What happened to the global economy and what we can do about it
Author: James Kwak
By James Kwak
Tomorrow I’ll be writing the February 18 post for the3six5, a collective diary written by 365 different people, mostly creative/artistic/media types (which I am not, in case you hadn’t noticed). The post should be a diary entry for that day — so, not an analysis of the Treasury’s proposal for Fannie and Freddie, for example. But if you have any suggestions feel free to let me know.
By James Kwak
That was undoubtedly the response of theoretical law and economics devotees to the premature retirement of Kansas City Royals pitcher Gil Meche a few weeks ago, which we discussed in one of my classes last week. Meche signed a five-year, $55 million, guaranteed contract before the 2007 season, which would have paid him $12 million in 2011 simply for showing up, despite a broken-down shoulder that made him an ineffective pitcher. Yet Meche decided to retire, giving up the $12 million. Meche said this:
“Once I started to realize I wasn’t earning my money, I felt bad. I was making a crazy amount of money for not even pitching. Honestly, I didn’t feel like I deserved it. I didn’t want to have those feelings again.”
By James Kwak
To make a vast generalization, we live in a society where quantitative data are becoming more and more important. Some of this is because of the vast increase in the availability of data, which is itself largely due to computers. Some is because of the vast increase in the capacity to process data, which is also largely due to computers. Think about Hans Rosling’s TED Talks, or the rise of sabermetrics (the “Moneyball” phenomenon) not only in baseball but in many other sports, or the importance of standardized testing scores in K-12 education, or Karl Rove’s usage of data mining to identify likely supporters, or the FiveThirtyEight revolution in electoral forecasting, or the quantification of the financial markets, or zillions of other examples. I believe one of my professors has written a book about this phenomenon.
But this comes with a problem. The problem is that we do not currently collect and scrub good enough data to support this recent fascination with numbers, and on top of that our brains are not wired to understand data. And if you have a lot riding on bad data that is poorly understood, then people will distort the data or find other ways to game the system to their advantage.
Readers of this blog will all be familiar with the phenomenon of rating subprime mortgage-backed securities and their structured offspring using data exclusively from a period of rising house prices — because those were the only data that were available. But the same issue crops up in many different stories covering different aspects of society.
By James Kwak
Bruce Bartlett (hat tip Catherine Rampell) reproduces a table from a paper by Suzanne Mettler showing that most people don’t realize that they are beneficiaries of government social programs. For example, 60 percent of people who take the mortgage interest deduction say they “have not used a government social program.” Now, while the mortgage interest deduction is a subsidy designed to enable people buy houses, you could get into an argument about whether it’s really a “social program.” But these are the analogous figures for some more classic welfare programs:
By James Kwak
Yes, I have said some critical things about Posner in the past, usually about his penchant for abstract theoretical arguments that presume perfectly functioning markets. But I’m happy to say we can make common cause on an issue of much greater importance: the Bluebook.
The Bluebook is the 511-page “uniform system of citation” that is prescribed by — well, actually, by the editors of the main student law reviews at Columbia, Harvard, Penn, and Yale — and enforced by the student editors of law reviews (almost) everywhere. But it is not enforced by the courts, whose citation systems vary from jurisdiction to jurisdiction and are not effectively enforced by anyone, anyway. Posner calls it “a monstrous growth, remote from the functional need for legal citation forms, that serves obscure needs of the legal culture and its student subculture.”[1]
By James Kwak
In a Congressional hearing today, Representative Paul Ryan (R-WI), chair of the House Budget Committee, strongly criticized Federal Reserve Chair Ben Bernanke for failing to contain the severe inflation threat posed by the Tooth Fairy.
Ryan pointed to numerous studies showing that, despite ongoing economic sluggishness, the Tooth Fairy is paying much more for children’s baby teeth than in past years. In neighborhoods such as Winnetka, Cleveland Park, the Upper East Side, and Palo Alto, children can receive more than $20 per tooth — a dramatic increase from the 25-50 cents that the Tooth Fairy paid only a decade or two ago. In the Hamptons, summertime prices for teeth can easily exceed $100, according to a survey commissioned by the American Enterprise Institute.* Because the Tooth Fairy is able to create money magically, her purchases of unused teeth (with no apparent economic value**) increase the money supply, fueling inflation. Without explicitly accusing Bernanke of participation in the Tooth Fairy’s scheme, Ryan implied that the Tooth Fairy’s higher payouts may be part of the Federal Reserve’s quantitative easing scheme.
Continue reading “Paul Ryan Criticizes Bernanke for Failing to Contain Tooth Fairy”
By James Kwak
A few days ago I wrote a post addressing Mike Konczal’s question of whether behavioral economics, as a whole, weakens the case for the welfare state or, more generally, for activist liberal policies. I said the answer was “no.” But I think positive psychology—otherwise known as happiness research—presents a more difficult question.
I’ve only consumed popular versions of happiness research, such as The Happiness Hypothesis, by Jonathan Haidt, but basically the story is something like this. For much of its history, psychology had a pathological bent: it was concerned with figuring out why people had psychological problems and how to cure those problems. (Whether it had any success whatsoever is a question for another day and another blog.) A few decades ago, however, some psychologists decided they would try to figure out what makes people happy, and they started a wave of happiness studies that continues today. In many of these studies, people are pinged at random times and asked to rate how happy they are at that moment. Then treatments are introduced so you can measure the difference in happiness between the treatment and control groups. For example, if people find a quarter in a pay phone,* afterward they will report they are happier than people who didn’t find the quarter; not only does this effect persist for a surprisingly long time (into the next day, I think), but also affects people’s reported happiness about unrelated parts of their life, like their family life.
By James Kwak
That’s the title of a post by Mike Konczal, who answers it in the negative. The question comes from Karl Smith and is based on a paper by Bryan Caplan and Scott Beaulier. The paper argues that welfare programs expand the set of choices available to people; while that is all good according to traditional economics, if we think that people are inclined to make bad choices (“behavioral economics”), then welfare programs give people more opportunity to make bad choices and hurt themselves. This is particularly a problem because, they claim, “there are good empirical reasons to think that behavioral economics better describes the poor than it does the rest of the population” (p. 4). In other words, if poor people are more irrational, then giving them more choices will hurt them more than other people.
Let’s start with that last claim. What could it even mean that “[some academic subfield] better describes [one group of people] than it does the rest of the population”? It seems to me there’s a category error here. Behavioral economics describes human beings, and the major population used in most experiments is undergraduates at prestigious universities. If the findings of the research are biased in any way, that’s the bias.
But what Caplan and Beaulier really mean to say is this: “Existing literature provides good reasons to think that the deviations of the poor from the standard neoclassical model are especially pronounced. Their judgmental biases are more extreme, and their self-control problems more severe, than those of the rest of the population” (p. 12). So basically they boil down all of behavioral economics to the proposition that people behave irrationally (admittedly, this is what is most prominent in the popular literature), and then they say that the poor are more irrational than “normal” people. (The normative standpoint is theirs, not mine. Check out this clause: “deviant behavior is much more pronounced among the poor.”)
Continue reading “Does Behavioral Economics Undermine the Welfare State?”
By James Kwak
Uwe Reinhardt has a post about the Rivlin-Ryan Medicare Plan, which would convert Medicare into a voucher program for people currently under 55 and also fix the growth rate of the value of the vouchers at GDP growth plus one percentage point. The issue Reinhardt focuses on, and which I also blogged about a while back, is that health care costs have been climbing considerably faster than that, so over time the value of the vouchers will fall relative to real health care costs.
But another problem is that, at least according to the CBO’s summary, the Rivlin-Ryan plan doesn’t say anything about how elderly people will buy insurance. Today, the cost of Medicare is reduced by the program’s bargaining power with providers. which means the total amount spent by Medicare is less than the total amount that would be spent by all Medicare beneficiaries if they had to buy insurance on the individual market. A voucher system would push them into the individual market, which means that the amount they would have to spend would go up dramatically.
Now, it’s possible that the Rivlin-Ryan plan takes the Obama health care reform and its reforms to the individual market (including a prohibition on medical underwriting and the creation of exchanges for buying insurance) as a starting point. But that would be interesting, since Paul Ryan voted to repeal the Obama health care reform.
By James Kwak
The Fordham Law School is holding a symposium on regulatory capture, with a vague emphasis on the financial sector, on Monday morning from 8 to noon, plus lunch if you want to stick around. Senator Sheldon Whitehouse (D-RI) will be talking — I’ve heard him, he knows his stuff — and the panelists will include Lawrence Baxter, Daniel Kaufman, Steven Davidoff and Robert Weber. And me. I’ll be talking (for ten minutes, plus discussion) about types of regulatory capture, in particular how regulatory capture can operate in the absence of corruption and dishonesty.
I believe according to the website it’s free if you don’t want lunch. And lawyers can even get CLE credit (you have to pay a bit more), even though I’m still in law school!
By James Kwak
My previous post on Fannie/Freddie had two major parts. In the first part, I questioned whether the thirty-year fixed-rate mortgage would really go away (or become much more expensive) without Fannie/Freddie, as some people have argued. In the second part, I said, who cares?
The first part has gotten a fair amount of good criticism, for example from Arnold Kling and John Hempton (by email), and also in comments. My position, simplified, was that a thirty-year fixed-rate mortgage includes three kinds of risk: credit risk, interest rate risk, and prepayment risk. Credit risk can be diversified, interest rate risk can be hedged, and Fannie/Freddie didn’t do anything about prepayment risk anyway. This is the kind of theoretical argument people make all the time, and the obvious question is whether the world actually works that way.
By James Kwak
(Yes, I know that isn’t saying much.)
Most people think that Fannie Mae and Freddie Mac had something to do with the financial crisis. Some people think that they were the major reason the crisis happened, which (to them) proves that activist government policy was the cause of the crisis. Other people, including me, think they were a modest contributing factor because they did buy a lot of securities that were backed by subprime loans, but they were well behind the curve when it came to mortgage “innovation” and the creation of toxic assets. But that’s not the question here.
The question now is what to do about them. Although they had been private, profit-seeking companies for forty years, they were taken over by government regulators in September 2008 when they had become clearly insolvent, and are still being operated in conservatorship. Because Fannie and Freddie were very, very long housing, they have suffered massive losses since the financial crisis began. But because the private mortgage securitization market has collapsed, they are the bulk of the secondary mortgage market at the moment, which means the housing market could collapse without them.
By James Kwak
Although I have written many blog posts pointing out that people are not actually rational maximizers (that is, they don’t know what their preferences are, and even if they did they don’t make rational choices to maximize those preferences), I actually try to be a rational maximizer as much as possible. That is, when making decisions, I try to think about what my expected utility (admittedly, some vague combination of immediate happiness, reflective happiness, reduction in stress, and increase in leisure time*) is from each course of action and decide accordingly. When I was working and very, very busy, this translated into the $25 rule: for personal stuff, I valued my time at $25 per hour.** So if I had to return something to the store, but it cost $10 and it would take me half an hour, I wouldn’t bother.
By James Kwak
Eric Cantor, House Republican Majority Leader, said the Republicans will demand spending cuts in exchange for the votes necessary to raise the debt ceiling.
Eric Cantor, member of Congress, voted for:
In other words, of the big five budget-busting measures of the past decade, the only one he didn’t vote for was the 2009 stimulus. In other words, he had the opportunity to vote for $3.1 trillion of the 2011 debt, and he voted for 75 percent, or $2.3 trillion — just like most Republicans who were in Congress for those five votes.
For explanation and sources, see this post.
By James Kwak
Sometime this spring, Congress is going to have to raise the debt ceiling or the federal government will face default. Republicans are going to demand many, many pounds of flesh in exchange, ranging from cuts in discretionary spending to rethinking of entitlement programs, which together could undermine the weak stimulative effect of the December tax cuts. Democrats are probably going to give in to at least some Republican demands for two reasons: politically, they fear that they would be held accountable for a default because the public still associates spending with Democrats, and they hold the White House; pragmatically, they are just not as crazy as the Republican right, and in most negotiations the crazy party gets a better deal.
Of course, this is insane. The deficit problem was created by Congress, through its many votes to increase spending and decrease revenues (otherwise known as taxes). As James Hamilton put it:
“One of the peculiar embarrassments of the American political process is the fact that Congress votes separately on the deficit and debt, as if they were two different decisions. . . .
“A politician who votes for the spending and tax measures that produced the deficit but against a debt ceiling consistent with these is deliberately wasting taxpayer dollars for no purpose other than to grandstand before voters as a ‘fiscal conservative’. Anyone playing such a game has complete contempt for the intelligence of their constituents.”
I know this is a bit early, but I wanted to get some facts out there in advance of the debate. I picked five major bills in the past decade that have significantly increased the national debt: the 2001 tax cut, the 2003 tax cut, the 2003 Medicare prescription drug benefit, the 2009 stimulus, and the 2010 tax cut. (I left out the Afghanistan and Iraq Wars because it’s hard to pin down Congressional votes specifically authorizing their costs, in part because the famous Senate vote wasn’t actually a vote to go to war, in part because of the peculiar way the costs of the wars were budgeted.)
The Baseline Scenario 