itself a 3-to-1 advantage, Ukraine would need about 150,000 troops — at least 100,000 more than it would normally have along such a short length of front.

If Ukrainian troops punched through Russian lines, they could then work to widen the breakthrough corridor and penetrate farther. Eventually, they would look for an opportunity to encircle and cut off all the Russian forces holding Ukrainian land to the west of the breakthrough corridor — up to a quarter million Russian troops.

At this point, geography and topography would favor Ukraine, as it could attack Russian forces from behind. However, Ukraine still would probably not wish to fight Russia with less than an equal number of troops, and this means it would want at least 250,000 troops of its own (including the 150,000 deployed in the breakthrough). Some of these soldiers might be found by thinning out Ukrainian front-line positions elsewhere. But most will need to be fresh recruits or draftees. Ukraine’s current military strength of a little under 1 million troops would need to increase by at least 200,000 (and maybe even more, should Russia further strengthen its forces in Ukraine prior to a Ukrainian attack).

That’s a long-winded way of saying that Ukraine doesn’t have the soldiers it would need to carry out such a campaign. Where would it get them? By expanding conscription? That may be easier to say than accomplish. Millions of presently sub-draft age Ukrainian men have already left Ukraine. Furthermore, sending raw, notionally trained troops into frontal assaults against enemy lines with plenty of opportunity to fortify them is a formula for mass slaughter.

Do the NATO countries severally or corporately have the production capability to provide the munitions required for such a force? The existing evidence suggests not.

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With a Little More Effort…

The Illinois Policy Institute reports that Illinois ranks 48th of the 50 states in economic competitiveness:

A new survey shows Illinois ranking pretty low on economic indicators: 48th in the U.S.

That was Illinois’ cumulative score on 15 economic indicators tracked by the American Legislative Exchange Council Center for State Fiscal Reform in its 16th “Rich States, Poor States” report. High taxes, high public debt, high rates of people moving away and slow economic growth drove the ranking.

Here’s our showing in the factors:

From the source of the information:

The Economic Outlook Ranking is a forecast based on a state’s current standing in 15 state policy variables. Each of these factors is influenced directly by state lawmakers through the legislative process. Generally speaking, states that spend less — especially on income transfer programs — and states that tax less — particularly on productive activities such as working or investing — experience higher growth rates than states that tax and spend more.

I don’t know if that claim is wrong or right. It is something to think about. C’mon, Illinois. With a little more effort you can reach #50! Although Illinois and Chicago voters have consistently rejected referenda that would have accomplished that feat.

It’s certainly one of the factors influencing the state’s outmigration.

We’re worse on this index than California and better than New York. We’re considerably worse than all neighboring states.

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Is Trump a Traitor?

In the comments thread of the OTB post linked above, in addition to some very sound remarks by a regular commenter here, there was a comment on Donald Trump that astonished me in its vehemence. Rather than recap the comment I will merely ask the question: is Trump a traitor? Is there actual evidence of it?

My take on some of Mr. Trump’s comments, things called by some “cozying up to dictators”, was that he think you catch more flies with sugar than with vinegar. Maybe I’m being overly generous.

I don’t hate Trump. I just don’t think he should be president. I don’t think he should ever have been president. The reasons are simple. First, I do not think he is a good or decent person. Second, I don’t think he has the temperament, skills, or ability to make good on his promises.

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What Happens With Ukraine?

This post by James Joyner at Outside the Beltway is largely a round-up of articles sounding a similar theme: Ukraine is losing in its war with Russia. He observes:

On the one hand, depending on unlimited and indefinite external support for one’s war effort is a pretty good indication that you’re destined to fail. On the other, most of the countries that have pledged such support are pretty wealthy and have a strong interest in seeing Russia weakened, if not defeated—to say nothing of the moral and humanitarian interests at stake.

I was wrong in predicting back in 2022 that Putin would not invade Ukraine. I misjudged the intensity of his views if not his motives. However, since the beginning I have questioned the achievability of Ukrainian victory, defined as a return to the pre-2014 borders, NATO membership, and the attendant security guarantees against Russia. It’s not that I wouldn’t like to imagine that happening. It’s a matter of understanding Russian objectives and arithmetic.

The pieces to which James links are either 1) facesaving measures or 2) beating up on the United States or 3) beating up on the Republicans or some combination of all of the above.

Let’s approach this more positively. What would it take to achieve victory for Ukraine? I support aid for Ukraine because our aid keeps the Ukrainian government afloat and prevents outright Russian victory on terms decreasingly favorable to Ukraine (or us for that matter). That’s why I always accompany my support on an insistence on oversight which we have never really provided. What good to support the Ukrainian government if the money goes to line the pockets of some corrupt official?

I don’t believe we are capable of producing munitions at the pace at which Ukraine requires them, by the time we could build up our capacity the war will be long over, there just aren’t enough Ukrainians, and the risks of direct confrontation between NATO countries and Russia are just too great.

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Pick One of Five Futures for Russia

In a piece at Foreign Affairs Stephen Kotkin hypothesizes about five possible futures for Russia. They are:

  • France. A bloody revolution followed by a more liberal democratic Russia
  • Retrenchment
  • Vassal of China
  • North Korea. Non-functional dependency on China
  • Chaos

I would dismiss the first. It’s not going to happen. Mr. Kotkin never actually defines what he means by “retrenchment”. Russia won’t be a vassal of China or a long-term dependency of it.

Of the five I think the most likely are retrenchment or chaos. My definition of “retrenchment” would be continuing on much as it has although possibly less assertive. Chaos is the way Russia was before Ivan Grozniy.

What Mr. Kotkin either misses or dismisses is that there’s little that Russia is doing now that hasn’t been the case for 200 years or more. Somewhat Europeanize, not a liberal democracy, lots of corruption, authoritarian leadership, a somewhat paranoid foreign policy, the Orthodox church, etc.

While Mr. Kotkin correctly observes that Putin is not Stalin he misses the degree to which Putin is just a Russian politician. He’s telling the people what they want to hear.

We should all hope that Russia doesn’t follow the French model—Mr. Kotkin seems to forget that between the revolution and the emergence of a liberal democratic France there was Napoleon.

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Why Israel Will Strike Back

In an op-ed in the Wall Street Journal Eliot Kaufman argues the case that Israel must strike back against Iran:

Israel is being told again to let the problem fester and accept a tit-for-tat equation, but on worse terms than ever. “It’s only 100 ballistic missiles” is only the latest gruel to swallow, while Mr. Khamenei releases ravings, such as on April 10, about Israeli normalization with Muslim states: “The Zionists suck the blood of a country for their own benefit when they gain a foothold.” The world brushes off the antisemitism. The media doesn’t even report his statements.

Mr. Biden asks Israel to put its faith in deterrence while its enemies become stronger and Israel is the one deterred. When the president threatens that Israel will be isolated, on its own if it defends itself properly, he is asking it to stick to the strategy that left it fatally exposed on Oct. 7 and that it swore off the same day.

I have no idea what the Israelis are thinking at this point. I suspect that failing to strike back at Iran will make matters extremely difficult for Mr. Netanyahu politically while Israel striking back at Iran will make things politically even more difficult for President Biden.

My own view is that while there were several ways to avoid tying the president’s political future to Israel, we have done none of them. Imagining an Israel that does not exist, a Gaza that does not exist, a Palestine that does not exist, and political leadership in Israel and Palestine that do not exist is not conducive to good policy.

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Signs of the Times

I’m going to violate my own conventional practice and quote in full an op-ed in the Wall Street Journal by Suzy Welch, the widow of former GE CEO Jack Welch, and a management prof:

To everyone who sent me the article reporting General Electric’s sale of Crotonville, the longtime learning center that was the pride and joy of my late husband, Jack Welch, I’d like to thank you for the ugly cry. It is indeed the end of an era: one when companies and employees were on the same team.

That’s done and over, isn’t it? Today, companies and employees are each in a boxer’s crouch, glaring across the ring.

I wonder sometimes what Jack would make of my M.B.A. students—not to mention Generation Z in general—who view every employer with a gimlet eye. They aren’t only thinking, “How are you going to help my career?” or “How much will you value my ideas?”

They’re thinking, “How fast are you going to chew me up and spit me out? Because that’s how it works now.”

In too many cases, they aren’t wrong. No one works at one company for very long anymore; that’s a given. We all know the reasons: changes in tech, economic shifts, demographic trends, the zero-sum zeitgeist. A friend, a Sloan graduate, just hit nine years with one company, a big e-commerce platform. She told me she’s considered a lifer and something of a freak of nature.

Crotonville was a shrine to such “freaks,” people who so bought into the company’s values that they considered it an honor to be invited to an off-site program where they got to talk about those ideas even more than they did at work.

Crotonville was based on the notion that you could love your company. And your company could love you. I remember those days with bittersweet nostalgia myself, but this seems like a laughable notion in 2024, doesn’t it?

Early last semester, I invited Emily Field to present to my class at New York University on managerial skills. She’s a McKinsey partner and a co-author of “Power to the Middle: Why Managers Hold the Keys to the Future of Work.”

During the Q&A, a student asked about motivation. After Ms. Field’s reply, which I agreed with, I added, “Look, what Emily is saying is that managing people is hard, because to do it right you have to authentically care about them. On some level, management is an act of love.”

“Oh, absolutely,” Ms. Field said. We both looked up to see 60 mortified faces. Hands shot up.

“You need to keep boundaries at work.”

“You can’t trust your boss.”

“Companies don’t love you, they use you.”

For a few minutes, Emily and I were like Butch Cassidy and the Sundance Kid. We stood our ground, but I left class shaken. For the rest of the semester I continued to make my case—that companies and their people are one and the same. Or they should be. Work is better that way—more productive, interesting, effective, enjoyable. Jeepers, it’s more fun.

Yes, fun at work. Imagine that.

Gen Z can’t, it seems. Work is what you do when you can’t be doing what you want.

Handshake, a job site solely for college students and recent grads, recently conducted a survey of 2,500 undergraduates. When asked for their definition of career success, 78% of Gen Zers named sustaining a work-life balance as their top choice. Dead last was “advancing to a senior role,” at 40%.

This trend has reverberations through corporate America. At Brunswick, where I’m a senior adviser, we’re used to clients presenting all sorts of strategic problems. Lately, “employee engagement” has topped the list again and again. Here’s another data point: In 2023 a Gallup poll found that Americans are unhappier at work than they’ve been in years.

Crotonville wasn’t built for times like these. That would have made Jack sad.

I thought you might find it interesting. Did Crotonville close because it was no longer useful, because it was too expensive, or GE’s management no longer saw the use of it?

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Jack in Motion


My wife managed to capture a picture of Jack in motion and I thought I would share it.

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Why Is Measles Back?

The editors of the Washington Post are alarmed about the return of measles to the United States:

This year is not yet one-third over, yet measles cases in the United States are on track to be the worst since a massive outbreak in 2019. At the same time, anti-vaccine activists are recklessly sowing doubts and encouraging vaccine hesitancy. Parents who leave their children unvaccinated are risking not only their health but also the well-being of those around them.

[…]

According to the World Health Organization, in 2022, 37 countries experienced large or disruptive measles outbreaks compared with 22 countries in 2021. In the United States, there have been seven outbreaks so far this year, with 121 cases in 18 jurisdictions. Most are children. Many of the outbreaks in the United States appear to have been triggered by international travel or contact with a traveler. Disturbingly, 82 percent of those infected were unvaccinated or their status unknown.

As the passage quoted above makes clear they lay the blame for the outbreaks solidly on those avoiding vaccinating their kids and the “anti-vaccine activists” sowing doubts.

While I don’t disagree with that I suspect there are other factors as well. Among those are the degree to which the public health bureaucracy has undermined itself. It only takes one lie to undermine confidence and during COVID the public health bureaucracy lied to us at least once. Furthermore they oversold the effectiveness of vaccinations, partly out of ignorance, partly out of good intentions.

Additionally, I don’t believe that most Americans understand that measles hasn’t been wiped out (like smallpox) but that materially universal vaccination against it prevents it from spreading. Measles can’t be wiped out until it’s wiped out everywhere and that appears very unlikely at present.

Finally, the strategy for dealing with anti-vaccine activists’ “sowing doubts” is through reasoned discourse and evidence rather than censorship. Censorship can come right back at you.

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