Hungarian Outrage

I stumbled across this lovely little post from Hungary, titled "This is why I don't give you a job"

It's full of classic unintended-consequence reminders for economists.  For example, protecting people by not letting employers fire them means that people don't get jobs in the first place.

It has some good reminders for the US as well.

The World's Biggest Hedge Fund

The world's largest hedge fund paid $79.3 billion dollars to its main investor last year, as announced to the press and reported by the Wall Street Journal this morning.

It followed classic hedge-fund strategies. It's leveraged about 55 to 1, meaning that for every dollar of capital it borrows 55 dollars to fund 56 dollars of investments. Its borrowing is mainly overnight debt. It used that money to make aggressive bets in long-run government bonds, as well as strong speculative positions in mortgage-backed securities and direct distressed lending. Lately it's been putting bigger bets on loans to Europe and currency swaps. (Balance sheet here.)

The payout was actually conservative, as it reflected only the greater interest payments earned on its portfolio of assets and realized gains, not the substantial unrealized capital gains it made over the last year as long-term bond prices rose.

Who is this miraculous fund? Why our own Federal Reserve of course! 

Is this good or bad?

Goolsbee on budgets

My colleague Austan Goolsbee wrote a thoughtful Wall Street Journal Op-Ed last week titled "Washington isn't spending too much." I agree with more of it than you might think -- though with a few important asterisks.

The last paragraph caught my eye:

"The election should lay out each candidate's fiscal grand bargain and growth strategy. Let us compare them. They matter. This could make up the heart of a historically important presidential contest."

Yes indeed. But I don't think Austan's partisan tone is justified -- he was criticizing Republicans in Iowa. This could have been written by the Ron Paul campaign, followed quickly by acid comments that "tax the rich" is not a "fiscal grand bargain" with any hope of closing the long-run budget gap, and neither it nor more Solyndras are a "growth strategy" as economists understand long-run growth.

Here's an optimistic interpretation: Austan advises the Obama campaign. Perhaps he's dropping a hint that the campaign will unveil that grand bargain -- with a plan to get it through Congress -- and a serious growth strategy. If they do, they'll win the election and save the economy.

Should Greece Devalue?

Two weeks ago I wrote the following in a little Bloomberg column about the Euro 

Defenders [of devaluation] think that devaluing would fool workers into a bout of “competitiveness,” as if people wouldn’t realize they were being paid in Monopoly money. If devaluing the currency made countries competitive, Zimbabwe would be the richest country on Earth. No Chicago voter would want the governor of Illinois to be able to devalue his way out of his state’s budget and economic troubles. Why do economists think Greek politicians are so much wiser? 

This paragraph set off a little kerfuffle in the Cochrane-is-a-moron section of the blogosphere. I won't respond in detail, because I presume you're more interested in economics than what anyone thinks of anyone else's intelligence.

But the paragraph was mighty distilled, and the evident interest in the question suggests a little fuller examination of whether devaluation is a good idea or not for a country like Greece, and trying to understand why people come to such different views.

I think I can sum it up this way: Devaluation is like a cigarette. The Keynesian camp basically says, "Boy, a cigarette would perk me up right now."' Modern macroeconomists (I'm looking for a good name -- "Dynamic?" "Intertemporal?" "Equilibrium?" Really everybody else, including new-Keynesians) basically say "Maybe, but smoking is a really bad lifestyle decision." We think of policies as rules, not decisions.

The following discussion resembles that between a teenager and the parent who found a pack of cigarettes. It sounds like facts are at issue -- just how good does it really feel, just how long does it take to get addicted, how bad are the long-run effects -- but there is a deeper difference in perspective, which is why the arguments are a lot more heated than the simple facts suggest. 

The VAT, a libertarian dilemma

Dan Mitchell wrote an interesting op-ed in the Wall Street Journal (Cato link for those without WSJ access), highlighting a great libertarian dilemma: is a consumption tax (VAT or similar) a good thing?

Every bit of economic analysis says yes. Economists hate distortions, taxes that lead to bad economic behavior. Our tax system is full of them.  Broaden the base, lower the rate, tax consumption not savings, dramatically simplify the code, and you can get the same revenue with much less economic damage.

A political argument disagrees: An efficient  tax code can also raise a lot more revenue. Dan opposes the VAT (and similar consumption taxes) on that grounds. Yes it looks good to start, but politicians will soon raise the rate to the sky and spend the results. (Becker and Posner have also tackled this one several times.) 

It's a strking dilemma: should we keep an atrocious tax system to limit the size of government?  Is there no way to get an efficient tax system and a limited government?

Three kinds of regulation

I am often asked, "doesn't the financial crisis mean we need more regulation?" It's one of those maddening questions, because the answer is "that's the wrong question," which gets you nowhere.

For regulation is not "more" or "less," something you just pour into a cup until you've had enough like a good beer. Regulation is most of all "smart" or "dumb." Dumb regulations produce the opposite of their intended effects, have all sorts of unintended consequences, or get used for fully intended but pernicious consequences like driving out competition. Smart regulations don't.

Krugman on stimulus

I usually don't respond to Paul Krugman's blog posts. But last week he wrote about Stimulus and Ricardian Equivalence. The post gives a revealing view of his ideas, so it's worth making an exception.

Paul explains:

...think about what happens when a family buys a house with a 30-year mortgage.

Suppose that the family takes out a $100,000 home loan .... If the house is newly built, that’s $100,000 of spending that takes place in the economy. But the family has also taken on debt, and will presumably spend less because it knows that it has to pay off that debt.

But the debt won’t be paid off all at once — and there’s no reason to expect the family to cut its spending right now by $100,000. Its annual mortgage payment will be something like $6,000, so maybe you would expect a fall in spending by $6000; that offsets only a small fraction of the debt-financed purchase.

So, according to Paul, "Ricardian Equivalence," which is the theorem that stimulus does not work in a well-functioning economy, fails, because it predicts that a family who takes out a mortgage to buy a $100,000 house would reduce consumption by $100,000 in that very year.

How could anyone who thought about this for even a minute — let alone someone with an economics training — get this wrong?

How indeed?

The answer is, we didn't, and Paul got this one wrong.

The Fed's Mission Impossible

A Wall Street Journal Op-Ed  reviewing the latest  Fed's proposal (press release) to regulate big banks -- and, soon, everyone else. Here's the much more fun introduction, which we had to cut for space,

Imagine that your brother-in-law and his 5 buddies are heading for Las Vegas. Again. You already cosigned the refi on his house, and it was only a last-minute wire to the bail bondsman that got him out of the slammer last time.

So, you’re going to have another little kitchen-table talk about “the rules.” This time, no lending to your buddies (“limits on credit exposure”). No buying rounds of drinks (“limit dividend payouts and bonuses”). And for God’s sake, don’t lose it all on one silly bet (“stress test”). Keep some cash for the flight home (“liquidity provisions.”) No pawning the wife’s engagement ring for one last double-or-nothing (“leverage limits”). And if I hear there’s trouble, I’m going to come out myself and make sure you don’t overdo it. (“Early remediation”)

Sure, he says, with a twinkle in his eye. Because you both know he’s got your credit card, and you’re not going to let your sister live in poverty (“systemically important”). And you can’t talk about her dumping this lug (“breaking up the big banks”), or at least stopping these Vegas trips (“Volker Rule”), not unless you want to sleep on the couch for a month (“Dodd Frank”).

On to the real oped:

The Fed's Mission Impossible

The Federal Reserve last week announced its new "Enhanced Prudential Standards and Early Remediation Requirements" for big banks, as required by the Dodd-Frank law. You have to pity the poor Fed because it faces an impossible task.

The Fed's proposal opens with an eloquent ode to the evils of too-big-to-fail and moral hazard. And then it spends 168 pages describing exactly how it's going to stop any large financial institution from ever failing again.

Health economics by anecdote

In a big-think post  "Is capitalism sustainable" on Project Syndicate, Ken Rogoff put in this little zinger

A third problem is the provision and distribution of medical care, a market that fails to satisfy several of the basic requirements necessary for the price mechanism to produce economic efficiency, beginning with the difficulty that consumers have in assessing the quality of their treatment.

Ok, a difficulty of the blogging/oped medium is that you have to keep things short, and I too hate to be quoted for little snippets out of context...But, really, Et tu Ken?

It's hard to know if the car mechanic is doing a good job. Get ready for the Federal takeover of the car industry. I can't tell B grade exterior from A grade interior plywood, so we need a Federal takeover of home rehab. Vets and dentists operate outside of the mass of stifling health care and insurance regulation, so I guess they're in for the treatment next.

Is it really that much harder to assess the quality of treatment for all health care than the other services we receive? For all medical care, not just extreme cases? Actually, my doctor complains that everyone who comes in has spent a week on the internet and knows too much about treatment options. The internet is ushering in a grand era of star ratings and consumer information.

Where is the evidence? Just this sort of armchair argument has been used for centuries (remember the guilds?) to justify competition-stifling regulation of all sorts of businesses.  Milton Friedman's PhD thesis showed that licensing doctors was good for raising doctor's salaries, but didn't do much for the quality of health care. (His later essay on health economics is still a classic.)

And as always, the real argument for the free market is not that the market is perfect, but that the government is usually far worse. Do we have any evidence that government regulators assess the quality of care better than the people whose lives and money are at stake? Is there any vaguely plausible way that the small asymmetric information in health care justifies the monstrous system we have constructed?

Rant over. But really, there is a lot of harm passing around anecdotes like these as if they are agreed-on economic facts, representing both documentation and a serious cost-benefit tradeoff of viable alternatives. 

(I've written a bit more on free-market heath insurance here. ) 

All the world's troubles in 10 minutes

Last month, John Taylor asked me to give some  lunch-time remarks at a conference on "Restoring Economic Growth" at the Hoover institution. "Oh," said John, "Just talk about what's going on in Europe and how to fix the U.S. economy. Keep it to about 10 minutes." As any economist knows, it's easy to talk for an hour and nearly impossible to talk for 10 minutes. Then I looked at my fellow panelists, who turned out to be George Schultz and Alan Greenspan. Heady company, I feel like a kid again.

The euro crisis,some emerging thoughts on how to create a run-free financial system, a review of why everything on the current policy agenda does not have a prayer of working, and a note of cation to economists'  collective habit of jumping from bright idea to policy. (There is a permanent version on my webpage)

In case you’re not reading the papers, we’re in financial crisis 3.0, a run on European banks stemming from their sovereign debt losses.

This is not high finance. European banks have been failing on sovereign debt since Edward III stiffed the Perruzzi in 1353. This is not a “multiple equilibrium,” a run of self-confirming expectations. People are simply getting out of the way of sovereign default, since it’s pretty clear that governments are at the end of the bailout rope.

How to destroy the middle class

In a splendid recent editorial piece, The New York Times  distilled every bad idea floating around the liberal policy agenda.

A few choice moments:

"Economic growth alone, ... would not be enough to restore the middle class"..."To lift wages requires generous tax credits for low earners, a higher minimum wage, and guaranteed health care" ... "Job training efforts" 

That is, after all, how our ancestors got off the farm.

"...the [jobs] bill recently filibustered by Republicans would have created an estimated 1.9 million jobs in 2012."

I didn't know the tooth fairy was making economic "estimates" these days.

..."unrelenting political pressure for principal write-downs of underwater loans, expanded refinancings for borrowers in high-rate loans, and forbearance for unemployed homeowners." 

Econ 101 quiz. What happens to the unemployment rate if you don't have to pay your mortgage so long as you don't get a job?

"..all forms of income to be taxed at the same rates"

That means dividends and capital gains at the 39.5%  rate. Well, at least it's consistent. If you don't believe in saving and investment, taxing the heck out of them should do the trick.  

 "a financial transactions tax."..."high-end tax increases.. to control the deficit"....  "public education, Social Security, unions, child care, affirmative action and, not least, campaign finance reform"

Read on, (how to destroy the) "Middle Class Agenda" at the New York Times

A continent of bad ideas

Why does noone see that Europe can have a nice currency union without fiscal union? I tried to put together this and some of the other bad ideas that I think are clouding the euro crisis debate in this post on the IGM/Bloomberg "business class" blog.

By artful application of bad ideas, Europe has taken a plain-vanilla sovereign restructuring and turned it into a banking crisis, a currency crisis, a fiscal crisis, and now a political crisis..

Read more here