Economics in a Nutshell

Greg Ip's new book, The Little Book of Economics, provides a nice, brief overview of the field, with a an emphasis on macro topics.

A Small Step in the Right Direction

The Obama administration is now proposing that businesses be allowed to expense investment expenditures.  That is, for purposes of calculating taxable income, businesses would be able to fully and immediately deduct the cost of equipment, rather than having to gradually deduct the cost via depreciation allowances.

This is a good idea.  People are feeling poorer and more uncertain about the future.  The rational response is greater saving.  The trick to restoring aggregate demand and full employment is to channel that saving into investment.  Normally, the Fed can help by lowering interest rates.  But with interest rates at the zero lower bound, that option is not available.  Tax incentives for investment can help achieve what monetary policy would if it could.

However, the impact will be relatively modest. Notice that expensing merely accelerates deductions. Thus, the value to the firm depends on interest rates. With interest rates near zero, the impetus to investment is small. Put another way, this policy can be seen as giving firms a zero-interest loan if they invest in equipment. But with interest rates near zero anyway, the value of the loan is not that great.

One can imagine more aggressive policies along similar lines, such as an investment tax credit together with expensing.  But let's not make the best the enemy of the good.  This policy proposal is a step in the right direction.  I hope Congress passes it quickly and in a bipartisan fashion.

Bernanke on the Financial Crisis

Ben offers some very readable testimony on the causes of the financial crisis.

Advice for Frosh

Click here to read my column in Sunday's NY Times.

Should the Bush tax cuts be extended?

This seems to be the economic policy question of the hour.  It might be worth recalling that last month, the Wall Street Journal polled economists about this question.  Of those who expressed an opinion, here are the results:

• 6 percent said no, all the tax cuts should be allowed to expire,
• 24 percent said yes, but only for those making less than $250,000 a year,
• 70 percent said that all the tax cuts should be extended.

Counting Small Businesses

From Kevin Hassett and Alan Viard:

Recently, for example, Vice President Joe Biden harshly rejected House Minority Leader John Boehner's assertion that the hikes would harm small businesses, saying that "he has created this myth that a tax cut for millionaires is actually a tax cut for small business. There aren't 3% of small businesses in America that would qualify for that tax cut."... 

In fact, the sound bite about 3% of small businesses, which has been picked up by numerous pundits, is one of the more misleading statements in the long history of economic propaganda.

The 3% figure, which is computed from IRS data, is based on simply counting the number of returns with any pass-through business income. So, if somebody makes a little money selling products on eBay and reports that income on Schedule C of their tax return, they are counted as a small business. The fact that there are millions of people in the lower tax brackets with small amounts of business income may be interesting for some purposes, but it is irrelevant for the assessment of the economic impact of the tax hikes.

The numbers are clear. According to IRS data, fully 48% of the net income of sole proprietorships, partnerships, and S corporations reported on tax returns went to households with incomes above $200,000 in 2007. That's the number to look at, not the 3%. Would Mrs. Pelosi and Mr. Biden deny that the more successful firms owned by individuals in the top income-tax bracket are disproportionately responsible for investment and job creation?

Cash for Clunkers

One of my Harvard colleagues recommends this critique.

This year's Freshman Seminar

My freshman seminar starts today.  Here are the books we are reading this year (in this order):

• The Worldly Philosophers, by Robert Heilbronr
• Reinventing the Bazaar: A Natural History of Markets, by John McMillan
• Thinking Strategically, by Avinash Dixit and Barry Nalebuff
• Capitalism and Freedom, by Milton Friedman
• Equality and Efficiency: The Big Tradeoff, by Arthur Okun
• Nudge, by Richard Thaler and Cass Sunstein
• How the Economy Works, by Roger E.A. Farmer
• The Return of Depression Economics, by Paul Krugman
• The Road to Serfdom, Friedrich Hayek
• The Myth of the Rational Voter, by Bryan Caplan
• The Big Questions, by Steven Landsburg

Da Vinci, Updated

Check out his choice of textbook.

Source.

The CEA Chair Says Goodbye

Here is Christy Romer's farewell speech.

An Enlightening Example

Chapter 1 of my favorite textbook talks about how policies can have unintended consequences because of their effects on incentives.  One example I use is Sam Peltzman's famous study of seatbelt laws.  Here, from The Economist, is another example:

SOLID-STATE lighting, the latest idea to brighten up the world while saving the planet, promises illumination for a fraction of the energy used by incandescent or fluorescent bulbs. A win all round, then: lower electricity bills and...less climate-changing carbon dioxide belching from power stations.

Well, no. Not if history is any guide. Solid-state lamps, which use souped-up versions of the light-emitting diodes that shine from the faces of digital clocks and flash irritatingly on the front panels of audio and video equipment, will indeed make lighting better. But precedent suggests that this will serve merely to increase the demand for light. The consequence may not be just more light for the same amount of energy, but an actual increase in energy consumption.

Barro on Unemployment Insurance

Harvard's Robert Barro says the recent expansion of UI explains the persistently high unemployment rate.

Reinhardt on Efficiency

Princeton's Uwe Reinhardt offers a thoughtful and thought-provoking perspective on economists' use of the concept of efficiency.

I know that Uwe has used my Principles of Micro textbook in his introductory class.  So his commentary on "modern textbooks" is, at least to some extent, directed at me. (In particular, I suspect he has chapters 7, 8, and 9 in mind.)  Uwe also provides some useful links to handouts he gives to his class.

Update: Steven Landsburg responds.

The Latest from Merle Hazard

Krugman reestimates the Mankiw rule

This scatterplot is from Paul Krugman.  x is the core inflation rate minus the unemployment rate.  y is the federal funds rate.  It uses data from 1988 to 2008.

This graph is motivated by a version of the Taylor rule I once proposed.  Paul uses a different sample than I did, so he gets slightly different parameter values.  Nonetheless, I think Paul and I agree that this equation provides a reasonable first approximation to what the Fed will and should do in response to macroeconomic conditions.

Notes from the Sixth Row

Last week, my friend Phill Swagel attended an event to hear about the future of policy toward housing finance.  He sends along the following.  (By the way, here is Phill's own proposal for GSE reform.)

Notes from the Sixth Row: The Treasury-HUD GSE Conference

Phillip Swagel

I took away four main points from Tuesday's Treasury-HUD GSE conference:

Hints of reform. Treasury Secretary Timothy Geithner said that the administration supported fundamental GSE reform but with still a government guarantee for housing finance in some form. The GSE portfolios, however, would disappear. None of this is a surprise, but it was still novel—especially in contrast with past policy efforts such as stimulus and healthcare, where the administration allowed the Congress to take the lead on policy formation.

Industry participants love government guarantees. Conference participants from industries involved with the financing and construction of homes assert that no American will ever buy a home again if the government does not provide a full credit guarantee against the financial market consequences of people defaulting on their mortgages. And that guarantee needs a fair (that is, low) price. Bill Gross made some news in calling for full nationalization of housing finance and complete guarantees on mortgage capital. He prefaced this by saying that he was speaking on behalf of public policy and not his firm. Mr. Gross is smart and was exceedingly public-minded during the financial crisis (even, yes, while profiting from some astute investment calls). There is no doubt that he means well. But it’s scary to think about what he might suggest when he speaks for his book of business instead of the public interest.

Blowback from the left. The administration is scared of its own shadow with respect to flak from the left—the White House staffer’s introductory remarks were an awkward ode to inclusion and conference guidelines such as time limits went out the window when advocates of affordable housing subsidies were speaking (As a note, I very much support these subsidies and think that an important element of GSE reform is to make the subsidies more effective. But this still does not mean that the people making that point should have had carte blanche to long-talk while avoiding answering direct questions.) Amidst the long-talking, it turns out that there is good reason for the administration’s trembling. To the limited extent that advocates of affordable/low-income housing participated in the conference, they vehemently opposed scaling back any form of government support, including reducing the activities of the portfolios. It was impossible to tell what the affordable advocates were for other than “more.” The administration’s GSE reform plan could come down on stone tablets from Mt. Sinai – and still be attacked by the advocate community as "not enough." GSE reform thus represents yet another conflict brewing between the administration and its frenemies in the “professional” left. And yet the President's political tactics of late center on demonizing the moderate/responsible Republicans (“privatizers”) with whom he might form a centrist coalition to actually move forward with a housing finance overhaul. GSE reform could be a long ways off—until we have a President who seeks to lead in a bipartisan fashion.

Settle in; this is going to be a long process. Yesterday's conference was a show of attention to the issue but not more. And next on the agenda are several regional conferences—perhaps the hotel and travel spending is a form of stimulus (or better—it’s time for Congress to shut off Treasury’s unlimited authority to spend money through the Office of Financial Stability). The wheels of GSE reform are turning, but the vehicle is moving forward at a crawl.

CBO's Latest Projection

Source

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