Minneapolis Fed Interview with Robert Barro

This is an interview with Robert Barro that appears in the Minneapolis Fed's The Region. The interview is somewhat long, but covers deficit spending, Social Security and Medicare/Medicaid, the economics of religion, inflation targeting, the equity premium puzzle, Europe's monetary union, economic growth, inequality and growth, the future of macroeconomics, and the IMF:

Interview with Robert Barro, The Region, Minneapolis Fed: The staircase that leads to Robert Barro's second-floor office at Harvard spirals like a helix; on the wall above these steps hang large photos of renowned Harvard economists. ... Schumpeter, Hansen, Kuznets, Leontief... In the early 1970s, Barro followed this lineage faithfully, publishing several significant papers along Keynesian lines. But ... Barro broke with tradition in 1974 with a powerful critique of Keynesian thought. ... His articles are among the most often cited in economics...

DEFICIT SPENDING

Region: The Ricardian equivalence hypothesis, which you brought to prominence in 1974, might be taken to suggest that deficit spending isn't inherently harmful since rational people, expecting to pay higher taxes in the future to pay off government debt, will save more, so private savings will balance out the public deficit. Does that imply that concerns about “irresponsible” levels of debt are unfounded? ...

Barro: Let me say first that I think the Ricardian equivalence idea is basically right as a first-order proposition. However, people get confused as to exactly what it says. ... To illustrate the potential pitfalls in what Ricardian equivalence says and does not say, one can consider the famous quote attributed to Vice President Cheney to the effect that President Reagan proved that budget deficits don't matter. The Cheney quote is often interpreted to mean that the level of government expenditure does not matter, and that surely is not what Ricardian equivalence says. The Ricardian proposition is about the consequences of paying for a given amount of public expenditure in different ways. Specifically, does it matter ... whether the government pays for its spending with current taxes or with current borrowing, which entails higher future taxes?

So, a central part of the proposition is that the amount of public expenditure—today and tomorrow—is being held constant. ... As a first-order proposition, it is right that it matters little whether you pay for government spending with taxes today or taxes tomorrow, which is basically what a fiscal deficit is. ... The method of public finance is an important question, but it is less important than the question of how big the government is and what activities it should carry out. Taxing now versus taxing later is ... a public-finance topic. This view moves the analysis away from pure Ricardian equivalence to the optimal tax perspective, which brings in the principle of tax smoothing. The idea is that ... optimal public finance dictates having tax rates ... that are similar from one year to another. ... erratic movements in tax rates ... are highly distorting. From that standpoint, it is not desirable to have a very low tax rate today, financed by a fiscal deficit, followed by much higher tax rates in the future. ...

Region: I'd like to follow that with an empirical question, if I might. By some measures, U.S. personal savings rates are quite low. What does this say about people's anticipation of having to pay higher taxes in the future?

Barro: National savings rates are not constant over time in the United States, and they are not the same across countries. ... However, economists have not demonstrated empirically for the U.S. or across countries that there is a regular relation between fiscal deficits or the size of the public debt and the level of the national saving rate. The idea that fiscal deficits drive down national saving is often claimed, but it is mainly proof by repetition. No one has actually shown convincingly that the U.S. national saving rate relates in a systematic way to the size of the fiscal deficit or the stock of public debt, both measured in relation to GDP. ...

SOCIAL SECURITY AND MEDICARE/MEDICAID

Region: Social Security and Medicare/ Medicaid are two major government expenditures, of course. Are you concerned about future spending for those programs?

Barro: I should say, in general, that the Bush administration has been a real failure with respect to fiscal discipline, especially during its early years. I mean this with respect to the level of federal expenditure, not about fiscal deficits per se. Particularly in the first term, there was a tendency to increase spending across the board—a very different pattern from most of the Clinton period, although Clinton did become less disciplined at the end of the 1990s. ... The expansion of Medicare, in terms of coverage for prescription drugs, is one important aspect of the lack of discipline, and this “generosity” will have long-term adverse consequences for the federal budget. So, although I am not particularly concerned about the current fiscal deficit, I am worried about the growth of federal outlays under Bush. ...

Of course, the legacy of deficits and debt came from Reagan and the first President Bush; that is, they involved what economists now call “strategic budget deficits.” I think this Reagan-Bush strategy actually worked to promote discipline on the federal spending side in the 1990s. ... Unfortunately, the spending discipline coming from fiscal deficits did not seem to work during Bush's first term. ... Anyway, I agree that the longer-term expenditure problems related to Social Security and Medicare are significant. But there is also a broader, short-run problem with regard to federal spending across the board. President Bush really should try vetoing a spending bill sometime.

ECONOMICS OF RELIGION

Region: Most economists will not expound on religion... You're an exception to that rule. In your work with your wife [Harvard scholar] Rachel McCleary on the associations between religion and growth, you're trying to tease out not just correlations but causality. Can you tell us what you've found?

Barro: I'm excited about this research project. It's on the interplay between religion and political economy, so there's a two-sided interplay here. One is about religion having influence on beliefs, values, traits like honesty, work ethic, thrift and so on... In this context, we are studying the impact of religion on economic growth and productivity, and also on political institutions, including democracy. These effects represent one direction of causation. The other effect, a big part of the literature on the sociology of religion, is that economic development and government policies influence the levels of religiosity in society. For example, one idea is that as nations get richer and better educated, they tend to become less religious.

Region: The “secularization” of society?

Barro: That's the secularization hypothesis, exactly. And though that hypothesis has lost favor, I think the empirical evidence supports it. ... A related idea is that what governments do in terms of having official state religions or regulating the market—either subsidizing or suppressing religion—has an impact. Communist countries were particularly focused on antireligion policies ... that is, if we do not count communism as its own religion. ...

Region: Could you explain your concept of “religious capital”?

Barro: The general idea is analogous to investing in education to accumulate human capital. Or, alternatively, one can think of investing in networks and friendships to form social capital. Analogously, you can invest in spirituality and beliefs to form a kind of religion capital. Rachel and I think of this influence as working through beliefs, not so much through networking, or going to church and meeting lots of people. That would be more like social capital. ... These beliefs matter ... if they support certain traits and values, such as honesty, work ethic, thrift and hospitality to strangers. These traits then influence productivity and work effort, which ultimately affect economic growth. ... The other thing I might mention is that I find that whenever I give a seminar on this topic, I inevitably get a question about whether I'm personally religious. The attitude seems to be that if I'm studying this topic it must come from some individual set of beliefs or commitment to a particular religion. It's curious because people studying other aspects of social science do not tend to get analogous questions. [University of Chicago economist] Gary Becker studied the economics of crime, and (as far as I know) nobody ever asked him if he was a criminal ...

Region: If I'm not mistaken, Gary Becker got his idea about crime and economics when he was thinking about parking illegally. ...

INFLATION TARGETING Region: Your research on rules, discretion and reputation in central banking has been very influential on monetary policy theory and practice. What is your view of inflation targeting?...

Barro: The change in monetary policy over the last 20 years or so has been a tremendous success in the United States and other advanced countries. It's been a tremendous change compared to what we were going through in the 1970s and early 1980s. In a general sense, there has been a shift toward the idea that the monetary authority should be committed to something like price stability or inflation targeting. This general idea has been pretty well accepted. ... In the United States, the watershed period was when Paul Volcker was in charge. The inflation rate shot up like crazy at the end of the 1970s, into the early 1980s. Volcker's committed policy with very high interest rates brought down inflation—I think that was the key event.

Region: Was Volcker essentially creating reputation, in the sense of your 1983 paper with David Gordon?

Barro: There were a couple of things there. Volcker was establishing the credibility and commitment to bringing down inflation. Secondly, there was the more technical point that driving up nominal interest rates actually worked. ... I think over the last two decades the Fed has come close to an inflation targeting regime even though it's not explicit. ...

Region: Is the relationship you have in mind here similar to a Taylor rule?

Barro: Yes, it looks like that, but there are some differences. For example, it's clearly not GDP that the Fed reacts to. ... when GDP growth goes up because of higher productivity growth, there's no tendency to raise the federal funds rate. But if the economy is strong in terms of ... higher employment growth and a low unemployment rate, there seems very regularly to be an upward movement of interest rates. The reverse holds when the labor market is weak. On the inflation side, it's a broad inflation index that seems to influence the Fed—something like the GDP deflator or the deflator for personal consumption expenditures. ... A crucial feature is that monetary policy responds to the economy in a way that's particularly strong with respect to inflation. The idea is that when you bring the [federal] funds rate up, inflation is supposed to go down. This mechanism has worked much better than I would have predicted at the end of the 1970s and early 1980s—it's kind of amazing how well this has turned out, and not just in the United States. Many other countries have gone further in terms of formalizing this policy reaction into a rule. I think the more formal rule is a good idea. I'm not sure it's that important because the United States is pretty close to it anyway. However, if Ben Bernanke becomes head of the Fed, he will likely try to implement something that looks more like a formal rule.

Region: “Constrained discretion” is a term he's used.

Barro: Yes. ...

THE EQUITY PREMIUM PUZZLE

Region: I understand you've made some headway on the equity premium puzzle, the unexplained gap between average returns on stocks and bonds that Rajnish Mehra and Ed Prescott pointed out 20 years ago. Your explanation for the gap, I believe, involves rare events, a suggestion made by [University of Iowa economist] T. A. Rietz in 1988 that was immediately dismissed by Mehra and Prescott.

Barro: It is certainly fair to say that this insight was in the 1988 paper by Rietz, which I think came out of his Ph.D. thesis. Mehra and Prescott were extremely critical of the Rietz analysis, and I think they managed to convince most people that low-probability disasters were not the key to the equity premium puzzle. But, ... I think the arguments in their 1988 comment on Rietz were incorrect. I had not thought much about this issue until a few months back... But when I began to study it, it seemed that low-probability disasters could be quite important. And then I found Rietz's paper, which I thought was a great insight, and I have been building on it. Frankly, I think this idea explains a lot. Of course, there is a good deal more to work out, to think about further, but I think his basic insight is correct. ...

EUROPE'S MONETARY UNION

Region: You've conducted research with [Harvard economist] Alberto Alesina on optimal currency areas. What's your viewpoint on the struggles that the Economic and Monetary Union is having with its Stability and Growth Pact?

Barro: I think the European monetary union or common currency is a good idea. The free trade area earlier was also a good idea. But I think it's a big mistake to be extending the integration to try to have more of a political union and a union that covers almost everything, including fiscal and social policies and regulations. That's why, from the standpoint of the United Kingdom, even though it would be attractive to be on the euro, I don't think it's worth it in terms of all the rest of the baggage that they would get from the Continent. ... But the monetary union itself is very positive in terms of promoting trade and financial flows. ...

ECONOMIC GROWTH

Region: I'd like to ask you more broadly about the issue of economic growth. ... [I]t seems that economists ... have been engaged in empirical analysis, trying to figure out the relative levels of influence of technology, human capital, geography, institutions—“do institutions rule?” is the phrase often used here at Harvard—or even culture, on economic growth. ... Where do your sympathies lie? What seems most powerful?

Barro: ...Some interesting recent empirical research has been on the formation and influence of institutions. ... I think it's right that institutions, rule of law, corruption and so on are important factors for determining economic growth. Even the World Bank now thinks that these issues are central.

INEQUALITY AND GROWTH

Region: What have you discovered in your research on the relationship between inequality and economic growth?

Barro: I did not find an important, systematic effect of income inequality on economic growth. And theoretically it can go in either direction. ... The Kuznets curve refers to ... the idea that, as a country develops... initially, inequality goes up and later it goes down. There is a little evidence to support the existence of this Kuznets curve, but the evidence is not that powerful. You can see the Kuznets relation in China. Inequality went up a lot because certain urban areas have been doing especially well. Rural agriculture, although performing better than under the previous regime (which really was communist), has not done as well as the urban areas. So that means inequality increased in China at the same time that per capita GDP went way up and poverty went way down. You would anticipate that, as China continues to grow, it will also integrate more fully the poorer rural sections of society with the advanced urban ones. Enhanced mobility from rural to urban areas is part of this process. This dynamic should generate a classic Kuznets curve...

THE FUTURE OF MACRO

Region: In the early 1970s, I believe, you told Gary Becker that you thought macroeconomics was stagnating and you thought you might get into microeconomics. ... And then rational expectations swept the field, and you were one of the pioneers in that revolution. Bearing in mind your past forecast, what would you say about macroeconomics today? What do you think are promising areas for research in macro now? And are you still thinking of going micro?

Barro: I was clearly a very bad predictor in the early 1970s of how macroeconomics would evolve. ... Now it does seem that perhaps the last 10 years or so have been less exciting ... There has been progress, even on the Keynesian side. We now have more sophisticated approaches to sticky-price models. ...

Region: If things are stagnating, perhaps another revolution is in the offing.

Barro: Well, it's the essence of a revolution that it has to be unpredictable, right? If you could have predicted it in advance, it would have already happened. ...

Region: Are you going to go micro?

Barro: I've always had a great interest in applied micro, ... I'm not sure why I got into macroeconomics in the first place, except that I started there. In fact, my first economics course used Keynes' General Theory as a textbook. In some ways, I like the applied micro topics better. However, macroeconomics usually deals with larger, more important issues.

THE IMF

Region: The International Monetary Fund came under severe criticism in the 1990s, but in recent years it has undergone substantial reform. ... Some of your research indicates that countries that take IMF loans or are involved in IMF lending programs do more poorly in terms of economic growth, in terms of rule of law and democracy. Would you tell us about that work?

Barro: Recently there has been a lot of discussion about debt relief, foreign aid, the role of the World Bank, as well as IMF programs. I think these are all basically analogous in terms of their impacts. ... The problems are embedded in the nature of the institution. By design, the setup has to encourage moral hazard; it has to encourage poor behavior on the part of the potential and actual recipients. I once suggested that they change the name to IMH for Institute of Moral Hazard, instead of IMF [laughter]. I guess that suggestion wasn't taken too seriously.

I'm often asked by government policymakers what the IMF should do better or how it should be reformed, and I think there's no answer to that—other than going out of business. ...

I don't think money for nothing is the way to get economic development. That's why even though I like [Irish rock star] Bono—I think he's very smart, a well-meaning person, and he's amazingly influential—I think his whole project of debt relief is so woefully misguided. This well-meaning assistance will not be the way to get poor African countries to do better.

Region: So you and [Columbia University economist] Jeff Sachs don't see eye-to-eye?

Barro: We had a wonderful lunch back in 1999—Sachs, Bono and I. It was clear that they invited me not to get information or advice. Instead, Bono wanted to learn the conservative, free-market objections to his approach so that he could come up with better counterarguments. Then he could be more persuasive, as he turned out to be, even with Republican officials in Washington. ... It's amazing what kind of influence he's had. He really did manage to convince many people in Washington to carry out substantial debt relief. It's a shame that we could not harness his talents for persuasion in more productive directions.

Region: Thank you very much.

Comments

[spencer]

One of the ideas he throws out in the article is that the falling price of capital goods may be responsible for the low savings rate.

But since the overwhelming bulk of capital spending is done by corporations rather then individuals this argument should imply that business saving would fall much more then personal savings. But, in fact business savings has not declined. So this idea of his does not seem to be supported by the facts.

[Movie Guy]

Mark,

Your blog presentations are outstanding. For the subjects that you address, there is no competition in blogland. This continues to be an impressive effort.

Every one of your students should be reading your posts, as should econ students all over the nation. And it goes without saying that those of us 'out in world' benefit immensely from your reporting and analysis.

[anne]

Business saving has hovered at about record levels from within a year of the end of the recession in November 2001. The problem is not business saving. Return on equity for the S&P index has been about 19 for a several years. There is no lack of saving or investment return or profits by American industry.

Again, however, household saving is taxed at disavantaged rates and the Federal Reserve kept interest rates at 40 years lows for quite a while. So why are we surprised that households are not saving?

[anne]

Also, Robert Rubin pointed out at a lunch several years ago that investors generally found the bond market trickier to use than the stock market. Absolutely, and investors who I know repeatedly make poor use of the bond market and missed out on capital gains through the astonishing bull market in bonds from 1981 to 1984.

[spencer]

The Federal Reserve Bank of San Francisco just did a very good study of personal savings that finds the drop in the savings rate is a function of low rates in combination with a strong stock market and high home prices.

But if this study is accurate it still implies that giving tax breaks for saving does not generate an increase in savings.

[anne]

Now, smile at Barro or Feldstein and especially now that the position of Federal reserve chair is spoken for you will get a mention of the sorry spending of the Republican Administration, but not really. Not really. The lecture will mention spending and the will be a bit of swipe at Bill Clinton, yes always, and then on to Medicare or Social Security or Social Security and Medicare. Phooey. When I find these cats complaining about the Medicare drug plan, I think the plan is grand! Phooey.

[anne]

Spencer:

Whether taxing interest at the same level as dividends and capital gains income will increase household saving is not clear, but it sure can't hurt :) If I can get 4.6% interest in a long term treasury and 3.2% in dividends from the utility index, I'll take the index; and the differential has been a lot less than this for some time. Besides I could get nicely over 4% in dividends from the REIT index for years, though REIT dividends are taxed similarly to interest. Once the capital gains potential from bonds was gone, there was little reason for bonds; less because of the tax penalty on interest.

[Mark Thoma]

Here's the FRBSF Letter Spendthrift Nation. I had it all ready to post, and at the last minute checked CR and he had put it up a few hours earlier.

[Bruce Wilder]

He's not even holding a real dog.

[Jeffrey Miller]

"Taxing now versus taxing later is ... a public-finance topic."

Not a single word about the fact that the people who will pay the tab, through higher taxes and lower growth and a weakened social safety net, for our current government deficits, namely our children and grandchildren, are not the same people who have pushed through the tax cuts and squandered money on pork for their friends - the people who disproportionally enjoy the "benefits" of defecit spending - Dick Cheney's class of people. I find such an omission really, really appalling.

[calmo]

Bruce notes that he's not holding a real dog...(and you careful readers who don't have to use the font enlargers, will agree that the dog is indeed stuffed) [alright, due to the magic of tranz body inhabitation, Barro really is the dog being held by the pooch who does his best to impersonate Barro...nearly pulling it off if it weren't for the astute Bruce Wilder who can always be trusted to alert us on these matters.]

Does the Queen (you know the one I mean people) still do photo ops with the corgies? [The men (Sir Lancerslot Ok, Philip The Puddin Head, the King in law...Mr Queenface) grin and bear it.]
Just how important are those dogs, people? What if Barro was different and preferred snakes?...ok, guppies in the fish tank? [Bruce Wilder is after a different breed...I just know it.]