Back in the early 1990s lots of liberals I knew argued that the S&L fiasco showed the need for “re-regulation.”  And so we re-regulated banking.  I argued that the fix would not work, as it didn’t address the core issue—moral hazard.  I suggested that Fannie and Freddie were time bombs waiting to go off.

You’ll have to take my word for all that.  But not for my 2009 prediction that Obama’s policy of pumping up FHA was another time bomb waiting to go off.  His solution to the financial crisis caused by reckless sub-prime lending was to try to use government levers to inflate another sub-prime bubble.  The bubble has not arrived yet, but three years later even the New York Times is worried about FHA:

DO we have another Fannie or Freddie on our hands “” another mortgage giant headed for a rescue?

Like Fannie Mae and Freddie Mac before it, the Federal Housing Administration is suffering in a mortgage hell of its own making. F.H.A. officials say they won’t need taxpayers’ help, but we’ve heard that kind of line before.

The F.H.A. backs $1.1 trillion of American mortgages and, by the look of things, it’s in deep trouble. Last year, its mortgage insurance fund was valued at $1.2 billion. Today that fund is valued at negative $13.48 billion.

Granted, that figure, reported by F.H.A.’s auditor, doesn’t represent actual losses. It’s an estimate of the difference between future mortgage insurance premiums that the F.H.A. will collect and the expected losses on the mortgages that the agency is obligated to cover over time, combined with the agency’s existing capital resources.

But the upshot is this: If the F.H.A. were to stop insuring new home loans today, it wouldn’t have the money it needs to cover its expected losses in the coming years.

Here’s Vince Cable, my favorite member of the Cameron government:

LONDON (Reuters) – British business minister Vince Cable said Britain could fall back into recession for a third time since the 2008 financial crisis but expected the economy to stagger on with minimal growth.

In an interview published on Sunday, Cable, one of the most senior ministers in the coalition’s junior Liberal Democrats, said Britain could also face a Japanese-style stagnant “lost decade”.

“There is a real worry about (that), a real risk of that,” he said. Asked if the economy was heading for a ‘triple-dip recession’, after falling twice into negative growth since the financial crisis, he said: “There is certainly a risk.”

.  .  .

Conservative finance Minister George Osborne announced new official forecasts on Wednesday that slashed expected growth to 1.2 percent in 2013 and 2 percent in 2014, with the economy seen shrinking this year by 0.1 percent.

Cable, a former economist who is responsible for Britain’s industrial policy, has long said Britain’s economy is starved of demand, but supports the coalition’s austerity program aimed at slashing its budget deficit.

The government hopes that loose monetary policy and record low interest rates will nurture a private sector recovery, but Cable said he hoped the Bank of England’s new governor Mark Carney would come up with fresh ways to assist the economy when he takes up the post next summer.

“We have got to have a very expansionary monetary policy, which we have had until quite recently, but I sense the Bank of England is running out of steam, or perhaps motivation. A lot depends on this new governor,” he said.

What’s really going on here?  It would be easy to make fun of Mr. Cable, as he is basically hoping that Mark Carney will ignore the instructions from the Cameron government to hit a 2% inflation target, and go for faster nominal growth.  How do I know this?  Because previously he’s called for the BOE to switch to NGDP targeting.

Now read it again.  Don’t you sense a depressed individual who has lost the argument within the administration (to the VSPs) and is afraid the growth may not materialize?

Here’s Paul Krugman:

Menzie Chinn has some fun pointing out that if the doctrine Heritage was pushing to oppose fiscal stimulus were true “” namely, that government borrowing always crowds out an equal amount of private spending “” then the fiscal cliff could not be a problem.

.  .  .

But what Menzie doesn’t mention is that the very same doctrine was propounded by distinguished economists at the University of Chicago “” John Cochrane and Gene Fama made exactly the same argument that Brian Riedl was making at Heritage, while Robert Lucas fell into a somewhat different but equally misleading fallacy.

So if you think the fiscal cliff matters, you also, whether you know it or not, believe that a whole school of macroeconomics responded to the greatest economic crisis since the Great Depression with ludicrous conceptual errors, of a kind nobody has had a right to make since 1936 at the latest.

Or perhaps one should take a deep breath, and spend a minute or two recalling that conservatives think the supply-side effects of taxes are very important.

PS.  In the post on Lucas that Krugman links to, he quotes Lucas as saying:

If the government builds a bridge, and then the Fed prints up some money to pay the bridge builders, that’s just a monetary policy. We don’t need the bridge to do that. We can print up the same amount of money and buy anything with it. So, the only part of the stimulus package that’s stimulating is the monetary part.

…

But, if we do build the bridge by taking tax money away from somebody else, and using that to pay the bridge builder “” the guys who work on the bridge “” then it’s just a wash. It has no first-starter effect.

Since Lucas was my adviser I won’t call this ludicrous, but it is wrong.  He’s saying that it has no effect holding M constant, when he should say holding M*V constant. Or it would have no effect if the central bank were targeting inflation, or the Taylor Rule, or whatever.  What he’s really saying is it makes no sense to do fiscal stimulus if the monetary authority is targeting some sort of nominal aggregate like M*V.  And that if fiscal stimulus works, it’s just a backdoor way of doing monetary stimulus (i.e. more M*V.)  That’s all true.

Here’s Krugman’s response:

I’ve tried to explain why Lucas and those with similar views are all wrong several times, for example here. But it just occurred to me that there may be an even more intuitive way to see just how wrong this is: 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 (I know, it’s hard to find houses that cheap, but I just want a round number). 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.

Now notice that this family is very much like the representative household in a Ricardian equivalence economy, reacting to a deficit financed infrastructure project like Lucas’s bridge; in this case the household really does know that today’s spending will reduce its future disposable income. And even so, its reaction involves very little offset to the initial spending.

How could anyone who thought about this for even a minute “” let alone someone with an economics training “” get this wrong? And yet as far as I can tell almost everyone on the freshwater side of this divide did get it wrong, and has yet to acknowledge the error.

I won’t call this ludicrous, but it’s a very strange argument.  Krugman should have said that Lucas forgot that fiscal stimulus can impact V.  But instead he makes a completely different argument that doesn’t seem to depend on V rising; one that opens the door to deflationary stimulus, i.e. real GDP going up without any rise in either M or V.  That’s possible, but not much of a refutation of Lucas.

I also don’t understand the representative household argument.  If the stimulus is to work, it must raise the quantity of labor supplied by the representative household.  If Krugman had made the standard Keynesian argument that more fiscal stimulus boosts NGDP, then he’d just need to assume sticky wages to get more hours worked.  But here he seems to be making an optimal consumption smoothing argument that requires people to work more hours, but doesn’t explain why they would want to work more hours.  Is it because the bridge makes them poorer?  It’s obvious to me that the representative household that buys a $100,000 house will not reduce consumption by an equal amount.  But it’s not obvious that they would avoid that drop in consumption by choosing to work more.

So what’s the Keynesian model all about?  Is it about nominal shocks combined with sticky wages and prices, or is it about inter-temporal consumption allocation decisions when the government decides to build bridges?

And if it’s “obvious” the bridge will make real GDP rise, is it equally obvious it will work if the central bank targets NGDP, or does it only work if the central bank targets M?  If it’s the latter, then Krugman should have just claimed that bridges boost velocity, and left it at that.  If the former, then he’s claiming bridges can provide deflationary growth.  Maybe, but that’s not the Keynesian argument, is it?

I wish Keynesians and freshwater economists could agree on a common language:

1.  There are nominal shocks when NGDP changes, and they may have real effects if wages and prices are sticky.

2.  There are all sorts of real shocks that can also impact RGDP.

Instead freshwater economists spend so little time thinking about nominal shocks that they forget it’s M*V that matters, not M.  And Keynesians spend so little time thinking about real shocks that they don’t see how fiscal policy could affect anything beyond AD.

Update:  Marcus Nunes got there first.

I’m pretty sure than most people don’t think it’s fair to tax people at higher rates, just based on eye color.  What about taxing people who are more patient? I think most people do favor policies that tax patient people at higher rates, although they they usually don’t know that the policies they favor would have that effect.  Ray Fisman has a very puzzling article discussing the pros and cons of eliminating the “tax shelter” for 401k accounts.

It turns out that savings incentives had scarcely any impact on the rate at which Danes accumulated nest eggs, while the nudges were very effective in making people save. These findings suggest that 401(k) plans and their brethren””which cost the U.S. government as much as $100 billion a year in lost revenue””don’t do much to further their stated objective of boosting retirement savings. Even if $100 billion wouldn’t go all that far toward solving America’s debt problems, it suggests that smart approaches to eliminating or improving government programs could quickly add up to fiscal solvency””and might help the two sides find common ground.

It seems to me that we should defer taxes on money saved because it is the fair thing to do.  Or if you want to be a utilitarian about it, because consumption is more closely correlated with utility than income.  People putting money into 401ks don’t get any sort of tax break–they must pay taxes on 100% of the funds (principal and interest) when the money is withdrawn.  The taxes are simply deferred.  If all saving were treated like 401k accounts then the government would be adopting a neutral position between current and future consumption, as it should.  I see no reason why either blue-eyed people or patient people should pay a higher tax rate on their lifetime consumption, as compared to a brown-eyed person, or an impatient person who consumes the same resources at an earlier stage of life.

Fisman points to a Danish study that shows the effects of saving incentives are very small, at least in the short run.  However I would caution readers that short run elasticities are almost always much lower than long run elasticities.  On the other hand, unlike many libertarians I’m not opposed to policies “nudging” people to save more, as our economy is absolutely riddled with all sorts of disincentives to save.

I suppose there is one utilitarian argument for taxing savers at a higher rate—they might derive less utility from an extra dollar of lifetime wealth than less patient people.  Of course (as Mankiw once showed) the same argument might apply to height, and all sorts of other innate characteristics.  It could also be applied to ethnicity.  Given our society’s moral revulsion against “discrimination,” I don’t know if there’d be much support for policies that might imply (even indirectly) that certain ethnic groups should face higher tax rates than other ethnic groups.  What do you think?  Are there any innate characteristics that we ought to tax at higher rates, for a given level of resources?

Update:  Josh Hendrickson just sent me an email that is far better than this post, and much shorter:

People with patience and blue eyes are taxed higher, its called Scandinavia. 🙂

(Note his last name.)

Update:  Here’s Evan Soltas:

Allowing the 2001 and 2003 tax cuts to expire would be, in large part, a win for Democrats. The party’s platform calls for reverting to the top two income-tax brackets under Clinton — 36 percent and 39.6 percent — while preserving the rate reductions for the lower brackets. Limits to personal exemptions and itemized deductions are another part of the Democratic plan, coming in at $200,000 in income for individuals and $250,000 for married couples. The top capital-gains tax rate would rise to 23.8 percent, due to an additional 3.8 percent levy in the Affordable Care Act.

The sentence about capital gains is correct.  The second sentence is correct but slightly misleading, and should read:

Obama is proposing that we raise the top two income-tax brackets to higher levels than under Clinton — 39.8% percent and 43.4% percent, due to an additional 3.8 percent levy in the Affordable Care Act  — while preserving the rate reductions for the lower brackets.

This NYT assertion is completely inaccurate:

Even if Republicans were to agree to Mr. Obama’s core demand “” that the top marginal income rates return to the Clinton-era levels of 36 percent and 39.6 percent after Dec. 31, rather than stay at the Bush-era rates of 33 percent and 35 percent “” the additional revenue would be only about a quarter of the $1.6 trillion that Mr. Obama wants to collect over 10 years.

He’s proposing even higher top rates.

Here are some interesting recent posts:

David Henderson finds another gem from Krugman:

Finally, it’s nice, although a little late in the game, to see Krugman explicitly say that only “a small piece” of the Bush tax cuts was for high-income people. It’s at about the 7:05 point of this video.

As usual, I eagerly await the creative and amusing explanations from his fans.

And speaking of Mr. Krugman, here he hints at the next transformation; Krugman 3.0 for the 2010s:

I think our eyes have been averted from the capital/labor dimension of inequality, for several reasons. It didn’t seem crucial back in the 1990s, and not enough people (me included!) have looked up to notice that things have changed. It has echoes of old-fashioned Marxism “” which shouldn’t be a reason to ignore facts, but too often is. And it has really uncomfortable implications.

Just reading that is making me uncomfortable.

Garett Jones on how the GOP continues it’s suicidal death march:

Derek Khanna, the author of the important policy brief on the excesses of copyright law, has been fired by the Republican Study Committee. The brief, which the RSC pulled from their website, is here. From the Examiner:

“The staffer who wrote the memo, an ambitious 24-year-old named Derek Khanna, was fired — even before the RSC had decided on other staffing changes for the upcoming Congress. The copyright memo was a main reason.”

David Brooks wrote about Khanna two weeks ago:

“Rising star Derek Khanna wrote a heralded paper on intellectual property rights for the House Republican Study Committee that was withdrawn by higher-ups in the party, presumably because it differed from the usual lobbyist-driven position.”

Brooks continued:

“Since Nov. 6, the G.O.P. has experienced an epidemic of open-mindedness. The party may evolve quickly. If so, it’ll be powerfully influenced by people with names like Reihan, Ramesh, Yuval and Derek Khanna.”

Looks like the epidemic is being contained.  Whew!

Lars Christensen on how Singapore solved the zero lower bound problem:

So in that sense MAS is a flexible inflation targeter in the same ways as for example the Swedish Riksbank or the Australian Reserve Bank. But contrary to most central banks – including the Icelandic central bank Sedlabanki – which use interest rates to hit the inflation target – MAS instead uses the exchange rate.

I see two very clear advantages to this operational set-up compared to “interest rate targeting”. First, there will never be a problem with a lower zero bound.

Matt Yglesias on the “staggering incompetence” of the ECB:

It gets boring to write this kind of stuff every month or so, but it really is worth taking note of the stunning ineptitude of the European Central Bank. Earlier this week they published new forecasts revising their projections for growth and inflation downward but taking no action on interest rates “because of concerns about the negative signal a cut might send.”

Imagine you’re piloting a ship. You think you’re in good shape. But it turns out you misestimated the currents and now with your revised estimate you see you’re going a bit further north than you’d thought and are probably going to arrive late. Then you decide torefuse to change the heading of the ship because steering would send a bad signal about your likely trajectory. But then you publish the revised estimates anyway. And then leak that you’re refusing to steer because you don’t want to send a negative signal.

It’s bizarre. It’s insane.

It’s interesting that Nick Rowe and David Glasner have completely different definitions of Cantillon effects than me, and also completely different from each other.  I look at the “who gets the money” question.  Rowe looks at the impact on fiscal policy.  Glasner looks at the impact on relative prices.  Bill Woolsey has a couple very good posts as well (here and here.)  I pretty much agree with everything in the 4 posts.