Saturday, December 11, 2010

Slutting My Way Through Macro Theory

. Saturday, December 11, 2010



Munger deals with me like he deals with all graduate students: he slaps me around while calling me an "ignorant slut". He somewhat mischaracterized my position, which I think he had to do to run far and fast from the part of his first post I was criticizing, but also could have been because I wasn't clear enough. I wrote that post after being at the bar celebrating the end of finals grading. Anyway, I want to clarify. But first here's his response:

Consider three offers to sell a car.

A. You can buy this car for $10,000
B. You can buy this car for a 60% discount, or $4,000
C. You can buy this car for $4,000 down, and finance $6,000

My claim was that the Republican tax cuts pretended to offer us deal B (big free discount), but in fact offered us deal C (borrow part of price). Deal B is WAY better than Deal C, but it was fake. If someone offered you B, but your contract said C, that would be fraud.

Kindred's objection was that many people prefer Deal C (borrow part of price) to Deal A (pay full price). Um...yes. That's why it is, as he rightly notes, very common. But his objection is a non sequitur. (He's a smart guy, and knew this, I'm pretty sure.)

I never said A was better than C. I said it is a lie to offer B, and then get C.


Munger's point here (which was what prompted his post) is that both Republicans and Democrats are promising option B: Democrats promise a Keynesian multiplier greater than one, Republicans promise supply-side voodoo. His point is that it was a lie to offer B then give C. That may be the right conclusion if you agree that bait-and-switch accurately describes events, but it's a completely different conclusion than what I was driving at. What he said in his first post was something closer to "Offering someone C instead of A will not change their behavior, because they know they'll have to repay the $6k loan so the cost is $10k in either case". I know he didn't say A was better than C, because I know that what he meant is that A and C are functionally equivalent. If you offered someone A they will take it or leave it. If you then added C as an option, Munger is saying that the people who accepted A would be indifferent, and that all the people that rejected A would also reject C.

This is the intuition behind Ricardian equivalence, which must be what Munger was referencing when he said "To have an effect on economic activity, tax cuts have to be credibly permanent". But if anyone would choose option C but not A then the assumptions underpinning Ricardian equivalence don't hold. Obviously some people do choose C, perhaps because they're too cash-constrained to choose A or for some other reason related to time inconsistency etc, so those assumptions do not hold.

I'm not saying that there is no Ricardian equivalence, just that there isn't full Ricardian equivalence. I saw cash for clunkers. It altered behavior. Banks operated differently post-TARP than they would have in the absence of it. Presumably Angus is excited about keeping 2% more of his income because he plans to spend or invest it. Therefore, to have an effect on economic activity, tax cuts do not have to be credibly permanent. That doesn't mean the multiplier is bigger than 1. That doesn't mean that promising B and delivering C isn't disingenuous.

So yes, this is a non sequitur when applied to Munger's objection to the Obama/GOP compromise: that B is not C. But it is not a non sequitur when applied to theories of taxation more generally. Just because B is not C does not mean C doesn't change things. Hopefully that all made sense.

Finally, I don't know who Wimpy is. I hear Wimpy and I think this. Someone needs to write a damn glossary for KPC, because I can't keep all the nicknames straight. I tried to find out by using Google Books to track down the reference to Munger's book (I don't own it) but there's no preview on there.

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Slutting My Way Through Macro Theory
 
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