AEIdeas The public policy blog of the American Enterprise Institute Fri, 24 Oct 2014 20:32:28 +0000 en-US hourly 1 Oil price slump sets the stage for America’s ‘shale boom 2.0′ Fri, 24 Oct 2014 20:32:28 +0000 read more >]]> eaglefordrigmarcellusIn today’s WSJ, physicist and Manhattan Institute senior fellow Mark Mills explains why “The Oil Price Swoon Won’t Stop the Shale Boom,” and why in fact Shale Boom 2.0 is coming, here’s an excerpt:

With oil prices sliding, energy investors are worried, while Saudi Arabia and Russia no doubt hope, that low prices will cap America’s boom in shale-oil production. But price dips are common in oil and other markets subject to cyclical swings. True enough, sellers of any product prefer high prices to low; but the current slump sets the stage for what I call America’s shale boom 2.0. Three factors make it unlikely that the decline in oil prices will bring the shale revolution to an end.

1. Shale production is profitable at today’s lower prices. We know this because the boom began during the Great Recession years of 2008-09, when prices fell below $50 a barrel. The price U.S. shale producers got for their oil during the boom averaged around $85 to $90, even though the world price stayed well over $100.
That spread—the difference between the West Texas Intermediate (WTI) and world (Brent) price—was a direct consequence of too much domestic oil chasing too little capacity to move, store and use it. Yet in the past five years alone more than $500 billion of private investment went into hydrocarbon infrastructure. U.S. shale output was obviously profitable enough to spur the stunning growth in production and infrastructure when domestic prices were in the same range as world prices today.

2. Shale production is getting more efficient, which means that profits are possible at prices even lower than today. Smart drilling techniques—horizontal drilling, hydraulic fracturing and information technologies that accurately locate where to place rigs and enable precise steering of the drill through meandering horizontal hydrocarbon-rich shales—are far more productive than when the boom started.
According to the Energy Information Administration, the quantity of shale or natural gas produced per rig has increased by more than 300% over the past four years (see examples in the charts above). This rise in productivity matches (in equivalent terms of capital cost per unit energy out) the improvements in solar power, but it took 15 years for solar’s gains. Solar is now experiencing a slow-down in efficiency improvements; there is no sign of a slow-down in shale technology.

3. You might think that the latest drilling technologies are already in use, an easy sell when cash is gushing. Not so. Businesses rationally resist spending to disrupt existing machinery and operations simply to learn new tools and techniques. But they will chase profits through efficiency-boosting innovation in leaner times.

The pipeline of next-generation shale tech has been piling up with unfielded advances. These include automated drilling, micro drilling that allows for far faster deployment with a smaller rig footprint and new types of drills (some may use lasers soon), and big-data analytics to maximize yields by tapping into the surprising volume of data from complex shale operations. There is also nanotechnology to radically improve chemical formulations and safety, on-site water recycling and even water-free fracturing, and new classes of high-resolution subsurface imaging to radically improve exploration and production using real-time and microseismic imaging.

In a few years, as new technologies are adopted, journalists will be writing again about the “surprise” that U.S. production expanded by another three million barrels per day on top of that much growth over the past few years. The bounty will in due course spread to other nations where the geophysical shale resources easily match the thousands of billions of barrels in the U.S. Oil prices will continue to experience cycles as technologies are deployed. And the world will stay awash in oil.

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Not-so-dangerous thoughts on retirement security Fri, 24 Oct 2014 19:02:49 +0000 read more >]]> John. G. Taft is undoubtedly a smart man. He runs the Royal Bank of Canada’s wealth management department for the U.S., which you couldn’t do without being pretty bright. One pitfall for bright people, however, is that you sometimes think because you know a lot about one thing that you know just as much about other things. And that’s the case in Taft’s Huffington Post column that casts my views on the so-called “retirement crisis” as “dangerously misleading.”

In a recent Wall Street Journal op-ed, Syl Schieber and I pointed to Social Security Administration estimates, which find that the typical new retiree today has an income equal to about 116% of his career-average earnings, adjusted for inflation. SSA projects that future retirees will have about the same “replacement rates,” which is one reason (among many others we cited) we don’t see a retirement crisis in the forecast.

Taft takes issue with comparing retirement incomes to real average earnings over a person’s full career, saying this comparison to “career average earnings” is “flawed and their conclusions are dangerously misleading.” Tafts elicits this explanation from investment consultant Charley Ellis:

My average lifetime age is 37, but I am 74. My lifetime average earnings peak came at 45, but my peak responsibilities and peak pay (adjusted for inflation) came almost 20 years later. I’m OK with retirement income at 70% or 80% of peak, but not 70-80% of my pay at 45 which would be (inflation adjusted) only 40-50% of my base rate.

Let’s assume that Ellis’s earnings trajectory over his life is typical of most Americans. If so, and if the median American retiree today has an income equal to 116% of his career-average earnings, that means he has a retirement income equal to 70% of his peak earnings at age 65, right in the 70-80% range that Ellis says is appropriate. If you’re going to use a numerical example to disprove something you should make sure that it, well, actually disproves that thing.

Moreover, there’s a whole field of research on retirement income security that, to be frank, most financial advisors really know very little about. For instance, research showing that a typical household could smooth its standard of living over its lifetime – which is the main point of retirement planning – with a retirement income equal to 69% of its real, career-average earnings? Or other research showing that most retirees judge their standard of living to be equal to or higher than before retirement? Or other research showing that most households are able to maintain their standard of living as they shift from work into retirement, and even increase spending on things like entertainment?

More generally, there’s too much argument from anecdote, based on citations to, say, the percentage of Americans with retirement accounts or the average account balance. But what percentage of Americans should be saving for retirement? It’s easy to say 100%, but that’s not what economic theory says – young people may rightly focus on, say, paying down college loans, while very poor individuals who receive high replacement rates might rightly focus on putting food on the table. What we need are comprehensive, rigorous studies of what households will need in retirement and what they are likely to have. Some of these exist – and they tend to debunk the “retirement crisis” meme – but more are needed.

I’m not saying that everything is hunky-dory in terms of retirement preparation. A large number of Americans are underprepared for retirement and we need to know who they are and what policies will (and won’t) help them. But these are serious issues and we need to treat them seriously.

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Low oil prices fuel death spiral of Venezuelan regime Fri, 24 Oct 2014 18:01:02 +0000 read more >]]> Oil prices plummeting to four-year lows has compounded Venezuela’s budget and governability crisis, leading that government to call for an emergency meeting of OPEC member nations. Until now, Venezuela’s petrodollars have prevented a complete collapse. Now that oil prices are declining drastically, the government does not have the revenue to placate its political base and buy off power-hungry rivals. (Ironically, the reliable source of oil revenue from the United States is propping up Maduro’s hostile regime.)

The price of oil benchmark West Texas Intermediate dropped today to its lowest point in over 4 years, reaching just $80.38 a barrel. Experts point to two causes for the steep decline, an excess supply and a decision by Saudi Arabia to cut its prices in hopes of undermining competition from US shale. Oil revenue is vital to Venezuela’s economy, making up 95% of its export earnings and nearly half of its fiscal income. Analysts have concluded that, in order for Venezuela to sustain its current spending levels, oil prices have to reach $120 a barrel-nearly 50% higher than current lows.

The precipitous drop in oil prices could not have come at a worse time for Venezuelan leader Nicolás Maduro. For years, his predecessor Hugo Chávez and he have burdened Venezuela with massive corruption, suffocating bureaucracy, bloated social programs, ruinous economic policies, and anti-competitive measures (such as the illegal seizure of ExxonMobil’s operations). These ruinous practices have caused food shortages, power outages, rampant insecurity, and crumbling infrastructure.

The drop in oil revenue exacerbates Venezuela’s already substantial economic woes. Last month, Standard and Poor’s downgraded the South American country’s credit rating into junk territory. It also has an inflation rate of 63.4%, the highest in Latin America. Rumors of default have been swirling for months, and the reduced oil revenue makes it all the more likely. Venezuela’s appeal for an OPEC meeting, presumably to advocate for a higher price, comes just after a ruling by a World Bank arbitration body ordering the government to pay ExxonMobil $1.6 billion in compensation for the 2007 expropriation of the US company’s operations in the Orinoco basin. Venezuela still has more than 20 pending cases against it based on similar abuses.

Maduro has been postponing budget cuts or other remedial measures for fear of upsetting his crumbling political base and roiling domestic opposition. Some analysts estimate that Venezuela could avoid collapse with oil prices as low as $60—but only after serious structural adjustments and curtailing of profligate spending.

If Maduro is forced to slash social programs or rein in corruption to compensate for lost oil revenue, it will threaten his shaky grip on power. His predicament underscores his dangerous dependence on Cuban advisors—who excel at repression, not reform.

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Are Americans saving enough for retirement? Some myth-busting by Andrew Biggs Fri, 24 Oct 2014 17:42:55 +0000 read more >]]> It’s national retirement week, so we have rounded up some of the top pieces by AEI economist Andrew Biggs on retirement, Social Security, and whether or not Americans are saving enough.

“Is there a retirement crisis?” Biggs:

Adequate retirement income, in this sense, is an income that allows retirees to maintain their pre-retirement standard of living. It is not an income that makes a household rich in retirement; indeed, it is possible for a household to smooth its consumption perfectly between work and retirement and yet have a very low level of consumption in both periods. …

Simply put, to understand retirement preparation we need to know how much Americans are setting aside for retirement and how much they will need. Unfortunately, many of the popular and influential studies pointing to a retirement crisis get one or both of these answers wrong. Some studies ignore Social Security’s progressive benefit formula, which replaces a far larger percentage of pre-retirement earnings for low and middle earners than for high earners. As a result, a lower earner need not save nearly as much to supplement Social Security retirement benefits. Other studies ignore the fact that workers with advanced degrees may have student debts that slow early-career saving relative to those with less education. But the advanced degrees often result in higher earnings that give workers greater saving capacity later. Finally, most studies completely ignore the effect of children on household consumption and saving patterns.

Simply put, says Biggs, the “retirement crisis is hyped.” Indeed,  the “better academic research concludes” that only about 25% of Americans “are undersaving for retirement. Of this group, savings fall short of optimal levels by 15 to 20%. These results match up well with opinion polls, in which 75% of current retirees say they have sufficient income to live comfortably.”

The above chart on the retirement “crisis” shows “the composition of household wealth over time, measured as a percentage of GDP.”

If you look for the single biggest change over about the past half century, you’ll see it’s a “massive increase in retirement savings – traditional defined benefit plans, IRAs, 401(k)s, and so forth. (These figures don’t include Social Security, which also has been growing.) Roughly speaking, pension saving today is equal to about 100% of GDP, while back in 1950 it was maybe one-fifth that large.”

“Miscalculating the retirement income you’ll need”:

It is now conventional wisdom that Americans face a retirement “crisis,” in part because Social Security benefits are seen as inadequate. For instance, the Social Security Administration’s website …. notes that “under current law, if you have average earnings, your Social Security retirement benefits will replace only about 40%.”

That line of thinking is misleading, often cited by progressives fighting benefit reforms that would address Social Security’s $10 trillion shortfall. Here’s why: Financial advisers do not calculate replacement rates the same way the Social Security Administration does. When the calculations are consistent, the replacement rate paid by Social Security comes closer to 60%, which substantially changes the retirement-income picture.

And finally, “there is an easier and cheaper way to improve retirement security,” according to Biggs, and several countries are already doing it. Here are someProgressive non-fixes to a non-retirement crisis”:

First, the government should provide all retirees with a flat retirement benefit, regardless of how much they worked, or earned, prior to retirement. For instance, we could provide every retiree with a poverty-level income at roughly half the cost of the current Social Security program. This would take the poverty rate among retirees from around 9 percent to zero percent. For the poorest one-third of retirees receiving Social Security, this would be a benefit increase. And for those who don’t even qualify for Social Security under current rules, this minimum benefit would be a life-saver.

But second, since the government benefit would be capped, middle and upper income workers would have to save more on their own. To help, every employee would automatically be signed up for a retirement plan if their employer offers one. For employees who aren’t offered a pension at work, the government could allow access to the Thrift Savings Plan, the retirement account for federal employees. Florida Senator Marco Rubio has already introduced legislation to open up the TSP to workers without pensions.

Follow AEIdeas on Twitter at @AEIdeas.

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Peter Thiel on the gold standard Fri, 24 Oct 2014 17:36:12 +0000 read more >]]> I’ve had little good to say about returning to the gold standard. But in the interest of fairness, here is entrepreneur and venture capitalist Peter Thiel on the gold standard — and how he sees it in the context of America’s capacity for innovation:

Where we’ve had progress in the world of bits but not in the world of atoms, and this world of bits, we’ve had progress in computers, Internet, mobile Internet. Technology just means information technology. It’s all about bits, but the world of atoms, space travel, energy like nuclear power, biotech, new medical devices, that’s been much slower, and there’s been much less progress in those areas in the last forty years. …

 One’s been regulated, the other has not, but we’ve had this sort of dualistic world where the virtual world of bits has been growing very fast, but the real world of atoms has been kind of stagnant. And I think there’s a strange counterpoint where the same thing happened with our currency, where the real value of money became separate from the virtual in August of ’71 when we went off the gold standard. And so, you know, whatever you think of the gold standard, it had the virtue of connecting the real with the virtual.

 So I think there’s nothing wrong with cyberspace or computers or anything, but it’s when it becomes separated from the real that it’s bad. And these successful companies have actually been the ones that somehow connected it. Facebook succeeded because it was about real people having a presence on the Internet. There were all these other social networking sites people had, but they were all about fictional people. One of my friends started a company in 1997, seven years before Facebook, called SocialNet. And they had all these ideas, and you could be like a cat, and I’d be a dog on the Internet, and we’d have this virtual reality, and we would just not be ourselves. That didn’t work because reality always works better than any fake version of it.

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2 great ideas to help the poor and jobless find work Fri, 24 Oct 2014 17:02:00 +0000 read more >]]> The Economist magazine’s Free Exchange column cites new research suggesting that geography is a big factor in unemployment, especially for lower income Americans, Simply put. “Jobs are often located where poorer people cannot afford to live.” 

One study the piece does not mention is that from the Equality of Opportunity Project,which finds that cities with greater economic mobility and less unemployment also tend to have less segregation: 

Areas with larger black populations tend to be more segregated by income and race, which could affect both white and black low-income individuals adversely. Indeed, we find a  strong negative correlation between standard measures of racial and income segregation and upward  mobility. Moreover, we also find that upward mobility is higher in cities with less sprawl, as measured by commute times to work. 

Equality of Opportunity Project

Equality of Opportunity Project

OK, then. So what to do about it? Well, you could force business to locate where the jobless live. Or this:

A better approach would be to help workers either to move to areas with lots of jobs, or at least to commute to them. That would involve scrapping zoning laws that discourage cheaper housing, and improving public transport. The typical American city dweller can reach just 30% of jobs in their city within 90 minutes on public transport. That is a recipe for unemployment.

Good ideas. Those sky-high housing prices are the result of regulatory and zoning policies that discourage new building. Such restrictions on development should be loosened. But don’t forget about the infrastructure bit. AEI’s Michael Strain:

One way to support employment and earnings is to spend money on transportation infrastructure to connect low-income workers with jobs. The amount of money involved could be relatively small: We could simply buy buses, have them pick up workers in lower-income, outer neighborhoods and exurbs, and then run them express from those places — not stopping along the way in middle- and upper-income neighborhoods — all the way into commercial centers. In larger cities, we could run the buses express from low-income exurbs to the last stop on commuter rail lines; basically, we could give low-income workers a fast lift to the train, connecting residents of exurbs with the labor markets of major cities.

Buses are great because they’re flexible, cheap and use existing roads. Additionally, we could spend more money to build more sophisticated transportation networks — more roads, maybe rail; roads that function as dedicated bus lanes? — to support working-class Americans in their noble effort to earn their own success in the labor market. By significantly decreasing commuting times from lower-income neighborhoods and exurbs — which are often measured in hours, not minutes — we would effectively increase the number of jobs available to low-income workers.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

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Aereo’s inefficient piracy machine has been terminated Fri, 24 Oct 2014 15:55:37 +0000 read more >]]> Yesterday, in ABC, Inc. v. Aereo, Inc., a federal district court issued a nationwide injunction against Aereo. This action came after findings that the company’s inefficient array of tiny antennae and duplicative server copies were nothing more than the latest example of technologically inefficient means to commit what the “Agreement on Trade-Related Aspects of Intellectual Property Rights” might call “copyright piracy…on a commercial scale.” This latest Aereo decision once again bids good riddance to bad rubbish.

For over a decade, a few rogue entities posing as “Internet entrepreneurs” have impeded innovation by attempting to sacrifice technological efficiency in favor of mass piracy. Their efforts have consistently failed. Consequently, Aereo now finds itself in the same dustbin of history as its equally inefficient comrades Aimster, Grokster, Morpheus, KaZaA, LimeWire, Hotfile, isoHunt, and, more recently, Grooveshark. All of these would-be Internet pirate-kings had one thing in common: they all tried to profit from mass piracy using means that made no sense from legal or technological perspectives.

Consequently, little need be said about the District Court’s reasoning in ABC, Inc. v. Aereo, Inc. It is a sound ruling and unlikely to be overturned. But for the copyright owners and broadcasters who have already spent millions of dollars that they may never recover, the best part of this new decision may be the court’s expressed intent to resolve all remaining issues in the case – quickly.

Those remaining issues are narrow. The court did not rule on whether Aereo’s time-delayed DVR-like service infringed copyrights. That aspect of Aereo was not at issue in the preliminary-injunction motion that eventually resulted in the Supreme Court’s decision in ABC, Inc. v. Aereo, Inc. The court thus limited its nationwide preliminary injunction to Aereo retransmission of broadcast TV programs while they were being aired, while acknowledging that the Supreme Court’s Aereo decision seems to give plaintiffs “a viable argument that even Aereo’s fully time-shifted retransmission of Plaintiffs’ copyrighted works violates Plaintiffs’ public performance right.” As the Court noted, that issue can probably be addressed swiftly, without further discovery, on a motion for a permanent injunction against Aereo.

I think that the court was right to (briefly) defer a decision on the legality of Aereo’s DVR-like function. As the court noted, “there may be both factual and legal nuances unique…to what is essentially the remote DVR aspect of Aereo’s operations.” There may be, but the court also seemed to realize that this possibility is barely plausible. If a 29-minute-delayed Aereo retransmission of a protected broadcast program infringes the Section 106(4) public performance right, then it seems likely that a 31-minute-delayed Aereo retransmission of the same program also infringes the same public performance right.

Consequently, the court deserves credit for its proposal to quickly resolve the remains of this case. The sooner that it is resolved, the sooner potentially productive persons and resources will be redirected away from Aereo-and-LimeWire-like piracy schemes, and towards real, efficiency-enhancing, non-piratical innovations.

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Matt Ridley on why falling oil prices are unambiguously good – they make the world richer and fairer Fri, 24 Oct 2014 15:42:35 +0000 read more >]]> oilMatt Ridley has a great column on why cheap oil is unambiguously good news – it makes the world richer and fairer, and in the process allows us to abolish much more poverty, disease and misery. Here’s an excerpt:

So ingrained is the bad-news bias of the intelligentsia that the plummeting price of oil has mostly been discussed in terms of its negative effect on the budgets of oil producers, both countries and companies. We are allowed to rejoice only to the extent that we think it is a good thing that the Venezuelan, Russian and Iranian regimes are most at risk, which they are.

Yet by far the greater benefit of the oil price fall comes from the impact on consumers. Making this essential resource cheaper allows everybody, whatever their nationality, to spend less money on dull things like heat, transport, metal and plastic, which leaves them more money for things like movies, holidays and pets, which gives other people new jobs, which raises everybody’s living standards.

The price of Brent crude oil has fallen from about $115 a barrel in June to about $85 today (see chart above, prices are now below $85 per barrel and the lowest in almost 4 years – since November 2010). That will make a tank of gasoline cheaper (though not by as much as it should, because of taxes) but it will also make everything from chairs to chips to chiropody cheaper too, because the cost of energy is incorporated into the cost of every good and service we buy. The impact of this cost deflation will dwarf any effect of, say, a fall in the price of BP shares in your pension plan.

The industrial revolution itself was built around abundant cheap energy, mainly in the form of coal, which enabled mechanization, which vastly amplified the productivity of the average worker and therefore his income. Today a typical British family of four uses as much energy as if it had 400 slaves in the back room pedaling eight-hour shifts on exercise bicycles. It would use even more if it also fed those slaves!

The falling oil price is largely the Americans’ fault. By reinventing the extraction process for first gas, then oil, with horizontal drilling and hydraulic fracturing, engineers have almost doubled the country’s output of oil in six years. That ingenuity was made possible by the high price of oil, which promised fabulous riches to those who could get oil out of shale, but it is no longer dependent on the high price of oil. It is often said that the cure for high oil prices is high oil prices and so it has proved.

But is cheap fossil fuel not bad news for the climate? A new paper in Nature magazine argues that when the gas boom sparked by fracking goes global, prices will fall fast, economic growth will accelerate and so we will end up using more energy and producing more emissions than before, even if we give up coal. It forgets to mention that if we get that much richer, we will also abolish much more poverty, disease and misery, and have the investment funds to invent new, cheap and low-carbon forms of energy too.

HT: Warren Smith

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Is the GOP changing its stance on entitlement reform? Fri, 24 Oct 2014 15:24:39 +0000 read more >]]> Well, this is curious. Part of the Republican brand, I thought, was that the GOP was the party of debt reduction and the need to reform entitlements. Paul Ryan made his name as a policy wonk because of his support for Medicare reform. And recall that President Bush unsuccessfully pushed for Social Security reform. Then I read this from the WaPo’s ace policy reporter Lori Montgomery:

Cutting federal health and retirement spending has long been at the top of the GOP agenda. But with Republicans in striking distance of winning the Senate, they are suddenly blasting the idea of trimming Social Security benefits. … But what has drawn attention – and charges of hypocrisy – is the decision by Republican groups to attack Democrats for supporting conservative ideas in a proposed “grand bargain” on the budget drafted by Democrat Erskine Bowles and former Republican senator Alan K. Simpson of Wyoming. … Republicans would raise taxes, the theory goes, in exchange for Democrats cutting health and retirement spending. Among its proposals: trim Social Security benefits for well-off seniors, raise the retirement age to 69 by 2075 and adopt the new inflation measure, known as the chained Consumer Price Index, or chained CPI.

Shorter: The GOP is bailing on these supposedly commonsense, bipartisan reforms because older voters dominate in midterm elections, and Republicans see an opportunity to slam Dems for supporting changes seniors might not like. That’s the gist of the WaPo story. A few thoughts:

1.) From a policy standpoint, raising the retirement age makes sense given the rise in life expectancy and improvement in health and working conditions. AEI’s Andrew Biggs has suggested gradually increasing the early retirement age from 62 to 65 for workers retiring in the 2030s. But this is key: The best reason to prevent early retirement claims is not to slash benefits but rather to delay and thus increase them for when individuals are older and need them more. Early retirement incurs a 25% benefit reduction. And as Biggs also wrote:

“It is inevitable that Social Security, Medicare, and other government programs will become less generous toward the rich than they are today. The only alternative is ever-increasing taxes and their toll on personal welfare, individual freedom, and economic growth.

2.) One other policy note: Republicans are correct in rejecting the chained CPI fix. Again, here is Biggs:

 … However, the chained CPI is the wrong measure for Social Security benefits and the income tax code. A better measure for Social Security would be a chain weighted version of the CPI-E, which measures price changes for individuals over 65. This probably would still show lower inflation than the current CPI, by around 0.1 percentage point annually, but would be superior to the current CPI-W, the chained CPI, or the CPI-E on its own (which tends to show higher inflation).

The chained CPI is also inappropriate for use in the tax code. By lowering adjustments to the tax brackets, over time it would make more of individuals’ earnings subject to higher tax rates, an effect known as “bracket creep.” Even using the current CPI, and assuming that the Bush tax cuts were made permanent, average tax rates and tax revenues relative to the economy would soon rise to record levels, according to the Congressional Budget Office (CBO). Applying the chained CPI to the tax code would only speed up this effect.

3.) Last year, the Wall Street Journal’s Holman Jenkins wrote a great piece on how the Affordable Care Act would change how Republicans and conservatives argue about entitlements and welfare. They will draw a line, Holman  writes, between “earned” entitlements such as Medicare and Social Security vs. “unearned” welfare such as Obamacare subsidies, Medicaid, and food stamps. Jenkins:

Tea-party activists have good reason to suspect their stand will pay electoral dividends in the months and years ahead. Not appreciated is the powerful new meme Mr. Obama has handed them, which will transform entitlement politics in our country. The new “conservative” position will be to defend Social Security and Medicare, those middle-class rewards for a life of hard work and tax-paying, against Mr. Obama’s vast expansion of the means-tested welfare state for working-age Americans. … Look for means testing possibly even to evolve into a new pejorative in Republican mouths, suggesting undeserved benefits for groups that mostly vote Democrat.

Unfortunately for this tactic — which may be what’s happening right now – you cannot solve realistically America’s long-term debt problem without entitlement reform. And given the evolving nature of the US economy, we may need more expansive supports for lower-income Americans, like an expanded Earned Income Tax Credit. Differentiating between good (deserved) vs. bad (undeserved) safety net spending might be an effective political approach, but it would make for poor policy.

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.


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How low can negative interest rates go? Fri, 24 Oct 2014 13:35:26 +0000 read more >]]> The Theory, as taught to generations of economics students:

  • “Economists say there is a zero bound on the nominal interest rate: it cannot go below zero.”
  • “Nobody would lend money at a negative nominal rate of interest because they could do better by simply holding cash.”

–Paul Krugman et al., “Economics: European Edition

The Fact:

  • “The two-year notes of Austria, Belgium, Denmark, Finland, France, Germany, the Netherlands, Slovakia and Switzerland yield less than zero.”

–Grant’s Interest Rate Observer 10/17/14

The Concerns, October 17:

  • “There are concerns about the possibility that custodian banks may start to apply negative interest rates to deposits.”

–Financial Times

The Fact, October 18:

  • “Now, instead of paying customers interest on their euro accounts, as they have done traditionally, some banks have started charging for them.” Credit Suisse “has told customers it will pass along negative interest rates on all currencies in which they apply.”

–Wall Street Journal

Numerous instances of negative nominal interest rates, including negative interest rates on bank deposits, are a reality. So much for the zero bound.

But how negative can interest rates become?

The simple argument for the impossibility of negative interest rates or the zero bound, as repeated by Paul Krugman in the quotation above, was that if faced with them, people would simply switch to using paper money, to get a zero interest rate instead. More subtle arguments recognized that using or holding paper money has costs, including inconvenience and security, so it was said, interest rates could be slightly negative to the extent of these costs. This replaced the zero bound, with a “slightly less than zero bound,” although I have not seen anybody try to put a number on how much less that is.

Recognizing the costs of trying to use paper money instead of deposit money and investments is a more realistic approach than the old simple argument, but it still assumes that it is possible to make such a switch. For the modern institutional financial system, it isn’t.

Of course an individual, dealing in hundreds of dollars (or euros, or any currency), could take to carrying more paper money around, or keeping a few thousand dollars in paper money under the bed. But even at the individual level, the alternative becomes increasingly implausible as amounts increase—say to savings of $100,000 or more.

For the institutional economy, moving millions and billions of dollars around the world, and holding trillions of dollars in deposits and near-cash investments, the economists’ postulated shift to holding and transacting in paper money instead looks operationally impossible.

So how low can negative interest rates go? We have yet to find out.

Alex J. Pollock is a resident fellow at AEI.

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