Politicians break their promises because voters don't rationally punish political promise-breaking.  But why do politicians want to break their promises in the first place?  What's the point of promising X, then backing out?

The simplest answer is just that circumstances change between promise time and action time.  Example: The politician says, "I'll keep us out of the war," then the country gets sneak attacked.   He doesn't keep his promise because people no longer want him to.

Another mechanism: Some people pay more attention to politics during campaigns, others during time in office.  For example, regular voters pay a lot more attention to trade policy during election season that at other times; the for exporters, pre- and post-election attention ratios go the other way.  So as long as voters don't compensate with probability multipliers, it makes sense for candidates to loudly oppose NAFTA during the election, then quietly drop the issue.

In my view, though, the most interesting and important reason why politicians break their promises is that voters have misconceptions about the effects of their favorite policies.  The upshot: If politicians did exactly what voters say they want, the results would be bad, and the politician would get blamed.  Under the circumstances, politicians who want to get elected promise to do as the people command, then "betray" them for their own good.  Making the promises helps politicians attract popular support before they get in office.  Breaking the promises helps politicians avoid losing popular support after they get in office.

A old saying tells us, "Thank goodness we don't get as much government as we pay for."  I'm tempted to add, "Yes, and thank goodness politicians don't actually do exactly what they promised."  Dishonest politics is sordid, but honest politics is absolutely scary.

One of the themes of their baseline scenario blog is that banking regulators have been captured by large banks.

In researching the history of capital regulation, I came across this paper by David Jones, of the Federal Reserve Board. It was written in 2000, and it describes how securitization and off-balance-sheet entities were used for regulatory capital arbitrage, meaning that it allowed banks to hold the same assets but less capital.

Although academic articles by Federal Reserve Board economists routinely carry a disclaimer that they do not reflect the opinions of the Board or its staff, the article clearly shows that the Fed was aware of regulatory capital arbitrage (RCA)and it paints a largely sympathetic picture of the phenomenon.

Since the underlying securitized assets tend to be of relatively high quality, a strong case can be made that the low capital requirements against these retained risks actually may be appropriate...

Unless these economic and regulatory measures of risk are brought into closer alignment, the underlying factors driving RCA are likely to remain unabated. Without addressing these underlying factors, supervisors may have little practical scope for limiting RCA other than by, in effect, imposing more or less arbitrary restrictions on banks' use of risk unbundling and repackaging technologies, including securitization and credit derivatives.

Such an approach, however, would be counterproductive (and politically unacceptable).

The thinking was that the Basel capital accords required banks to hold too much capital for mortgages (this was probably true). Accordingly, the article takes a sympathetic view of regulatory arbitrage. In retrospect, this is a bit like watching a movie in which a jailer becomes sympathetic to a prisoner, when we know that the prisoner is eventually going to escape and go on a crime spree.

Opening today's Washington Post, there are three editorials. The lead editorial is on Obama's policies with respect to the automobile industry.

the spectacle of creditors being stripped of their legal rights in favor of a labor union with which the president is politically aligned does little to attract private capital at a time when the government and many companies need these investors the most.

The second editorial argues that the entitlement problem is serious and cannot wait. The third editorial defends the DC school voucher program.

Since we know that the Obama Administration is centrist and pragmatic, the only inference to draw is that the Post has become a mouthpiece for the far right wing.

Rightly or wrongly, autistics are often seen as staking out their independence from the group and from group norms. They're seen as questioning the psychological power of the leaders and bullies and indicating that they do not, within their minds, bend to the worlds created by those cliques

This is from Tyler Cowen's forthcoming Create Your Own Economy. Because it gave me a lot to think about, I am enthusiastic about the book. However, if people buy books in part to demonstrate their cultural disposition, you should be warned that having this book featured prominently on your shelf may send some strange signals.

In today's Wall Street Journal, Todd Zywicki lays out how President Obama attacked holders of Chrysler debt. A key paragraph:

The Obama administration's behavior in the Chrysler bankruptcy is a profound challenge to the rule of law. Secured creditors -- entitled to first priority payment under the "absolute priority rule" -- have been browbeaten by an American president into accepting only 30 cents on the dollar of their claims. Meanwhile, the United Auto Workers union, holding junior creditor claims, will get about 50 cents on the dollar.

Zywicki reminds us of unintended consequences, "what is not seen:"

By stepping over the bright line between the rule of law and the arbitrary behavior of men, President Obama may have created a thousand new failing businesses. That is, businesses that might have received financing before but that now will not, since lenders face the potential of future government confiscation. In other words, Mr. Obama may have helped save the jobs of thousands of union workers whose dues, in part, engineered his election. But what about the untold number of job losses in the future caused by trampling the sanctity of contracts today?

Zywicki, by the way, wrote the article on bankruptcy in The Concise Encyclopedia of Economics.

I just read Bernanke's 2004 piece on "The Great Moderation."  It's written by the wise Bernanke I remember, not the embarassment he's become.   In hindsight it's tempting to treat Bernanke's analysis as pure delusion.  But in the end, I bet a lot of it will hold up, especially since he was careful to highlight his uncertainties.  When the dust settles, it still seems plausible that output and inflation volatility will still on average be lower for the post-1984 era than it was for 1960-83.  Remember that so far the decline in financial markets far exceeds the decline in the real economy.

Still, there's plenty in this piece that Bernanke might want to re-write.  First and foremost:

Why has macroeconomic volatility declined? Three types of explanations have been suggested for this dramatic change; for brevity, I will refer to these classes of explanations as structural change, improved macroeconomic policies, and good luck.

[...]

...In particular, I am not convinced that the decline in macroeconomic volatility of the past two decades was primarily the result of good luck, as some have argued, though I am sure good luck had its part to play as well.

In retrospect, luck looms large, no?

Oh, and don't forget the "Those who forget the past are condemned to repeat it," department:

Nevertheless, a number of economists have argued that monetary policy during the late 1960s and the 1970s was unusually prone to creating volatility, relative to both earlier and later periods (DeLong, 1997; Mayer, 1998; Romer and Romer, 2002). Economic historians have suggested that the relative inefficiency of policy during this period arose because monetary policymakers labored under some important misconceptions about policy and the economy.

I fear we'll be paying for Bernanke's under-estimation of the long-run dangers of bail-outs and massive intervention for decades to come.  What happened to you, Ben?

In my recent post praising Krugman's popular writing on international trade, I highlighted the following quote from one of his essays:

the United States is not now and may never be as open to trade as the United Kingdom has been since the reign of Queen Victoria.

This view is widely held. Indeed I held this view until a few days ago. Its falsity would not undercut anything substantive in Krugman's case for free trade, but it is false. The place to see why is in this article by George Mason University economist John Nye. Check out his eye-popping graph of the average tariff rates for Britain and allegedly protectionist France. The whole article is worth reading. Here's his book on the topic.

H/T to Lauren Landsburg.

My co-author Scott Beaulier blogs a meaty question for me:

...The policy implication often taken from MRV is an elitist one: the world needs constraints from the mob through franchise restrictions, etc.  While Rothbardhad his elitist moments (and there's plenty in the Austrian oral tradition to support the Rothbard as elitist position, too), I've always thought of him as a "people's libertarian."  That is, we need a lot of "buy-in" from the mob before we can enjoy a new liberty.

In MRV, franchise restrictions only get a paragraph.  I spend more far time on the need for better economic education - and this probably reflects Rothbard's influence on me.  He certainly lives up to my three rules for improving economic communication: "(1) Highlight the contrast between the popular view and basic economics in stark terms; (2) Explain why the latter is true and the former is false; and (3) Make it fun." 

I completely agree with Rothbard that massive "buy-in" will be required to really get a libertarian society.  Unlike Mr. Libertarian, however, I'm willing to bluntly admit that persuading the man-in-the-street is extremely difficult, and explore substitutes - however imperfect - for mass conversion.

The key difference between Rothbard and me, though, is that he refuses to acknowledge the hard fact that American elites, for all their statism, are much more libertarian than the general public.  He's according willing to embrace demagoguery, while I see this as not just morally wrong, but pointless.

Scott continues:

Do you think of your major project as one consistent with Rothbard?  Or, is this is a case of the two of you slaying different dragons (e.g, he's trying to popularize libertarianism; you're addressing a major issue in public choice--voter ignorance/irrationality)?  Given that it was such an influential book on you, I'm just wondering if Rothbard's influence is showing up at all in MRV?

MRV is inspired by my libertarian outlook.  It is to a large degree an attempt to rebut what I see as the most intellectually powerful critique of libertarian economics - Donald Wittman's The Myth of Democratic Failure.  Unlike Rothbard, though, I strive to be both scientifically and normatively persuasive to smart people with no libertarian sympathies.

The Obama Administration wants it.

Wall Street pay has long been a hot-button issue in Washington, but the public outrage over excessive compensation has erupted in recent weeks.

I interpret the public outrage a bit differently. It seems to me that if the financial firms were allowed to fail, many people would be satisfied with that as punishment. When it comes to satisfying some of our outrage, Washington is part of the problem, not part of the solution.

What strikes me is the unlimited thirst for power among politicians, and the overwhelming support they receive in the media. Every day, it seems, Bernanke and Obama say the need more power. When will it stop?

William Easterly takes on Paul Collier (and implicitly many other users of regression techniques).

Oodles of regressions were run...Oodles of control variables were tried...Sample was sliced up to get results...

Read the whole thing.

My father used to say that the third iron law of social science is that the methodology is flawed. The first iron law is "sometimes it's this way and sometimes it's that way." The second iron law is that the data are insufficient.

One of the classic critiques of econometric practice is Ed Leamer's Specification Searches, a book that I highly recommend.

We've finished the chapter-by-chapter of Murray Rothbard's For a New Liberty.  Now I'd like to wrap things up by answering most or all of your questions about the book.  Please limit yourself to questions, not statements, phrase them succinctly, and avoid compound questions.

I'll do separate posts on my favorite questions, and try to answer the others directly in the comments.  If there's overlap, I may just answer one version, and leave the rest to your imagination.

P.S. For your convenience, I'm putting links to the whole prior discussion below the fold.

He writes,

The President is attempting to claim credit for [health care] savings that (a) do not yet exist, (b) are not backed up by any specific changes in industry practices or government policies, and (c) are related to him only in that the groups announced they were adopting his quantitative goal. For all three of these reasons, the President's claim that these savings will materialize is wildly unrealistic, and it is absurd to attach a per-family savings number to it. This is like the Mayor claiming credit for the 40 additional wins now, and telling fans that he will be responsible for the team winning the pennant. No one should take these claims seriously.

The serious issue in health care is that we cannot all have unlimited access to medical services without having to pay for them. Obama the wonk recognizes this. But Obama the politician knows that you cannot sell health care reform by telling people it means getting fewer medical procedures. So he offers lollipops instead.

As Hennessey points out, the whole point of today's announcement is to show political muscle, so that the Republicans just roll over. I see conservatives and Republicans as in an impossible position (even before all the health care lobbyists lined up on Obama's side). Imagine you are a parent, and you have been having an issue with your kid about junk food and snacking between meals. Next thing you know, your mother is over for a visit, offering the kid a lollipop. At this point, you can forget the anti-junk-food campaign. You have nothing but down side if you try to get between your kid and grandma's lollipop.

Obama's health care plan is positioned like grandma's lollipop. You cannot stop it. You'll just have to deal with the consequences down the road.

By the way, if you think I'm the only economist who is cynical about the political process, read William L. Davis and Bob Figgins in Econ Journal Watch.

I just came across a fun paper that asks "Is the Tendency to Engage in Self-employment Genetic?" (Management Science 2008).  As usual, the answer is yes.  Based on a sample of over 3000 British twins, the authors estimate that 48% of the variance in entrepreneurship is genetic.  The rest is noise; nurture once again fails to rear its hopeful head.  Highlight:

[O]ur results offer the potential to reinvigorate a longstanding, but not universally agreed upon, aspect of entrepreneurship research: the role of individual differences in the tendency of people to become entrepreneurs. Although some entrepreneurship researchers consider individual differences to be an important explanatory factor in who becomes an entrepreneur (Shane and Venkataraman 2000), many researchers believe that individual differences are unimportant (Gartner and Carter 2003) or even a dead end (Aldrich and Wiedenmeyer 1993). As a result, in recent years, the field of entrepreneurship has tended to focus less on the role of individuals and more on the role of environmental conditions to explain the tendency of people to become entrepreneurs (Thornton and Flynn 2003). Our results indicate that individual differences matter considerably, and offer an avenue for invigorating research on the role of individual differences in entrepreneurship.

Austrian economists ought to care about this, but will they?

Andrew Biggs writes,

Over the next 30 years, population aging is our main entitlements problem and it makes sense to seek solutions that are based on the problem we have, not the problem we want to have.

Beyond 30 years, it is "excess cost growth" in health care that is the main driver of the entitlement deficit. By "the problem we want to have," Biggs refers to the view that we have to worry about health care costs, not demographics. Even if one accepts the view that health care costs are a big problem for Social Security and Medicare, it is odd to imply that the solution is to expand government's involvement in health care.

Regardless of whether you are worried about demographics or the growing use of medical services with high costs and low benefits, raising the future age of eligibility for Social Security and Medicare would be a logical solution.

The discussion of the misnamed Employee Freedom of Choice Act is taking place at the local level as well as nationally. In our local newspaper, Chris Fitz wrote a pro-EFCA letter to which I responded. My response is below:

"Let's give him a fair trial and then hang him." That's the essence of what Chris Fitz wrote in his May 8 letter endorsing the misnamed Employee Freedom of Choice Act (EFCA). Fitz says he wants the Board of Supervisors to have a "full public discussion" of the federal proposal to change the law on unions. Once the board has discussed it, he writes, it can endorse EFCA. What kind of discussion is that? If everyone knows at the beginning how the discussion will turn out, it's not much of a discussion.

So let me start a real discussion. Fitz claims that the added power that EFCA would give to unions would "build wages and benefits among workers." But many economists who have studied the monopoly power of unions would disagree. Economists agree that unions use their monopoly power to increase wages. But at these higher wages, employers employ fewer people. The workers who lose their jobs or don't get hired in the first place move to the nonunion sector, where the increased supply causes nonunion wages to fall.

Most of the gains of union workers are at the expense of nonunion workers.

For more on the union wage premium, see Morgan Reynolds, "Labor Unions," and the references therein.

"When the facts change, I change my mind."  The crash of 2008 has brought Keynes' famous line back into popular use.  But should it have done so?  Here's my claim:

Nothing that happened in the last two years should have significantly revised the general macroeconomic views of anyone who is (a) familiar with the last two centuries of global economic history, and (b) reasonable.

The most someone could reasonably claim to have learned since last year is that the "Great Moderation" has been oversold.  After all, a generalization about the last two decades is a lot easier to unseat with one big event than a generalization about the last two centuries.

This may seem like libertarian dogmatism, but I insist that it's just good Bayesianism.  Financial crises happen all the time.  Disastrous global crises are rarer, but the Great Depression was vastly worse than anything we've seen or are likely to see, and there have been plenty of scary shocks before and since.  And before we follow Arnold and deny the powerful effect of monetary policy on nominal variables, we've got to remember that monetary policy has always been subject to Friedman's "long and variable lags."

Admittedly, you could look at this history and say, "2008 is just another in an endless series of macro disasters caused by capitalism."  If that's your position, then at least you're updating correctly.  But if you claim that 2008 overthrew everything you thought you knew about economics, I've got to wonder what you knew in the first place.

Russell Hardin describes an economic theory of what people "know" (I keep wanting to substitute "believe" for "know").

we can explain bits of knowledge that a given person has as being substantially affected by the costs and benefits of obtaining and using those various bits. Moreover, we can explain the retention of bits of knowledge in the face of competing knowledge by the seeming costs and benefits of retaining them, balanced against the costs and benefits of revising or rejecting them.

There is more to it than that. Pointer from Tyler Cowen.

Interesting throughout. They join the rest of what I call the peanut gallery (those of us, left and right, who cannot understand the bank bailouts).

The effect of the government's current policy is to pay off all claimants on financial institutions at face value, including those which, when they were first issued, had no expectation of federal bailout and received substantial interest premiums on account of their willingness to accept the risk of default. This policy is hugely expensive and stands in stark contrast to the losses that the government has expected investors in the debt of automakers to recognize.

On future financial reform, they write,

Among economists, a consensus is forming that regulation of the financial instutitons that enjoy the government's protection should compel those institutions to have a structure that eases the type of reorganization discussed above (see the statement of the Squam Lake Working Group, an alliance of leading financial economists). The simplest version is to require that banks hold fully subordinated debt and equity of, say, 40 percent of assets, in a holding company, in such a way that the bankruptcy of the holding company would not interfere even briefly with the immediate operations of the bank.

...The idea that banks should have large amounts of fully subordinated debt is hardly new.

Indeed. The group of economists calling itself the Shadow Financial Regulatory Committee has been calling for subordinated debt for years. For example, in May of 1998, they wrote,

the Committee believes that we should take this opportunity to require that all large banks have to raise a certain portion of their capital through the continued issuance of subordinated debentures. To count towards a bank's capital requirements such debentures should have maturities of two years or longer. Subordinated debentures would more closely tie a bank's cost of funds to its financial condition and activities, imposing greater market discipline on banks and mitigating the moral hazard problem associated with a "too-big-to-fail" policy.

I'm old enough to remember the days when many people seriously believed that America Online's gated content was the wave of the future.  Over at Cato Unbound, Adam Thierer takes apart Lawrence Lessig, influential past prophet of techno-doom:

Had there been anything to the Lessig's "code-is-law" theory, AOL's walled-garden model would still be the dominant web paradigm instead of search, social networking, blogs, and wikis. Instead, AOL -- a company Lessig spent a great deal of time fretting over in Code -- was forced to tear down those walls years ago in an effort to retain customers...

[...]

...Lessig admits things haven't turned out to quite as miserably as he predicted they would, yet he quickly reassumes his skunk-at-the-cyber-libertarian-garden-party posture by noting, "I concede that some of the predictions made there have not come to pass -- yet. But I am more confident today than I was then," he proclaims. More confident? Can he muster any evidence to support that assertion? I suppose we'll have to wait another decade or so to see if Lessig's continuing cyber-pessimism is warranted, but I remain an unrepentant techno-optimist -- and, at least so far, I generally have history on my side.

The funny thing about the Internet is that economic literacy probably leads one to underestimate it.  After all, in what other market do people eagerly supply high-quality products for free?

Once I finish refinancing my 30-year fixed-rate mortgage at a ridiculously low nominal rate, a giant inflationary surprise would probably be in my best interest.  But Scott Sumner says I shouldn't get my hopes up.  The first and foremost of his "10 Reasons Not to Fear Inflation":

I am a product of the 1970s, with a visceral distaste for inflation.  Yet despite the massive budget deficits and doubling of the monetary base, I am for some strange reason worried about excessively low inflation, rather than high inflation.  Why?

1.  The bond market shows very low inflation expectations.  Especially the TIPS spread.  As I have said many times, "good economists don't make predictions, they infer market predictions."  (It's fun to create maxims that imply you are almost the only "good economist" in the world.)

Convinced?