A Parting Gift as Ben Bernanke Hangs Up His Cleats

Ben S. Bernanke now has his own baseball card.

The Federal Reserve distributed the card at a staff reception this week in honor of its outgoing chairman, who steps down Friday after eight years at the helm - a banker who also happens to be a passionate baseball fan.

Mr. Bernanke has a cabinet full of baseball memorabilia in his office at the Fed, and he has season tickets near the first-base line at Nationals Stadium. He once rooted for the Boston Red Sox, but transferred his loyalties when the Nationals came to Washington.

In 2012, he described himself in The Wall Street Journal as an “Unabashed Nats fans â€" and I’ve been one since the team arrived in town in 2005.”

The card, a fine piece of Photoshop work, shows a bareheaded Bernanke (no honorifics for athletes in these pages) in Nationals gear.

The back describes him as “first drafted from the Ivy League” in 2002, when he joined the Fed’s Board of Governors. During those early years, with his family still in New Jersey, the card says he lived on “a steady diet of Hot Pockets.”

The listed stats include 226 speeches and 79 Congressional appearances.

The back of the card displays Mr. Bernanke’s career stats.

The Moral Hazard of the All-Volunteer Army

Uwe E. Reinhardt is an economics professor at Princeton.

It may be sheer coincidence that in this 10th anniversary year of the invasion of Iraq, my fellow blogger Casey Mulligan chose to use the economist’s case for an all-volunteer military as a peg to assert that political factors, rather than the sound reasoning of economists, tend to drive our nation’s public policy, including the decision in the 1970s to abandon the military draft.

The economist’s case for the all-volunteer army is straightforward â€" and also quite interesting from a broader perspective.

In classrooms or textbooks, the case is usually illustrated with the aid of a simple demand-and-supply analysis, with a hypothetical supply-of-soldiers curve such as the solid, upward-sloping line in the chart below.

A supply curve of anything exhibits the quantity of the thing suppliers are willing to supply to the market per period at different prices being offered for the thing. In the present context, the curve represents the number of individuals willing to rent out and potentially sacrifice their bodies, so to speak, for military service in the armed forces at different wages being offered them for that service (including such benefits as health insurance for them and their families).

On the lower left of the solid, upward-sloping supply curve are individuals who either (a) have meager economic opportunities in the civilian sector (i.e., with relatively low opportunity costs for serving in the armed forces) or (b) are patriots willing to bear sacrifice for their country, regardless of their own opportunity costs of doing so.

On the upper right of the supply curve are individuals who may well love their country and consider themselves “patriots” but who either (a) face great economic opportunities in the civilian sector (i.e., have high economic opportunity costs for serving in the armed forces) or (b) are averse to the risk of getting maimed or killed in a theater of war.

Now suppose in the wake of a military campaign somewhere in the world the armed forces needed a force of N0, as shown in the graph above.

Under a military draft with, say, a draft lottery, the Selective Service Boards tasked with conscripting military recruits would, in principle, conscript individuals all along the segment AC in the graph, including segment BC.

By contrast, under an all-voluntary armed force, only individuals on line segment AB would join the armed forces, sparing the individuals located on segment BC the duty to fight and sacrifice for their country.

This is the core of the economist’s case for the all-volunteer army. As the University of Rochester economist Steven E. Landsburg puts it succinctly in his welfare-economic analysis of the military draft in his textbook “Price Theory and Applications”:

In concrete terms, what this means is that [under a military draft] the Selective Service Board will draft young people who are potentially brilliant brain surgeons, inventors and economists â€" young people with high opportunity costs of entering the service â€" and will leave undrafted some young people with much lower opportunity costs. The social loss is avoided under a voluntary system, in which precisely those with the lowest costs will volunteer.

What if the authorities choose to draft only the low-cost young people? Here, of course, the problem of knowledge becomes insurmountable. Information about individual opportunity costs, available free under a voluntary system, is available only at high cost with great uncertainty in the absence of prices.

How well that lecture would be received at, say, the Basic School on the United States Marine Corps Base at Quantico, Va. (where Marine Corps officers are educated and trained), or on any American military base, is an interesting question.

On the other hand, I know from personal experience that, before the invasion of Iraq and thereafter, this welfare-economic analysis of the military draft was music to the ears of the many undergraduates who enthusiastically cheered on that invasion and the subsequent dangerous occupation of Iraq, leaving the fighting, the bleeding and the dying to someone else, all the while being assured by their economics professors that by this posture they were actually helping to maximize their nation’s overall economic welfare (review this letter, starting at Page 5).

Remarkably, one does not find in the economist’s welfare-economic analysis of the all-volunteer army any mention of a phenomenon that usually creates great concern among economists, namely, the moral hazard built into the arrangement.

Economists can wax quite stern when exposing moral hazard in the context of health insurance, environmental pollution or tax-financed bailouts of banks. Amazingly, though, not in connection with decisions to go to war.

The dictionary defines moral hazard as “a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost,” or as Investopedia puts it, as the “idea that a party that is protected in some way from risk will act differently than if they didn’t have that protection.”

In the context of war, moral hazard crops up when the socioeconomic class empowered to declare war is largely insulated from the lethal risks faced by those sent to the battlefield because neither they nor their offspring are likely to be thrust into harm’s way by the war.

Under our system of governance, in which political power is highly correlated with economic power, Professor Landsburg’s “low-cost” people recruited into the military and onto the battlefield are unlikely to have much representation in a decision on whether to go to war. On the other hand, few of those authorized to make that call are likely to have offspring in the fray.

Clearly this is a classic case of moral hazard. It raises the probability of a nation going to war, especially if huge profits can be made off a war by those bearing little personal risk in that war but with powerful sway over government.

On this 10th anniversary of the invasion of Iraq, we shall see numerous retrospectives on that event, reminding us, among other things, of how few of those in government or in the news media who most ardently pushed for that war had ever donned a uniform, let alone served in combat, and how few of them had offspring in harm’s way. Former Marine Corps Gen. Anthony Zinni referred to them acerbically in a television interview last year.

Moral hazard arguably played a major role in this nation’s decision to embark on a pre-emptive strike on Iraq and a haphazardly mismanaged subsequent occupation. One can fairly wonder whether the United States would quite so readily have stumbled into that military adventure if more of the cheerleaders for that war had had their own children exposed to the risk of lethal weapons, including the biological and chemical weapons we were assured that Iraq had and was willing to deploy.

Moral hazard is likely to have played a role all the more so, of course, because the war was accompanied not by a war tax, to pay for it, but by a tax cut. For the most part, the policy-making elite did not bear any sacrifice at all for its decision to go to war.

In the eyes and minds of economists, their welfare-economic case for the all-volunteer army has great intuitive appeal. To make their analysis complete, economists should give some thought to the moral hazard of war to which an all-volunteer armed force can give rise.

The Moral Hazard of the All-Volunteer Army

Uwe E. Reinhardt is an economics professor at Princeton.

It may be sheer coincidence that in this 10th anniversary year of the invasion of Iraq, my fellow blogger Casey Mulligan chose to use the economist’s case for an all-volunteer military as a peg to assert that political factors, rather than the sound reasoning of economists, tend to drive our nation’s public policy, including the decision in the 1970s to abandon the military draft.

The economist’s case for the all-volunteer army is straightforward â€" and also quite interesting from a broader perspective.

In classrooms or textbooks, the case is usually illustrated with the aid of a simple demand-and-supply analysis, with a hypothetical supply-of-soldiers curve such as the solid, upward-sloping line in the chart below.

A supply curve of anything exhibits the quantity of the thing suppliers are willing to supply to the market per period at different prices being offered for the thing. In the present context, the curve represents the number of individuals willing to rent out and potentially sacrifice their bodies, so to speak, for military service in the armed forces at different wages being offered them for that service (including such benefits as health insurance for them and their families).

On the lower left of the solid, upward-sloping supply curve are individuals who either (a) have meager economic opportunities in the civilian sector (i.e., with relatively low opportunity costs for serving in the armed forces) or (b) are patriots willing to bear sacrifice for their country, regardless of their own opportunity costs of doing so.

On the upper right of the supply curve are individuals who may well love their country and consider themselves “patriots” but who either (a) face great economic opportunities in the civilian sector (i.e., have high economic opportunity costs for serving in the armed forces) or (b) are averse to the risk of getting maimed or killed in a theater of war.

Now suppose in the wake of a military campaign somewhere in the world the armed forces needed a force of N0, as shown in the graph above.

Under a military draft with, say, a draft lottery, the Selective Service Boards tasked with conscripting military recruits would, in principle, conscript individuals all along the segment AC in the graph, including segment BC.

By contrast, under an all-voluntary armed force, only individuals on line segment AB would join the armed forces, sparing the individuals located on segment BC the duty to fight and sacrifice for their country.

This is the core of the economist’s case for the all-volunteer army. As the University of Rochester economist Steven E. Landsburg puts it succinctly in his welfare-economic analysis of the military draft in his textbook “Price Theory and Applications”:

In concrete terms, what this means is that [under a military draft] the Selective Service Board will draft young people who are potentially brilliant brain surgeons, inventors and economists â€" young people with high opportunity costs of entering the service â€" and will leave undrafted some young people with much lower opportunity costs. The social loss is avoided under a voluntary system, in which precisely those with the lowest costs will volunteer.

What if the authorities choose to draft only the low-cost young people? Here, of course, the problem of knowledge becomes insurmountable. Information about individual opportunity costs, available free under a voluntary system, is available only at high cost with great uncertainty in the absence of prices.

How well that lecture would be received at, say, the Basic School on the United States Marine Corps Base at Quantico, Va. (where Marine Corps officers are educated and trained), or on any American military base, is an interesting question.

On the other hand, I know from personal experience that, before the invasion of Iraq and thereafter, this welfare-economic analysis of the military draft was music to the ears of the many undergraduates who enthusiastically cheered on that invasion and the subsequent dangerous occupation of Iraq, leaving the fighting, the bleeding and the dying to someone else, all the while being assured by their economics professors that by this posture they were actually helping to maximize their nation’s overall economic welfare (review this letter, starting at Page 5).

Remarkably, one does not find in the economist’s welfare-economic analysis of the all-volunteer army any mention of a phenomenon that usually creates great concern among economists, namely, the moral hazard built into the arrangement.

Economists can wax quite stern when exposing moral hazard in the context of health insurance, environmental pollution or tax-financed bailouts of banks. Amazingly, though, not in connection with decisions to go to war.

The dictionary defines moral hazard as “a situation in which one party gets involved in a risky event knowing that it is protected against the risk and the other party will incur the cost,” or as Investopedia puts it, as the “idea that a party that is protected in some way from risk will act differently than if they didn’t have that protection.”

In the context of war, moral hazard crops up when the socioeconomic class empowered to declare war is largely insulated from the lethal risks faced by those sent to the battlefield because neither they nor their offspring are likely to be thrust into harm’s way by the war.

Under our system of governance, in which political power is highly correlated with economic power, Professor Landsburg’s “low-cost” people recruited into the military and onto the battlefield are unlikely to have much representation in a decision on whether to go to war. On the other hand, few of those authorized to make that call are likely to have offspring in the fray.

Clearly this is a classic case of moral hazard. It raises the probability of a nation going to war, especially if huge profits can be made off a war by those bearing little personal risk in that war but with powerful sway over government.

On this 10th anniversary of the invasion of Iraq, we shall see numerous retrospectives on that event, reminding us, among other things, of how few of those in government or in the news media who most ardently pushed for that war had ever donned a uniform, let alone served in combat, and how few of them had offspring in harm’s way. Former Marine Corps Gen. Anthony Zinni referred to them acerbically in a television interview last year.

Moral hazard arguably played a major role in this nation’s decision to embark on a pre-emptive strike on Iraq and a haphazardly mismanaged subsequent occupation. One can fairly wonder whether the United States would quite so readily have stumbled into that military adventure if more of the cheerleaders for that war had had their own children exposed to the risk of lethal weapons, including the biological and chemical weapons we were assured that Iraq had and was willing to deploy.

Moral hazard is likely to have played a role all the more so, of course, because the war was accompanied not by a war tax, to pay for it, but by a tax cut. For the most part, the policy-making elite did not bear any sacrifice at all for its decision to go to war.

In the eyes and minds of economists, their welfare-economic case for the all-volunteer army has great intuitive appeal. To make their analysis complete, economists should give some thought to the moral hazard of war to which an all-volunteer armed force can give rise.

Finding Common Ground on the State of the Union

Jared Bernstein is a senior fellow at the Center on Budget and Policy Priorities in Washington and a former chief economist to Vice President Joseph R. Biden Jr. Phillip Swagel is a professor at the School of Public Policy at the University of Maryland and was assistant Treasury secretary for economic policy from 2006 to 2009.

News reports in advance of the State of the Union address focused on President Obama’s promise to take unilateral action on his priorities in defiance of Congress, and subsequent reports have stressed the president’s intention to go over Congress’s head.

But while the two of us come from alternative sides of the aisle on much economic policy, we think this story line misses some potential opportunities for bipartisan progress.  Such progress is by no means assured even when there is broad agreement on a policy â€" the details matter for reaching agreement, as does the political messaging (the latter sometimes too much). But even so, we see possibilities to make for a truly stronger union.

Here are some areas raised in the speech upon which we (mostly) agree, and where we wonder if perhaps something useful could come to fruition.  Even as we’re old friends trying to model good behavior and play nice, however, there are patches of this common ground where we disagree.  We briefly elaborate those as well.

Immigration Reform

We agree that the bipartisan agreement reached in the Senate would be a positive step for the overall economy, for our fiscal situation, and for the millions of undocumented workers and families stuck in the shadows.  President Obama struck the right tone in calling for progress but giving the House the political space to move forward.  There are signs that the House leadership intends to do so, with legislation in steps, presumably focused on border security first and then on providing undocumented immigrants with some sort of legal status, though perhaps not a path to citizenship.

We share concerns about immigration reform that brings in new workers when the labor market is weak.  Inbound immigration decreases when United States economic growth slows, as has been the case in recent years. But even so, the Senate bill includes provisions in which the flow of low-skilled immigrants is adjusted depending on local labor-market conditions.

For undocumented workers already in the United States, immigration reform is a pure positive â€" legal status should diminish the extent to which such workers can be exploited in ways that undercut others in the low-wage work force.

Improving the Quality of Low-Wage Jobs

We disagree on the minimum wage but we’re happy to add to the consensus that is building around expanding the earned-income tax credit (the president cited Senator Marco Rubio’s support in the speech), a wage subsidy for low-wage workers in low-income families.  Specifically, the idea is to raise the part of the credit that goes to childless adults, as this part currently provides a much smaller subsidy than the credit to families with children. The president could welcome movement here without giving up on his push for a higher minimum wage.

Phill: A modest increase in the minimum wage will have modest effects, but I see unintended consequences arising from some low-skilled workers who are not hired and do not get started on the upward ladder.

Jared: It takes both a higher earned-income tax credit and an increased minimum wage to raise the pay of low-wage workers.  They’re complements, not substitutes.  We cannot fully offset the burden of low-wage work with tax credits.  In fact, to do so ends up wasting some of the credit on subsidizing low-wage employers.  Plus, evidence shows that moderate increases in the wage floor, like the $10.10 that the president called for, would help low-wage workers without markedly hurting their job prospects.

Early Childhood Education

We both support the part of the recent budget agreement that relaxed the sequestration and provided about $1 billion in early childhood funding that will restore cuts to programs for low-income children and expand both access to and evaluation of high-quality early childhood programs.

This is a crucial step toward the president’s goal of providing quality educational opportunities for every 4-year-old, a proposal based on the considerable evidence that early interventions can improve the lifelong trajectory of children’s lives. The key, however, is to know first what works. Additional funding would help figure this out.

Jared: No disagreement here, but there is this: when I hear conservatives express support for ideas like this, I don’t see how they’re compatible with their proposed budgets, which cut extremely, and unrealistically, deep into precisely such spending areas.

Phill:  Republicans are looking for programs that work. Readers who are shaking their heads at this should read the recent remarks by Representative Paul Ryan and Senator Marco Rubio.  I would cut dumb spending â€" start with the “crazy train” in California, which the president and Gov. Jerry Brown absurdly still support.  But fund good things.

Other Issues

Other issues on which there is bipartisan support at a broad level include housing finance reform, patent reform, and continued development of American natural gas resources.  While the two parties disagree on important details in each area (we both share concerns about the environmental impact of fracking), there are common goals:  to ensure the availability of mortgages while protecting taxpayers from future bailouts; to support innovation; and to make the United States less dependent on imported energy while providing a bridge to lower-carbon energy sources and renewables.

The two sides will continue squabbling, and neither of us is predicting an end to gridlock (note that the president’s first trip in support of his agenda is focused on the minimum wage).  But the question is whether both sides can get to “yes” on areas where they, like us, agree.  The fact that we both see President Obama as having set out several such areas on Tuesday suggests that there may be more common ground than you’ll read about in the headlines.

Why the Homeownership Rate Is Misleading

Jed Kolko is chief economist and vice president for analytics at Trulia, an online marketplace for residential real estate.

On Friday, the Census Bureau will remind us that the homeownership rate is at or near an 18-year low. After rising to an all-time high of 69.2 percent in 2005 near the height of the housing bubble, the homeownership rate fell to 64.9 percent in 2013, the lowest level since 1995. This drop represents millions of people who lost homes to foreclosure, can’t get a mortgage or haven’t been able to save for a down payment. Furthermore, the homeownership rate is likely to fall further before hitting bottom. Shouldn’t we be panicking that the American dream of homeownership is drifting out of reach?

Nope. At this stage of the housing recovery, the falling homeownership rate turns out to be misleading. In fact, for young adults, who were hit especially hard in the recession and housing crisis, the decline in their homeownership rate might paradoxically be a sign of improvement. The rate can mislead in the other direction, too: During the worst of the housing crisis, the falling homeownership rate clearly understated the damage done.

Source: Current Population Survey, Annual Social and Economic Supplement (Census Bureau and Bureau of Labor Statistics).

Let me explain. Households can be one of two things: owners or renters. The homeownership rate equals the share of households that are owners. But look at people instead of households, and people have a third option: living under someone else’s roof. When young adults live with their parents, or older people live with their grown children, or people live with housemates, they count as part of someone else’s household. Those people are technically neither owners nor renters, and they don’t count in the homeownership rate. That’s why the homeownership rate can mislead: It omits people who are not in the housing market themselves as owners or renters.

This is similar to the better-known shortcoming of the unemployment rate, which doesn’t count people who are “not in the labor force” for various reasons, including having given up looking. As we know, the unemployment rate understated the weakness in the job market during and after the recession because more people dropped out of the labor force. To get the full view of the job market, economists look not only at the unemployment rate, but also at labor force participation.

A simple illustration shows how the homeownership rate can mislead. Suppose you have 10 friends, each living alone; five own their homes and five rent. The homeownership rate among this group is 50 percent. Then, one homeowner loses the house to foreclosure, and three renters lose their jobs and can’t afford to keep their own apartment. These four people all move in with one of the remaining homeowners. Now there remain four homeowners (one of whom is doing lots of laundry and dishes) and two renters, which means the homeownership rate went up to four out of six, or 67 percent. The homeownership rate missed the real story, which is that four of 10 dropped out of the housing market and are now couch-surfing.

When the homeownership rate steers us wrong, the “headship rate” â€" housing’s answer to the labor force participation rate - can come to the rescue. It’s the percent of adults who head a household. Put another way, it is the ratio of households to adults. If there are 200 million adults living in 100 million households, the headship rate is 50 percent. A higher headship rate means fewer adults, on average, per household. Over the longer term, demographics explain shifts in the headship rate (and in labor force participation, for that matter). An aging population, for instance, typically increases the headship rate because older adults are more likely to head their household than younger adults are because many young adults live in their parents’ home or with housemates.

In the short term, though, economic swings affect the headship rate, just as they affect labor force participation. When people lose their home to foreclosure or can no longer pay the rent and move in with someone else, the headship rate falls. When they get back on their economic feet and move out of their parents’ or roommate’s home into their own place - either as an owner or a renter - the headship rate rises.

Let’s go to the numbers. The headship rate can be calculated from two different government surveys, the Annual Social and Economic Supplement of the Current Population Survey, a joint project of the Census Bureau and the Bureau of Labor Statistics, and the American Community Survey compiled by the Census Bureau. To the frustration of housing economists, these surveys sometimes show inconsistent trends. Among other differences, the latest Current Population Survey is more recent, but the American Community Survey is based on a much larger sample.

Sources: Current Population Survey, Annual Social and Economic Supplement (Census Bureau and Bureau of Labor Statistics) and American Community Survey (Census Bureau).

The headship rate peaked just before the height of the housing bubble, reaching 52.3 percent in 2003 and then falling to 51.2 percent in 2010, according to the Current Population Survey; the American Community Survey showed a similar decline over the period 2006-10. That drop in the headship rate translates into 2.5 million fewer households in 2010 than there would have been if the headship rate hadn’t fallen. That means that the decline in actual homeownership was steeper than the homeownership rate alone showed. The rate fell by 3.2 percent, but the actual share of all adults who owned a home dropped 4.9 percent â€" half again as much - because people dropped out of the housing market altogether.

Since 2010, the trend in the headship rate is murkier. The Current Population Survey shows an increase in the headship rate in 2011, 2012 and 2013, while the American Community Survey shows continued decline in 2011 and a near-flattening in 2012, the most recent survey. That means people have either started returning to the housing market or, at least, are dropping out at a slower rate.

Looking at the headship rate is especially important to understand what happened to young adults. The headship rate for 18- to 34-year-olds dropped three times as much as for adults over all, largely because the share living with their parents climbed to the highest level in decades. But this trend has either slowed or reversed. The survey shows that the number of young homeowners has stabilized (adjusting for population growth), and the number of young renters rose by 3 percent as young adults have slowly begun to move out of others’ homes and re-enter the housing market from 2011 to 2013. (The American Community Survey shows their headship rate still falling through 2012, but by less than in the several years prior.)

In fact, the headship rate is the key to how much the housing recovery contributes to economic growth. The headship rate and the population determine the total number of households, so a rise in the headship rate means more new households, all else equal. New household formation stimulates construction activity, and construction adds jobs and investment to the economy. Builders have already increased construction to keep pace with new rental demand: 2013 saw construction begin on the most new rental apartment units in 15 years.

Headship is poised to increase. Young adults still living with their parents won’t do so forever, and the Current Population Survey headship rate in 2013 - even with its recent rise â€" is still below its 20-year average. That will prompt more new construction. Of course, an increasing headship rate isn’t necessarily a good thing: at the extreme, a 100 percent headship rate would mean that each adult has his or her own household, either alone or with children. That would make for a huge construction boom but a lot of loneliness. Age, marital patterns and even cultural preferences all affect living patterns: Among those 65 or older in the United States, for instance, the foreign-born are four times as likely as the native-born to live with relatives rather than in their own household.

How soon will homeownership recover? It depends on job and income growth, mortgage credit availability, affordability and more. But today, since many young adults are still living with their parents, let’s watch first for an increase in the headship rate. And we should not be alarmed by the falling homeownership rate if it’s falling because people are renting their own place instead of living in someone else’s.

The Disappointing Office of Financial Research

Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz professor of entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

One of the better ideas to surface during the early financial reform discussions was to create some form of national institute of finance, an independent body that could support outstanding research and help develop a broader understanding of lurking risks. In the Dodd-Frank Act of 2010, largely through the efforts of Senators Jack Reed, Democrat of Rhode Island (who introduced specific legislation),and Mark Warner, Democrat of Virginia, this became the Office of Financial Research.

Unfortunately, while the office had well-intentioned parents, it was also cursed at birth by a modern Carabosse (the bad fairy who curses Sleeping Beauty). Timothy Geithner, then Treasury secretary, strongly opposed the creation of an independent body focused on diagnosis and assessment of systemic risks. Not being able to talk the Senate out of taking some action in this direction, Mr. Geithner fell back on a standard bureaucratic trick - he took the Office of Financial Research into the Treasury and set about ensuring that it would never be particularly effective.

Four years down the road, it looks as though Mr. Geithner largely got his way. It would take a sweeping change and perhaps new leadership for the vision of Senators Reed and Warner to become something close to reality.

There are many excuses offered for the Office of Financial Research’s lackluster results. It is still hiring (as reflected in a recent report to Congress), its mandate overlaps those of other agencies (the Federal Reserve and the Securities and Exchange Commission have proved hard to work with), and the analytical problems are daunting.

All this may be true, but it does not fully explain why the office’s reports make, at best, for such uninteresting reading. And based on the testimony Wednesday by its director, Richard Berner, to the economic policy subcommittee of the Senate Banking Committee, its briefings to Congress are unlikely to prove any more informative.

In the view of the subcommittee’s chairman, Senator Jeff Merkley, Democrat of Oregon, a clear lesson from the financial crisis is “that we need to do a much better job of identifying and addressing systemic risk before it’s too late.” But the hearing did not provide any discernible improvement along those lines.

Mr. Geithner’s perspective on financial system surveillance seems to have been shaped largely by his time as president of the Federal Reserve Bank of New York, although his previous experience at the International Monetary Fund and Treasury may have played a role.

In this approach, officials largely defend existing practices of the financial sector and provide generous support when important firms need assistance. The board of the New York Fed, for example, has long represented the financial elite of that city. Jamie Dimon, the chief executive of JPMorgan Chase, was a member of that board in early 2008 - and declined to resign, even though the Fed helped his company buy Bear Stearns. Quite why the Federal Reserve’s Board of Governors did not suggest or force his resignation, to avoid the appearance of any conflict of interest, remains a puzzle.

The Office of Financial Research could have been set up to be more independent of Treasury - and this was part of the original intent. It has an independent budget, but appears to operate very much under Treasury’s wing.

Compare this with the Office of the Comptroller of the Currency, which is also nominally within Treasury but which has been much more independent - and, under its current director, Thomas J. Curry, much more effective.

The Office of Financial Research is not a complete loss. For example, among its research papers is some sound work by Rick Bookstaber and others. (Mr. Bookstaber’s book on the financial crisis, “A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation,” written before he joined the office, deserves to be widely read.)

But the office’s data page provides details on just one initiative, and I don’t find much more of substance in its agenda (a sampling of which is provided by their news and events page as well as elsewhere on its website). The 2013 annual report was not impressive; it read like some of the less informative systemic risk assessments that we saw prior to 2007.

And the office’s most high-profile product was its report on asset management, about which Dennis Kelleher of Better Markets had this to say in a blistering comment letter:

It appears to confirm some of the worst suspicions that O.F.R. is influenced by and biased toward the too big-to-fail sell-side banks that dominate Wall Street. After all, rather than focusing on the known systemic risks that they pose, which materialized just five years ago and which inflicted widespread economic wreckage across the country, O.F.R. chooses to take aim at the asset management buy-side of the financial industry, which, by comparison, presents much lower risk and played no role or virtually no role in the most recent financial crash.

It is all very disappointing, particularly given that the office’s annual budget is running at a remarkable $86 million (see Page 119 of the 2013 report).

There is much more that the Office of Financial Research could do, including - just as one example - Eric A. Posner and E. Glen Weyl’s idea of establishing a form of Food and Drug Administration for complex financial products. It is currently far too easy to create financial products that have toxic systemic side effects. We used to allow such unregulated innovation for pharmaceutical products but learned the very hard way that this is not in the social interest.

Over all, the Office of Financial Research is very disappointing. Mr. Berner can and should turn this important agency around.

The Disappointing Office of Financial Research

Simon Johnson, former chief economist of the International Monetary Fund, is the Ronald A. Kurtz professor of entrepreneurship at the M.I.T. Sloan School of Management and co-author of “White House Burning: The Founding Fathers, Our National Debt, and Why It Matters to You.”

One of the better ideas to surface during the early financial reform discussions was to create some form of national institute of finance, an independent body that could support outstanding research and help develop a broader understanding of lurking risks. In the Dodd-Frank Act of 2010, largely through the efforts of Senators Jack Reed, Democrat of Rhode Island (who introduced specific legislation),and Mark Warner, Democrat of Virginia, this became the Office of Financial Research.

Unfortunately, while the office had well-intentioned parents, it was also cursed at birth by a modern Carabosse (the bad fairy who curses Sleeping Beauty). Timothy Geithner, then Treasury secretary, strongly opposed the creation of an independent body focused on diagnosis and assessment of systemic risks. Not being able to talk the Senate out of taking some action in this direction, Mr. Geithner fell back on a standard bureaucratic trick - he took the Office of Financial Research into the Treasury and set about ensuring that it would never be particularly effective.

Four years down the road, it looks as though Mr. Geithner largely got his way. It would take a sweeping change and perhaps new leadership for the vision of Senators Reed and Warner to become something close to reality.

There are many excuses offered for the Office of Financial Research’s lackluster results. It is still hiring (as reflected in a recent report to Congress), its mandate overlaps those of other agencies (the Federal Reserve and the Securities and Exchange Commission have proved hard to work with), and the analytical problems are daunting.

All this may be true, but it does not fully explain why the office’s reports make, at best, for such uninteresting reading. And based on the testimony Wednesday by its director, Richard Berner, to the economic policy subcommittee of the Senate Banking Committee, its briefings to Congress are unlikely to prove any more informative.

In the view of the subcommittee’s chairman, Senator Jeff Merkley, Democrat of Oregon, a clear lesson from the financial crisis is “that we need to do a much better job of identifying and addressing systemic risk before it’s too late.” But the hearing did not provide any discernible improvement along those lines.

Mr. Geithner’s perspective on financial system surveillance seems to have been shaped largely by his time as president of the Federal Reserve Bank of New York, although his previous experience at the International Monetary Fund and Treasury may have played a role.

In this approach, officials largely defend existing practices of the financial sector and provide generous support when important firms need assistance. The board of the New York Fed, for example, has long represented the financial elite of that city. Jamie Dimon, the chief executive of JPMorgan Chase, was a member of that board in early 2008 - and declined to resign, even though the Fed helped his company buy Bear Stearns. Quite why the Federal Reserve’s Board of Governors did not suggest or force his resignation, to avoid the appearance of any conflict of interest, remains a puzzle.

The Office of Financial Research could have been set up to be more independent of Treasury - and this was part of the original intent. It has an independent budget, but appears to operate very much under Treasury’s wing.

Compare this with the Office of the Comptroller of the Currency, which is also nominally within Treasury but which has been much more independent - and, under its current director, Thomas J. Curry, much more effective.

The Office of Financial Research is not a complete loss. For example, among its research papers is some sound work by Rick Bookstaber and others. (Mr. Bookstaber’s book on the financial crisis, “A Demon of Our Own Design: Markets, Hedge Funds and the Perils of Financial Innovation,” written before he joined the office, deserves to be widely read.)

But the office’s data page provides details on just one initiative, and I don’t find much more of substance in its agenda (a sampling of which is provided by their news and events page as well as elsewhere on its website). The 2013 annual report was not impressive; it read like some of the less informative systemic risk assessments that we saw prior to 2007.

And the office’s most high-profile product was its report on asset management, about which Dennis Kelleher of Better Markets had this to say in a blistering comment letter:

It appears to confirm some of the worst suspicions that O.F.R. is influenced by and biased toward the too big-to-fail sell-side banks that dominate Wall Street. After all, rather than focusing on the known systemic risks that they pose, which materialized just five years ago and which inflicted widespread economic wreckage across the country, O.F.R. chooses to take aim at the asset management buy-side of the financial industry, which, by comparison, presents much lower risk and played no role or virtually no role in the most recent financial crash.

It is all very disappointing, particularly given that the office’s annual budget is running at a remarkable $86 million (see Page 119 of the 2013 report).

There is much more that the Office of Financial Research could do, including - just as one example - Eric A. Posner and E. Glen Weyl’s idea of establishing a form of Food and Drug Administration for complex financial products. It is currently far too easy to create financial products that have toxic systemic side effects. We used to allow such unregulated innovation for pharmaceutical products but learned the very hard way that this is not in the social interest.

Over all, the Office of Financial Research is very disappointing. Mr. Berner can and should turn this important agency around.

Fed Decision Day: What to Watch For

President Obama gave a long speech Tuesday night about the things government can do to help the economy without ever mentioning the Federal Reserve. Presidents rarely do. But it’s also the case that folks at the White House, like most Fed officials, think the central bank already has done as much as it should.

The Fed ended 2013 by announcing that it would begin to reduce its extraordinary efforts to stimulate the economy. At the end of its first policy-making meeting of 2014 on Wednesday, it is likely to announce that the retreat will continue.

This is also the last meeting for the Fed chairman, Ben S. Bernanke, who will step down on Friday after leading the central bank for eight years. After failing to foresee the financial crisis, he led the Fed’s aggressive efforts to contain the damage, and then its more tentative campaign to help restore the flow of economic activity.

He said at the beginning of his second term that he hoped to see that effort through to completion, but with the retreat barely begun, a significant part of Mr. Bernanke’s legacy will be shaped by the performance of his successor, Janet L. Yellen.

Here are three things to watch on Wednesday:

1. Twice is a pattern

Fed officials have given every indication that they plan to reduce their monthly accumulation of Treasury and mortgage-backed securities by $10 billion at the January meeting, just as they did at their last meeting in December. That, in turn, would reinforce the expectation that the Federal Open Market Committee will do the same thing when it next meets in March.

Investors will be watching the language of Wednesday’s statement for any sign that the Fed has doubts about the wisdom of maintaining that pace, like a weakening in the Fed’s description of the economic outlook.

2. What happens after the unemployment rate hits 6.5 percent?

The unemployment rate used to be a pretty decent proxy for the health of the labor market. But its rapid fall to 6.7 percent in December, from a peak of 10 percent in 2009, probably overstates the actual improvement in the labor market. The rate is based on the number of people who are looking for work, and a lot of people have given up. Some have settled into retirement or qualified for disability benefits, but others may simply be waiting for economic conditions to improve.

The Fed has said since December 2012 that it plans to keep short-term interest rates near zero at least as long as the unemployment rate is above 6.5 percent. With the unemployment rate about to drop below that threshold, a number of Fed officials have said that the central bank needs to clarify its plans.

The Fed took a stab at the problem in December, saying that it intended to keep interest rates near zero “well past the time that the unemployment rate declines below 6.5 percent, especially if projected inflation” remains modest.

That’s a thin reed, particularly for a central bank that has described forward guidance as its most powerful means of stimulating the economy. But in deciding whether to say more, the Fed is wrestling with the balance between precision and accuracy. Precision increases the power of forward guidance, but only if investors believe the Fed will hew to its plans. And the decision to taper bond purchases has already shown that officials are nervous about doing too much.

3. Hey, aren’t you guys in charge of inflation?

The pace of price increases remains sluggish and, with each passing month, the confidence of Fed officials that inflation will rebound gets a little harder to justify.

The Fed says that it wants annual inflation of about 2 percent, but last year the Consumer Price Index rose by just 1.5 percent. (A second measure, which the Fed regards as more reliable, will be published Friday.)

The Fed’s official statements have reflected growing concern about low inflation. In its December statement, the Fed said that “inflation persistently below its 2 percent objective could pose risks to economic performance.”

Strikingly, a number of Fed officials also have expressed puzzlement, saying that they do not understand why prices are rising so slowly.

State of the Union: Few Horatio Alger Stories

There were a lot of pedigree shout-outs Tuesday night in the State of the Union address and the responses, generally in reference to humble beginnings.

From President Obama:

It’s how the daughter of a factory worker is C.E.O. of America’s largest automaker â€" (applause) â€" how the son of a barkeeper is speaker of the House â€" (cheers, applause) â€" how the son of a single mom can be president of the greatest nation on earth.

And later on:

And this son of a factory worker just found out he’s going to college this fall.

Then from the Republican reply of Representative Cathy McMorris Rodgers:

My dad drove a school bus and my mom worked as a part-time bookkeeper.

So frequent were these genealogical citations that when Mr. Obama mentioned “Mad Men,” Jacob Weisberg of Slate tweeted:

Don Draper, the son of a streetwalker…

â€" Jacob Weisberg (@jacobwe) 29 Jan 14

These are moving, memorable examples of people who rose above the station they were born to. But part of the reason these examples are so impressive is that they happen so rarely. And in the future, they might become rarer still.

Recent research from economists at Harvard, the University of California, Berkeley, and the Treasury Department (as reported in an article by my colleague David Leonhardt) looked at intergenerational economic mobility across the country. It found that while there have been modest gains in absolute living standards, the likelihood of someone escaping the socioeconomic class that person were born into has remained stagnant.

Children of single parents seem especially unlikely to climb the income class ladder, as are children who grow up with married parents but still live among a lot of single-parent families. (One of the best ways to escape the economic fate of one’s low-earning parents, meanwhile, is to go to college.)

The authors note that the interaction between stagnant mobility and increasing inequality means your parents’ earnings have especially big consequences for your own economic future:

Although rank-based measures of mobility remained stable, income inequality increased substantially over the period we study. Hence, the consequences of the “birth lottery” â€" the parents to whom a child is born â€" are larger today than in the past. A useful visual analogy … is to envision the income distribution as a ladder, with each percentile representing a different rung. The rungs of the ladder have grown further apart (inequality has increased), but children’s chances of climbing from lower to higher rungs have not changed (rank-based mobility has remained stable).

In other words, it has actually become increasingly impressive over time for the son of a barkeep or single mother or school bus driver â€" or other parent likely to have low earnings â€" to rise to a highly paid position like head of state, executive or legislator.

Addendum: A few months ago, Pew’s Economic Mobility Project developed an interactive tool that allows you to see the chances of surpassing your parents’ income and socioeconomic class, based on family structure and other demographics like race. Definitely worth checking out.

The Sunny Side of the Unemployment Report

David A. Rosenberg, the chief economist at Gluskin Sheff, a Canadian research firm, is not known for his rose-colored glasses. Indeed, when he was at Merrill Lynch in New York, there were complaints that he was too negative.

All of which makes the following discussion of the American employment situation interesting. Rather than look at the (disappointing) December report in isolation, he looked at the job market performance in 2013.

His comments are in italics. I will occasionally interject with parenthetical explanations where I think a reference may be obscure.

1. Employment rose 2% last year, representing a 2.26 million gain for all of 2013. I do hope nobody has too much trouble with a number like that in a year of near-record fiscal retrenchment. It was actually pretty good.

2. Part-time jobs actually fell 0.7% so even with Obamacare, this was a full-time employment story. The ratio of full-time to part-time rose to 4.285, the highest it has been in over five years.

(There was a lot of talk that companies would force workers into part-time jobs to avoid having to provide health insurance. It is not clear that actually has happened.)

3. Those working part-time for economic reasons fell 2% last year.

4. Those not in the labor force aged 25-54 that do not want a job rose 4.5% in 2013.

5. Those in that above-mentioned cohort who do want a job actually fell 3.3%.

6. The number of 25-54-year-olds who are not counted in the work force that claim they are “discouraged” sagged 18.5% last year.

7. The number of people who needed a second or third job fell 2.2% in 2013.

8. Both the U1 and U2 unemployment rates have fallen to cycle lows of around 3.5%. And according to a recent Morgan Stanley report, there is scholarly research proving that these shorter-term unemployment rate measures have a tighter relationship with wage growth than the longer-term jobless numbers do.

(The U1 rate is the percent of the work force that has been unemployed for at least 15 weeks. A year earlier it was at 4.3 percent. The U2 rate is the percentage of the work force that is unemployed because workers either completed temporary jobs or were laid off. It was 4.2 percent a year earlier.)

9. The unemployment rate in the financial sector is down to 4.2%, in manufacturing down to 5.5%, in information technology down to 4.8%, in education/health down to 4%, and all the way down to 3.6% in the resource sector. This is over 40 million workers and represents a 40% chunk of private payrolls.

10. If the unemployment rate in construction had not gone up from 8.6% to 11.4% due to the inclement weather in December, we would be sitting at a 6.2% national unemployment rate. The jobs market is tighter than you think.

11. After all, the pool of available labor contracted 13.4% in 2013 to a five-year low.

12. The unemployment rate for those with a college degree is only 3.3%.

13. The employment/population ratio in the key 25-34 year cohort finished 2013 at a seven-month high of 75.4%; 373k net new jobs have been created since Labor Day â€" all key for housing since this is the first-time homebuyer cohort.

14. The number of job openings as per the JOLTS data show a YoY increase of 5.6%. New hires managed to rise 1.7%. Layoffs plunged 14.3%. And the number of folks quitting their jobs for greener pastures jumped 13.5%.

(The JOLTS data comes from the Job Openings and Labor Turnover Survey, which gets much less publicity than the regular jobs report.)

15. As if to slap the nonfarm payroll headline in the face, the Rasmussen Employment index in December jumped to 89.8 from 85.7 in November â€" to stand at a six-month high.

(That index comes from polls of workers regarding worker confidence.)

So what is wrong with this jobs performance, exactly? And please â€" I’m not a cheerleader; simply a data wonk.

She’s a 29er

Casey B. Mulligan is an economics professor at the University of Chicago. He is the author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy.”

Much has been made of the burdens of the Affordable Care Act on healthy young men, but young women are the ones most likely to see the law push them out of full-time work.

A “29er” refers to someone working 29 hours per week, the maximum that an hourly employee can work and still be considered part time by the federal government, as defined under the Affordable Care Act.

Before 2014, when the new federal definition took effect, Census Bureau data suggest that hardly anyone worked exactly 29 hours a week: about one in 1,000. Only six in 1,000 worked 26 to 29 hours a week.

The Affordable Care Act requires that, beginning next January, large employers provide health insurance for their full-time employees (by the federal definition) or pay a penalty per full-time employee on the payroll. The annual penalty is $2,000 and, unlike employee salaries and benefits, is not deductible from business taxes. Small employers do not owe a penalty, unless they cross the 50-employee threshold, in which case the annual penalty is $40,000 for having that 50th employee. Subsequent hires would each carry a $2,000 annual penalty.

Part-time employees do not create a health-insurance requirement or a penalty for their employer, which gives large and small employers an incentive to reduce at least some employees’ hours to 29 hours. A number of employers plan to do exactly this.

But the incentives are not limited to penalty avoidance by employers, and began this month. Employees in families with income of less than 400 percent of the poverty line will lose access to generous federal subsidies if they make themselves eligible for employer health coverage by working full time at an employer that offers coverage to such employees.

In other words, employees may have something to gain, or less to lose than they did before this year, by limiting themselves to a 29-hour work schedule. For full-time salaried workers (as opposed to hourly workers) the federal definition is those who work more than three days a week. (For the purposes of discussion, I will refer to the three-day limit as “29 hours,” although in practice it may be, say, a 26-hour schedule).

As the new law goes into full effect the next couple of years, I expect that more than 2 percent of workers will be 29ers, an increase by more than a factor of 10. Moreover, as the labor market adjusts to avoid penalties and enhance subsidies, the adjustments will tend to be those that are least costly.

One of the least costly ways to move full-time workers to the 29er group would be to focus on those who already work slightly more than 29 hours. It is usually less costly for a 35-hour-per-week worker to cut hours to 29 than for a 55-hour-per-week worker to do so.

I used the Census Bureau’s data to put together a sample of people likely to be 29ers over the next couple of years, based on working 30 to 37 hours per week before this year and not having health insurance available through a spouse (if married). Women outnumber men more than 2 to 1 among likely 29ers. The 29ers are also likely to be less than 30 years old.

Naturally, working fewer hours means less pay. By disproportionately reducing women’s work hours, health reform may have the unintended consequence of increasing the gap between men’s and women’s wages and salaries.

In Search of Confidence

The consumer confidence figures just released showed an increase, but they remain at a level that is historically low.

One question that determines the index is whether consumers expect their own income to rise, fall or remain level over the next six months.

As can be seen from the chart, from 1978, when the Conference Board began asking the question each month, through 2007, there was never a month when more people were pessimistic than optimistic. But starting in mid-2008, that reversed.

Source: Conference Board

In the January survey, there was a slight plurality of optimists, after two months when the pessimists were more numerous.

One eye-catching fact, at least for me, is that during the 30 years before 2008, there were only 11 months when fewer than 17 percent of the people thought their income would rise. Since the end of 2008, there have only been three months when as many as 17 percent of the people expected an increase. And only one of those was in 2013. In January of this year, the figures were 15.8 percent optimistic and 13.6 percent pessimistic. The rest expected their income to be about the same.

When the results of that question turn around, consistently, it will be a sign that Americans really believe there is an economic recovery.

Challenges for the Yellen Fed

Joshua Roberts/Reuters Janet Yellen at her confirmation hearing in November.

Phillip Swagel is a professor at the School of Public Policy at the University of Maryland and was assistant secretary for economic policy at the Treasury Department from 2006 to 2009.

The good news for Janet Yellen is that she will take the reins at the Federal Reserve on Saturday with inflationary pressures subdued and the United States economy finally in an upswing (occasional stock market gyrations notwithstanding). Too many Americans remain out of work or have given up looking for a job, but the worst of the financial crisis and recession are past - an accomplishment for which Ben S. Bernanke, the departing chairman, will receive deserved acclaim.

The difficult part for Ms. Yellen is that she faces a new set of challenges involving not just monetary policy but also broader questions regarding the role of the Fed in the nation’s economy and political system.

Most immediately, she will be charged with guiding a monetary tightening â€" first by completing the Fed’s tapering of purchases of Treasury bonds and mortgage-backed securities, and then by returning to a more usual level of interest rates after five years in which the overnight rate set by the Fed has been virtually zero. Ms. Yellen has associated herself with the view of Mr. Bernanke that the pace of monetary normalization depends on the data, but this still leaves the difficult question of knowing when the labor market is nearing a level of full employment at which inflation would become more of a concern.

If a strong enough economy can bring people off the sidelines and back into the labor force, then there is more slack in the labor market than implied by the recent decline in the unemployment rate. In this case, the Fed could maintain easy monetary conditions in an attempt to drive up wages and the participation rate. The benefits of the third round of quantitative easing, the so-called QE3, have shown up most prominently in driving up asset prices like stock values. While the move is intended to strengthen the broad economy, the immediate gains thus appear to have been skewed toward wealthier households. One could imagine that the new Fed chief, the first Democrat in the position in decades, might view monetary policy as a way to produce higher wages, and thereby direct more of the benefits of Fed actions to a broader group of Americans.

If inflation picks up, however, this would signal that the labor market has reached a new normal in which wage and inflation pressures arise with lower participation and higher unemployment than in the past â€" a sign that the crisis and recession have brought about a lasting change for the worse. In this case, the Fed would need to tighten sooner and more quickly than is now envisioned.

A misstep in either direction would be costly.  An overly rapid monetary tightening might unnecessarily choke off some growth and job creation, while a mistake in the other direction would leave the Fed behind the curve as elevated inflation gets embedded into wage- and price-setting.  This would then require a yet more painful monetary contraction to restore price stability and reset the Fed’s credibility. Worries over soaring inflation are distant now, but a strengthening economy and easy lending conditions could combine to change that.

The episode last June in which Mr. Bernanke’s hint of a taper led to a sharp increase in long-term interest rates illustrates that even communication missteps can have significant results. The resulting market whipsaw last summer, for example, led to a spike in mortgage rates until the Fed explained itself better in September.

The Fed has convinced markets that even as it gradually backs away from quantitative easing, interest rates will remain near zero into 2015 and the low-rate environment will continue for a considerable time after that. The communication challenge for Ms. Yellen is to assure market participants that the Fed will stick to this plan even when an improving economy would normally signal the time to tighten under historical relationships between the job market, inflation and monetary policy.  And if new data lead the Fed to revise its plan, the yet steeper challenge will be to explain the change.  At some point continued declines in the unemployment rate without a pickup in participation will lead Ms. Yellen to try her hand at some new forward guidance.

Regardless of whether this more rapid tightening becomes necessary, Ms. Yellen will face the new challenge of adapting her institution to a world in which Fed actions do not just affect other countries (as has always been the case), but the impacts in turn spill back over to have meaningful consequences for the United States.  Last week’s market plunge threw into relief the challenge posed by higher United States interest rates for emerging-market countries that have depended on inflows of capital to sustain investment and consumer spending.  With higher yields in the offing in the United States, global investors are looking warily at emerging market favorites such Brazil, Russia and India.

The concern is even greater in countries such as Turkey, where domestic political problems threaten to affect political stability and thus the economy. The Fed is well aware of what its decisions mean for other countries, but in the past it has given little weight to this in setting monetary policy since there was scant consequence for the United States. Increased cross-border feedbacks could change this calculus. To be sure, the Fed will not hesitate to adjust rates to counter domestic inflation, but it will think carefully if a rapid monetary tightening creates havoc overseas that seriously affects American markets.

Such market convulsions highlight a conundrum for the Yellen Fed. On the one hand, markets accustomed to easy credit could have problems once it is withdrawn.  This possibility is built into the Fed’s calculations and is a reason for its cautious approach to tightening.  In the other direction, however, is the concern that easy credit has led investors to take inappropriate risks, meaning that continued monetary ease could give rise to another bubble and the attendant consequences once it deflates.  Thus the possibility of problems if credit is tight or too loose.

In an interview at the Brookings Institution on Jan. 16, Mr. Bernanke said that he recognized these concerns over distortions in asset markets, but concluded that the Fed could prevent another bubble with more careful supervision over the financial industry and through policies like requiring banks to fund themselves with more capital and have better access to liquidity. This sounds reassuring, but regulators did not prevent the last crisis despite considerable legal authority.

Moreover, while increased regulatory oversight and heightened capital requirements were surely appropriate in the wake of the crisis, there is a trade-off between measures such as these that can improve the stability of the financial system and the economic activity that financial firms support. The Fed going forward will face a delicate balancing act â€" not just between inflation and jobs, but also regarding financial market stability. Steps to improve stability, for example, could dampen economic activity, giving rise to calls for additional monetary easing that threaten to pump up yet new bubbles.

Finally, Ms. Yellen must respond to continued demands for greater transparency from the Fed regarding its policy interventions.  Mr. Bernanke knew that lending money to investment banks or bailing out the counterparties of the American International Group would be unpopular, but he took these extraordinary steps because he recognized that a failure to act could be catastrophic and he was willing to take the political consequences for the good of the country.  The Federal Reserve is independent precisely to allow such decisions, but this status could yet be tested.

While Fed skeptics are clustered to the right of the political spectrum, catcalls will come from the left if Ms. Yellen determines that tighter monetary policy is needed to head off inflation even while the unemployment rate remains high.  A natural response will be for the new chief to speak clearly about the rationales behind her policy steps.  There will always be critics, but Ms. Yellen can win the respect of fair-minded observers by explaining her view of the economy and connecting these observations to policy steps.

Alan Greenspan was tested by the October 1987 stock plunge just two months after becoming Fed chairman, and the housing bubble began to unwind within months after Mr. Bernanke took over in February 2006. Economic and financial conditions seem more favorable for the start of Ms. Yellen’s term, but she will nonetheless face considerable challenges both in setting monetary policy and in explaining her decisions to an anxious public and political system.

The Roots of the Tax Reform Act of 1986, Part II

Bruce Bartlett held senior policy roles in the Reagan and George H.W. Bush administrations and served on the staffs of Representatives Jack Kemp and Ron Paul. He is the author of “The Benefit and the Burden: Tax Reform â€" Why We Need It and What It Will Take.”

Last week I discussed the roots of tax reform dating back to the 1960s. Until the late 1970s, it was a movement driven largely by liberals trying to close tax loopholes and make the rich pay their fair share. By the early 1980s, conservatives had joined the debate.

In my earlier post, I said that inflation was the most important factor that largely ended the liberal tax reform effort. People were more concerned with tax cuts and stimulating growth than they were with fairness, which was the principal liberal objective.

But there was a theoretical element as well. Liberals had a theory of the ideal tax system based on the notion that taxable income should consist of consumption plus the increase in net worth over the course of a year. This would include taxation on unrealized capital gains, which is a constitutional problem as well as a practical one. Liberals of that era were also strong in their support for “vertical equity,” which meant steeply progressive tax rates.

Conservatives did not really have a competing idea; they just opposed what the liberals were for. Treasury Secretary William E. Simon, who served from 1974 to 1977, thought the lack of a conservative alternative to the liberal idea of tax reform put conservatives at a disadvantage. He recruited the Princeton economist David Bradford to come up with an ideal conservative tax system.

Professor Bradford thought that a pure consumption tax was best from a conservative point of view, because it exempted the taxation of wealth and savings implicit in the liberal ideal. He worked through many important technical problems with a consumption-based tax system, and his report was published as “Blueprints for Basic Tax Reform,” issued by the Treasury just days before Jimmy Carter took office in 1977.

For the next several years, conservatives concentrated on reducing statutory tax rates, which Ronald Reagan accomplished in 1981. His tax cut reduced the top income tax rate to 50 percent from 70 percent and the bottom rate to 11 percent from 14 percent. Conservatives wanted to go further, but rising budget deficits precluded further tax cuts.

In December 1981, two Hoover Institution fellows, Robert E. Hall and Alvin Rabushka, put forward a tax reform plan that married Professor Bradford’s idea of a pure consumption base to a flat-rate tax system. In an op-ed article in The Wall Street Journal, they contended that their proposal was so simple that everyone could file their income taxes on a postcard and that a single rate of 19 percent, including a large personal exemption, would collect the same revenue as the existing income tax.

Conservatives were very excited to finally have an ideal tax system they could support. Moreover, it gave them a way to continue to talk about tax rate reduction in an era constrained by large budget deficits. Some conservatives, such as the economist David Hale, even asserted that the Hall-Rabushka plan would raise net revenue and reduce the deficit because it would expand economic activity.

By July 1982, Reagan said he was very interested in the idea of tax reform based on a flat rate. When asked about it, he said:

Let me just say, we support looking at that. It’s a very tempting thing, because let’s all of us admit that probably there is more resistance to the income tax in America today, not from the amount of it, but from the complexity of trying to figure out what the amount should be, that the people are pretty fed up with something so complex that even the government has to warn that their own agents cannot be depended on to give you sound advice as to what your tax burden should be. I can remember when you used to go in there to them and just hand it to them, and they’d tell you what you owed and that was it. They can’t even do it anymore. So, the flat rate does look tempting.

However, to the dismay of conservatives, Reagan did not endorse the Hall-Rabushka plan and, in fact, went in the other direction, supporting the largest peacetime tax increase in American history, the Tax Equity and Fiscal Responsibility Act, which he signed into law on Sept. 3, 1982.

Undeterred, congressional conservatives went to work on their own tax reform plans. My former boss, Representative Jack Kemp of New York, and Senator Robert Kasten of Wisconsin, both Republicans, drafted a proposal that would have established a nominal 25 percent flat rate, although effective rates would vary. They proposed paying for this rate reduction with various reforms, including elimination of the deduction for state and local taxes, one of the biggest tax expenditures.

Simultaneously, Senator Bill Bradley of New Jersey and Representative Richard Gephardt of Missouri, both Democrats, developed a tax reform plan with a top rate of 30 percent. It was also meant to be revenue-neutral and paid for rate cuts with base-broadening. One of the big revenue raisers in the Bradley-Gephardt plan was the inclusion of untaxed fringe benefits in taxable income.

People quickly noticed a lot of overlap between the Kemp-Kasten and Bradley-Gephardt plans. (See the Congressional Budget Office’s side-by-side comparison from October 1984.) This, more than anything else, persuaded members of Congress that bipartisan tax reform was doable. The fact that the Senate was under Republican control and the House under Democratic control was also important, I think, because each side knew its interests were protected.

On Nov. 1, 1984, the Treasury Department issued the tax reform study Reagan had asked for in his State of the Union address in January of that year. Although the plan was generally praised, some conservatives were highly critical of its impact on the cost of capital. The Treasury’s former assistant secretary for economic policy, Paul Craig Roberts, called for its rejection.

The White House reviewed the Treasury study, made some adjustments and sent a formal proposal to Congress in May 1985. There followed 18 months of intense congressional debate and negotiation, well reviewed in the 1988 book “Showdown at Gucci Gulch: Lawmakers, Lobbyists and the Unlikely Triumph of Tax Reform” by Alan Murray and Jeffrey Birnbaum, reporters at The Wall Street Journal. It is still considered the go-to source on the politics of tax reform.

In my view, the preconditions for tax reform that were present in the mid-1980s do not now exist. That effort built on 25 years of research on tax reform that resulted in two previous tax reforms, in 1969 and 1976, similar ideas among Republicans and Democrats, and strong leadership from the White House, Treasury Department and the chairmen of the House Ways and Means Committee and Senate Finance Committee.

I believe it will take several more years, at least until after the 2016 elections, before meaningful tax reform can move forward.