Cut the Corporate Income Tax

So says one of my favorite economists.

Toward a Better Mortgage Business

In today's Wall Street Journal, Bert Ely suggests that securitization of mortgages has gone too far, and he has a couple of intriguing ideas about how to fix things:

- Encourage banks to use "covered bonds" to fund – and hold onto – the fixed-rate mortgages they originate. Widely used in Europe, covered bonds have longer maturities than bank deposits and are on-balance-sheet liabilities. For example, a bank might sell $2 billion of five- and 10-year covered bonds secured at all times by $2.1 billion of high-quality mortgages and other assets. Those longer maturities would reduce maturity mismatching, which was the underlying cause of the U.S. S&L fiasco and more recent problems in the financial markets. The FDIC has begun to look more favorably upon covered bonds, but far too cautiously.

- Eliminate the double taxation of corporate dividends. This raises the cost of equity capital relative to debt, encouraging financial institutions to use excessive leverage to offset the high cost of equity capital. It also tilts banks toward securitizing assets into trusts not subject to the corporate income tax.

The Law of Demand

From the NY Times.

GDP Growth

With revised GDP data released today, I thought it might be worth taking another look at recent history. Click on the graph to enlarge.

Is the yen a negative beta asset?

Here is an intriguing graph I ran across recently. The blue line is FXY, an exchange-traded fund that tracks the yen. The red line is the S&P 500 index. Over the past year, the two time-series look like mirror images of each other. That is, holding yen seems to hedge U.S. stock-market risk.

Update: John Campbell, the smartest finance economist I know, offers me this explanation:

Why the striking pattern in the last year? I think it's because during the liquidity crisis, the stock market has fallen at times when hedge funds and investment banks are deleveraging -- at such times, they cover the carry trade, that is, they buy yen and sell high-interest currencies such as the Australian dollar.

That story is consistent with the increasing risk of the carry trade.

On the Case for Free Trade

Vanderbilt's Robert Driskill takes free-trade supporters to task. The article is thought provoking, even if I end up unconvinced.

The essence of his argument:

Do economists know something, though, that Joe Sixpack doesn’t, and does this knowledge inform their thinking about free trade? What they know that Joe Sixpack doesn’t is a basic but not obvious result from economic analysis: The gains to winners from free trade are sufficiently large that a hypothetical redistribution of these gains from winners to losers could make everyone better off. Note that economic analysis doesn’t say that these compensations actually take place. In fact, everyday experience shows us they don’t, and economists know that there are practical problems that make it virtually impossible to carry out such redistribution schemes. Why, then, do economists support free trade?...

What if free trade is making a small percentage of the country much better off, but is hurting a much greater percentage (the “Joe Sixpacks”), as some argue is the case? Even if the total gains to the few winners are sufficiently large that they could hypothetically compensate the losers, why would it be obvious that “Americans as a group are net winners”?

I agree with Professor Driskill about one thing: Any normative statement goes beyond sheer economics and involves a degree of political philosophy. Economists' devotion to free trade is based not only on the positive conclusion that it leads to a bigger economic pie but also on a couple of related philosophical positions.

Some economists take the libertarian view that people should presumptively be allowed to engage in mutually advantageous trades, absent any externalities. Under this view, the restricted-trade equilibrium has no claim to moral superiority--indeed, just the opposite. The fact that some people lose when trade is opened up compared to a restricted-trade status quo is of little moral relevance.

Other economists take the utilitarian view that we should use society's resources to maximize total utility of everyone. Because of diminishing marginal utility, income redistribution from the rich to the poor is a key part of the utilitarian's plan. But a progressive tax and transfer system, rather than restricting international trade, is the most effective way of achieving that goal. Once again, the economic gain or loss compared to the restricted-trade equilibrium is no special relevance. Maybe it would be relevant if for some reason a progressive tax/transfer system were infeasible, but that is not at all the case.

As a theoretical exercise, we often examine the effects of trade by imagining the economy with and without trade. But the situation without trade is not a philosophically noteworthy benchmark under either libertarian or utilitarian perspectives. The libertarian wants maximum freedom; the utilitarian wants maximum social utility. Neither goal is best served by trade restrictions. The fact that some people lose when trade is opened up has no philosophical significance. (Whether it has political significance is another matter.)

Note that the arguments that Professor Driskill uses would also suggest that we economists should not be so hard on the Luddites. After all, there are sometimes losers from technological progress. And the original Luddites were precisely such losers. Yet I doubt that one would find many thoughtful libertarians or utilitarians (or economists of any other stripe) siding with the Luddite cause.

Sen on Hunger

Amartya is no fan of ethanol.