Packing Heat in My Class

Daniel Hamermesh says I should expect guns in my classroom soon:

 The Texas legislature seems likely to pass a law allowing people to carry concealed weapons on campus.  Having observed enough shootings of professors by students in the U.S. over the past 45 years, I think this is a dreadful idea.  But it has interesting implications for wages.  Some people who might be willing to take jobs at Texas campuses will be hesitant to do so.  Unless there are enough others who welcome guns on campus, which I doubt, Texas universities will have to pay professors more — have to pay a compensating differential for the risk of being shot — or will be hiring lower-quality faculty members than before.  Interestingly, although there are many more undergrad than grad students, it seems like the large majority of shootings of professors have been by grad students.  Assuming that’s true, the new law will cause a change in wage differences between those who teach mostly undergrads and those who teach most grads, since teaching grads will become relatively riskier.  I doubt that our legislators thought about the extra labor costs, or the diminution of quality, that their ideas are likely to create.

Time to start wearing a Kevlar vest to class.  At least I will get a pay raise to pay for it.

Pick Your Poison

After reading Nouriel Roubini's latest article in the FT I feel less certain about what the Fed should be doing going forward. On one hand I see figures like the one below from the IMF's World Economic Outlook (p. 32) that point to excess global capacity and the ongoing threat of global deflation (the bad kind) and come to same conclusion as Scott Sumner:

If the Fed adopted a much more expansionary monetary policy, and if the PBOC kept its policy stance the same, then world monetary policy would become more expansionary, and world aggregate demand would increase. That would help everyone.

In short, the Fed should use its monetary superpower status to ensure there is ample global liquidity and in so doing stabilize global nominal spending.


On the other hand, Nouriel Roubini claims the current Fed policies in conjunction with a large dollar carry trade is creating a new set of asset bubbles:

Risky asset prices have risen too much, too soon and too fast compared with macroeconomic fundamentals... So what is behind this massive rally? Certainly it has been helped by a wave of liquidity from near-zero interest rates and quantitative easing. But a more important factor fueling this asset bubble is the weakness of the US dollar, driven by the mother of all carry trades. The US dollar has become the major funding currency of carry trades as the Fed has kept interest rates on hold and is expected to do so for a long time.Investors who are shorting the US dollar to buy on a highly leveraged basis higher-yielding assets and other global assets are not just borrowing at zero interest rates in dollar terms; they are borrowing at very negative interest rates – as low as negative 10 or 20 per cent annualised – as the fall in the US dollar leads to massive capital gains on short dollar positions.

Let us sum up: traders are borrowing at negative 20 per cent rates to invest on a highly leveraged basis on a mass of risky global assets that are rising in price due to excess liquidity and a massive carry trade. Every investor who plays this risky game looks like a genius – even if they are just riding a huge bubble financed by a large negative cost of borrowing – as the total returns have been in the 50-70 per cent range since March.

People’s sense of the value at risk (VAR) of their aggregate portfolios ought, instead, to have been increasing due to a rising correlation of the risks between different asset classes, all of which are driven by this common monetary policy and the carry trade. In effect, it has become one big common trade – you short the dollar to buy any global risky assets.

Yet, at the same time, the perceived riskiness of individual asset classes is declining as volatility is diminished due to the Fed’s policy of buying everything in sight – witness its proposed $1,800bn (£1,000bn, €1,200bn) purchase of Treasuries, mortgage- backed securities (bonds guaranteed by a government-sponsored enterprise such as Fannie Mae) and agency debt. By effectively reducing the volatility of individual asset classes, making them behave the same way, there is now little diversification across markets – the VAR again looks low.

So the combined effect of the Fed policy of a zero Fed funds rate, quantitative easing and massive purchase of long-term debt instruments is seemingly making the world safe – for now – for the mother of all carry trades and mother of all highly leveraged global asset bubbles.

Roubini is not optimistic about what this means for the future:

[O]ne day this bubble will burst, leading to the biggest co-ordinated asset bust ever: if factors lead the dollar to reverse and suddenly appreciate – as was seen in previous reversals, such as the yen-funded carry trade – the leveraged carry trade will have to be suddenly closed as investors cover their dollar shorts. A stampede will occur as closing long leveraged risky asset positions across all asset classes funded by dollar shorts triggers a co-ordinated collapse of all those risky assets – equities, commodities, emerging market asset classes and credit instruments.

So what is the bigger threat: global deflation or asset bubbles driven by Fed policy and "the mother of all carry trades"? Tim Lee via Buttonwood also sees potential problems to the unwinding of this dollar carry trade. I hope there is another way out for the Fed.

A Great Summary of the Policy Innovations by the Fed

Previously I discussed how much of what you learned in your money and banking class is now outdated given the many policy innovations by the Federal Reserve since last summer. Stephen Cecchetti now has a nice summary of these innovations that can be found here (shorter version) or here (longer version). Read these updates and you will be current on the workings of the Federal Reserve.

Looking for an Updated Monetary Textbook

I am slated to teach two sections of undergraduate Money & Banking in the fall semester and am already being accosted by the book reps. Talking with the book reps started me thinking--are there any monetary textbooks out there that will make sense in the fall? Given the ongoing meltdown in financial markets and the many central banking innovations that have taken place in response (e.g. TAF, TSLF), I suspect many, if not all, monetary texts will have gaping holes in them. So I was pleased to read Jim Hamilton was thinking along similar lines when wrote the following:

If you took a college course on monetary policy more than six months ago, what you learned has already been rendered out of date by the big changes Bernanke has implemented in how monetary policy can be used.

So are there any monetary textbooks out there that will reflect the new realities of central banking? Fortunately, we live in a world of the internet and economic blogging where all you need to know about this crisis is just a click away. Still, it would be nice to have a textbook that is current for students.

Update

I should have stated more explicitly that the link above is to Francisco M. Torralba's nice summary of the Fed's new tools. Also, see Vincent Reinhart's article, "The Fed's New Alphabet Soup."