Uncertainty about federal economic policy has been high at any time in the last 40 years. On the one hand, senior policymakers have already called for raising huge budget deficits, locking up lo reversible monetary policy for the foreseeable future, and raising taxes on businesses, Wall Street and the rich if inflation rates rise. On the other hand, we have a president and senior finance officials who are direct members of the coalition between mainstream liberal education economists and Wall Street executives who have dominated Democratic Party economic thinking since the Carter administration.
In the absence of clear statements from superiors, a recent document co-authored by Nobel laureate economist George Ackerloff, husband of Treasury Secretary Janet Yellen, may be our best understanding of the intentions of the Biden administration. Although the paper did not indicate an official policy, Yellen said it was thankful in its receipts.
This paper is valuable because it focuses on one topic of controversy between academic liberal economists and Wall Street executives: Tobin Tax. The idea goes back to a 1972 speech by Nobel laureate economist James Tobin, who suggested that taxing short-term financial transactions would make markets more stable and efficient. Many liberal economists are impressed by this idea. Wall Street hates it.
So, Eckerloff may have written about Tobin taxes without thinking of any political reaction, and his wife may have only helped with technical comments, suggesting that Wall Street input policy would be excluded from the design and that liberal economists would try to find common ground. Ground with progressives.
When arguing for the Tobin tax, the paper considered scheduling information about security, such as corporate earnings. It assumes that dealers, market makers and commercial companies will buy if the news is good and sell if it is bad. Despite the extreme simplifications, the model accurately predicts dealers and market manufacturers to keep their lists better than the expected outflow of order before scheduled announcements. This is generally considered a good thing because it makes the market impact of events sensitive. One of the complaints about the Dodd-Frank rules was that they discouraged having long or short positions, which led to less efficient markets and expanded bid / ask spreads. The paper then introduces some transparent decorative tricks to make the inventory position look bad. The listed market manufacturers are called “Front Runners”. Front running is the offense of a broker or other agent making transactions before executing a client order. Ackerloff expanded the definition to mean any preemptive action by a broker. This is no small error with the phrase used 100 times on paper. Thus the purely legal and ethical practice of inventory management is labeled with a phrase indicating a criminal act.
Most market manufacturers maintain a passive list. If they want to accumulate a positive list, for example, they will be a little more aggressive in filling out sales orders and a little less aggressive in filling out purchase orders. In the Akerlof model, market manufacturers build a list by looking for “sophisticated” investors. Retail investors are unaware of the scheduled data release and seem to have imagined that they could attract some portion with securities through bids, somewhat above the final transaction price. Whoever they are, we want them to make more money. When ‘front runners’ reduce their transaction costs by expanding their orders, ‘advanced’ investors make less money. Finally, the paper-tax transactions pointed out by the paper discourage inventory positions and offer large returns to ‘sophisticated’ investors. Other objections aside, the imposition of a tax on all financial transactions for a small fraction that does not refer to the list positioning trades of the market manufacturers is out of proportion to the sophisticated retail investors.
I can’t think of any scheduled information releases of the type that the paper considers. Earnings and other big news are usually scheduled when the market closes or trading stops. Government figures released on trading day affect thousands of securities and no market manufacturer adjusts the listed positions in thousands of securities just minutes before release.
But this is the absurdity of the policy arguments of the paper, which leads me to suspect that it is a sign. Economists who read the paper dismiss it. Non-financiers who read second-hand accounts seize on Nobel laureate paper supporting financial transaction taxes. Liberal economists can shut up and succeed on an issue that most progressives think is not a bad idea — certainly not as silly as modern monetary theory.
Aaron Brown is a former managing director and head of financial market research at AQR Capital Management and author of The Poker Face of Wall Street.