Category: Economics

Johan Almenberg, a loyal MR reader, asked me to ask Tyrone why rent control is a good idea.  I walked over to Tyrone’s crawl space, knocked, and posed the query.  He ridiculed me and told me the question was really not worth his while:

You Troglodyte, surely you know the happiness literature shows that better or larger living quarters don’t make people much happier.  It’s one of the pleasures we most quickly get accustomed to.  So if rent control pushes everyone into a lower price, lower quality equilibrium for residences, that’s for the better.  If you want high cost living, go to Monaco or Aspen; low rents were what made New York City great.  The greatest American city, during the highest cultural peak of its existence, had lots of binding rent control.

Rent control also encourages new or refitted buildings to have a greater number of smaller units.  In other words, it brings more population to the city and we all understand the external benefits from having more people around.  Furthermore the external social benefits of cities are highest for the elderly poor, who can’t afford cars and would require external aid, and bagel-seeking young’uns, high in human capital, low in liquid wealth, and able to do great things for the world if only they are removed from the suburbs.  That’s exactly who rent control puts into your city.

Johan himself offers an interesting argument:

…if rent control makes it
harder to live in a particular city temporarily, this encourages long-term
commitments. This, in turn, could increase the repeated-game character of that
city, which in turn could be good for cooperation. These sort of arguments –
admittedly vague – tend not to get mentioned.

Did I mention that Tyrone is biased, because he lives under rent control himself?  That’s right, he lives upstairs in the crawlspace.  It is the strongest force in the world that won’t let me charge him a price any higher than zero.  And the resulting arrangement seems to work out just fine.

Knowledge@Wharton: In your chapter, "The Dangerous and Necessary Art of Self-Deception," you write that some degree of optimistic self-deception is critical for success, and that "depressive realists," with their more accurate view of the world, fall behind. What advice would you give to a board choosing a CEO? Is it better to have an optimistic self-deceiver or a depressive realist?

Cowen: For a CEO, I’d tend to go for the realist, because at the leadership level, the costs of hubris are very high. The problem with realists is they can get depressed and feel they are not going anywhere, but this is less likely to happen to CEOs, because they are in charge.

In the lower rungs of the company, however, I would favor overly optimistic people, those who are motivated by the idea that they always have a chance of being promoted or earning more money. The higher up you are, the more I would prefer realism. A president who won’t listen can be pretty disastrous. But a senator who doesn’t listen — maybe it’s not ideal, but there are checks and balances, and if the optimism gets the senator to work harder, then that is the compensation.

Here is the full interview with me.  By the way here is a recent Indian review of Inner Economist, from Mint.

Everything.

Hat tip from you know where.

Don’t forget to click on the Amazon link to the left while shopping for your holidays.  It will help Tyler and I to cover our costs, especially Tyler’s book budget, and it won’t cost you a penny.   And if your total comes to just under the $25 that you need for free shipping, try the Amazon Filler Finder, it will find those $1.29 items that you need to save $6.

There is my own piece, Brad DeLong, and Don Boudreaux, all of which express different degrees of optimism about the current state of the dollar.  Yet the approaches differ in both theory and rhetoric. 

DeLong cites the near-equality of nominal interest rates
between America and Europe as an important consideration.  To him this signifies that the market does
not expect the dollar to fall much further and thus that foreign investors won’t be
scared off.  I believe this emphasis reflects Brad’s "upbringing" in
sticky-price open economy macro models, a’la Rudy Dornbusch and
Harvard/MIT circa the early 1980s.  I never drank of that tradition
with much fervor, instead receiving the influence of Fischer Black.  I don’t
expect current interest rate spreads to tell us much about future currency changes, which I view as mostly news and noise in the short to medium run.  Brad is somewhat less optimistic than I because he would
start worrying if a nominal interest rate differential opened up
between the U.S. and Europe.  I would tend to shrug it off, thinking
the variance of future currency movements still dwarfs the new change
in forecast.

Don Boudreaux starts with the view that having a trade deficit wasn’t bad in the first place, so getting rid of it — through a falling dollar — is no gain.  For him the key is to have policies, such as free trade and low taxes, that keep America a prosperous nation.  The value of the dollar will then take care of itself.  I also read Don thinking that a market-generated
real exchange rate will possess Hayekian properties and pass along the
right information to investors.  I am more likely to think that the value of the dollar is an accident, and more likely to think we can simply make
do with "the wrong exchange rate."   I recall the strong dollar in 1985, and the weak dollar in 1988; in between not that many other things seemed to change.  I conclude that when it comes to the value of the dollar it is sometimes possible to "stuff a lot into the box," and at many different angles. 

Most of all, my relative economic optimism stems from a very naive look at current conditions, which do not (yet?) indicate collapse.  Because of
Austrian influences and again Fischer Black, I am suspicious of long chains of reasoning, or for that matter medium-long chains
of reasoning, which imply that an apparently OK state of affairs must
end in ruin.  Current market prices are indeed very noisy, but no intertemporal theory gives us better forecasts.  Caution is always in order but right now equity prices and interest rates are not predicting ruin.  Furthermore growth and recovery are the natural and more likely state of affairs in a relatively free economy, so I will believe in them until I see otherwise.  Don, in contrast, is more
likely to worry about state interference messing up the U.S. exchange rate,
and the U.S. economy.  In that sense he is potentially more pessimistic than either Brad
or I.   Plus Brad and I both put some stock in the aggregate demand stimulating effect of a lower dollar, while Don doesn’t seem to.

Peter Ireland and Scott Schuh write:

A two-sector real business cycle model, estimated with postwar U.S. data, identifies shocks to the levels and growth rates of total factor productivity in distinct consumption- and investment-goods-producing technologies.  This model attributes most of the productivity slowdown of the 1970s to the consumption-goods sector; it suggests that a slowdown in the investment-goods sector occurred later and was much less persistent.  Against this broader backdrop, the model interprets the more recent episode of robust investment and investment-specific technological change during the 1990s largely as a catch-up in levels that is unlikely to persist or be repeated anytime soon.

Here is the paper, have you noticed that NBER working papers seem to have been freed from the gate? 

On questions like this I prefer to be "judgment-driven" rather than model-driven, and judgment says "who knows?"  Plus two-sector calibrated RBC models are not in every regard a smashing success.  Yet why should the rate of productivity growth remain permanently higher?  At the very least, this is an admonition to be sober and modest in our economic judgments.  The rate of productivity growth is a fundamental determinant of long-run living standards.  Yet when it comes to understanding or predicting this variable, economics has been sadly deficient, especially at the turning points.  Commentators of various political persuasions rail against taxes, tax cuts, spending, spending cuts, poorly thought deregulation, whatever, but might they be chomping at gnats?

Here is my latest column:

A low dollar simply looks bad. We are, after all, used to judging ourselves against others – comparing our salaries with the earnings of our peers, and our homes with those of our neighbors. We’re used to thinking it is a big advantage to stand at the top of a numerical list.

But when it comes to currencies, a higher value neither brings national success nor predicts future prosperity. The measure of a nation’s wealth is the goods and services it produces, not the relative standing of its currency. Take a look at 1985-88, when the dollar lost more ground than in the last few years. Those were good times, and the next decade was largely prosperous as well.

Most of the piece is standard economics, not far from recent writings by Krugman or DeLong.  The more interesting question is which measures of a national economy we, for reasons of pride, inefficiently attach too much importance to.

A second interesting question is: if we should not be worried about a low dollar, what should we be worried about?  I see two answers at the current time.  First, if a negative shock hits China, or perhaps some other negative shock hits the U.S. or Europe, we have precious little room to maneuver.  Second, there remains some chance of a cascading credit crunch.

Addendum: Here is Brad DeLong’s new piece.

Francisco Torralba writes:

First of all, settle on a bankruptcy text and stick to it. The latest
overhaul of the Bankruptcy Code took place as recently as 2005.
Regulatory uncertainty inhibits lenders.

Second, lawmakers
should give the two parties in a contract more leeway to renegotiate
their loans. I applaud the congressmen’s proposals to allow
modifications of the terms of the original loans, but they could go
further. For example, they should allow converting 30-year adjustable
rate mortgages (ARM) into 50-year fixed-rate mortgages.

The
modifications could be proposed by the court, but then they should
require consent from both mortgagee and lender. Two of the bills under consideration — the ones by Senator Durbin
(D-IL) and Representative Miller (D-NC) — allow the bankruptcy court
to modify the terms of the loan without restrictions, not even
agreement in writing between the parties. Giving such power to the
court has at least two effects. First, it tilts the balance towards the
consumer — in a free negotiation between mortgagee and bank, the
latter would have the upper hand. Second, it increases the uncertainty
of the bank’s payoffs. Both effects reduce the supply of debt.

Congress
should also modify the Code so that the least creditworthy borrowers
have more incentives to file for Chapter 7 instead of Chapter 13.

Going beyond the current problems, better ex ante disclosure would be welcome. Most borrowers don’t understand 95 percent of the legal mumbo jumbo on their contracts. Mortgage applicants should be given worst-case scenario simulations of their monthly payments.

We could also set a floor on “teaser” introductory mortgage payments. Hybrid ARM’s,
for example, start out carrying a low, fixed rate. Two to five years
later the interest rate resets to a higher, floating level. Option ARM’s
let the borrower initially make interest-only payments, minimum
payments (often below the interest accrued), or fixed, low-rate
payments, also until the first reset date. Any of those schemes make
mortgages affordable, but only for the first few years. Legislation
could provide, for example, that initial monthly payments never be
below 80 percent of the expected payment after the first reset date.

Here is Francisco’s blog, if you don’t already know it.

In the wake of subprime losses we are hearing claims that the United States should have regulated its banks more.  It is worth pointing out that the U.S. has some of the most heavily regulated banks in the world:

1. The Bank Holding Company Act of 1940, still in force, prevents bank from owning non-financial corporations.

2. The previous Glass-Steagall Act (repealed in 1999) discouraged banks from diversifying out of home mortgages.

3. The Office of the Comptroller of the Currency charters, regulates, and oversees banks, including with respect to risk.

4. Several rounds of the Basel accords, including subsequent fine-tunings, have regulated bank capital holdings and reporting requirements.  These are international regulations and not the sole design of a possibly defective U.S. regulatory system.

5. Banks are chartered by individual states and subject to varying regulations, disclosure, and reporting requirements, including with respect to risk.

6. Banks are regulated and supervised by the Fed, especially with regard to their risk-taking.

7. Banks are regulated and supervised by the FDIC, especially with regard to their risk.

8. Banks face additional regulations, both at the state and federal level, to the extent they are involved in commodities and insurance markets.

9. The Federal Housing Finance Board regulates Federal Home Loan Banks, which are involved in mortgage markets.

10. The Sarbanes-Oxley Act applies to publicly traded banks.

11. The Gramm-Leach-Bliley Act, the revision of the Glass-Steagall Act, regulates bank assets, albeit less than in times past. 

12. The Home Mortgage Disclosure Act "…requires financial institutions to maintain and annually
disclose data about home purchases, home purchase pre-approvals, home
improvement, and refinance applications involving 1 to 4 unit and
multifamily dwellings."  These regulations are intended to limit the ability of banks to discriminate against borrowers; in practice this encourages subprime loans.

13. The Community Reinvestment Act encourages banks "to reinvest in the communities they serve," which again in practice encourages subprime loans.

14. I believe this list is not complete.

I guess we didn’t have enough bank regulation!

It is also worth noting that many European banks have suffered heavy losses as well, despite operating under different regulatory regimes.

It is plausible to argue that the United States should have fewer bank regulators (I’ll nominate the Fed for the main role), but that consolidation should be accompanied by greater efficacy of regulation.  In the meantime there are too many regulatory authorities, and too many regulations.  We have completely blurred lines of accountability, legal, political, economic, and otherwise.

Tumbleweeds:

Linda started her online business, the Prairie Tumbleweed Farm, as a joke. It was 1994 and she wanted to teach herself how to design a website. Since she lived on the prairie in southwest Kansas, where rolling tumbleweeds are sometimes the only dynamic feature of an endless flat horizon, she invented a farm that sold tumbleweeds, listing prices at $15 for a small one, $20 for a medium and $25 for large.

Hollywood has also come calling. Katz’s tumbleweeds have appeared in films like Johnny Depp’s “Neverland.” And she has supplied tumbleweeds to the big purple dinosaur kid’s show, “Barney.”

Katz says people usually use her tumbleweeds to recreate the look and feel of the old west for theme parties. But some customers tell her they buy tumbleweeds to remind them of the home on the prairie they left long ago.

She is now making about $40,000 a year.

The pointer is from David Welton.  Here are David’s writings on Padua.

Herb Gintis reviews Krugman on Amazon:

Krugman’s vision for the future has three key premises, all wrong.
First, he believes progressives can win on a platform of
redistributing from the rich. However, no one cares about inequality.
People care about injustice, unfairness, poverty, sexual predators,
family values, gay marriage, terrorism, and many other problems of
everyday life. People don’t care about Gini distributions and other
abstractions. Moreover, Krugman should know that if the wealth were
redistributed to the middle class, the US investment rate would fall,
since the rich save their money and it is translated into investment,
whereas the middle classes would spend their gains on consumption, thus
driving out investment. A "soak the rich" policy simply cannot work to
the advantage of the middle classes.

Second, Krugman would strengthen the labor unions, which he
credits for their egalitarian effects. However, unions were strong only
when industry was highly non-competitive in such areas as automobiles
and steel. The oligopolistic character of mid-twentieth century
industry, with a few countries in the lead, made fighting over the
excess profits highly rewarding. With globalization, there are no
excess profits to be fought over. Thus, it is not surprising that most
successful unions in the USA are public service, not private (e.g.,
teachers, government employees). There is no future in unionism,
period.

Third, Krugman believes that liberalism can be restored to its
1950’s health without the need for any new policies. However, 1950’s
liberalism was based on southern white racism and solid support from
the unions, neither of which exists any more. There is no future in
pure redistributional policies in the USA for this reason. Indeed, if
one looks at other social democratic countries, almost all are moving
from corporate liberalism to embrace new options, such as Sarkozy in
France (French socialists have the same pathetic political sense as
American liberals, and will share the same fate).

I am sorry that we can’t do better than Krugman. There are very
serious social problems to be addressed, but the poor, pathetic,
liberals simply haven’t a clue. Conservatives, on the other, are
political sophisticated and hold clear visions of what they want. It is
too bad that what they want does not include caring about the poor and
the otherwise afflicted, or dealing with our natural environment.
Politics in the USA is no longer Elephants and Donkeys; it is now
conservative Pigs and liberal Bonobos. The pigs are smart but only care
about what’s in their trough. The Bonobos are polymorphous perverse and
great lovers, but will be extinct in short order.

Hat tip to PrestoPundit.

The Bureau of Justice Statistics has just released a new study, Pretrial Release of Felony Defendants in State Courts (pdf).  The study is interesting reading if only to remind oneself how crime is concentrated among a small minority of repeat offenders.  Nearly a quarter of released defendants, for example, fail to appear on the day of their trial; worse yet 17 percent of released defendants are rearrested for a new offense before their trial even begins.  If 17 percent are rearrested you can be pretty sure that the percentage of releasees who have committed a new crime is much higher.

The BJS study also verifies my research with Helland showing that commercial bail and bounty hunters work well.  Defendants released on commercial bail are less likely to fail to appear and are more likely to be recaptured if they do fail to appear compared to those released on their own recognizance or on a public bail system.

Paul Krugman points this out, for instance read today’s FT article, titled in the print edition "Investors Fear New Turmoil: Credit markets Expect Recession in US."  InTrade gives about a fifty percent chance of recession in the U.S., so you could argue the case for optimism or pessimism either way.

Does the greater pessimism of Europeans produce more disciplined and respectful children?  Or just more pessimistic newspapers?  I believe the "America is due for a comeuppance" view remains very popular across the Atlantic.

Addendum: Here is one optimistic account, from Oklahoma.