First, listen to Scott Sumner argue that monetary policy in the U.S. was unintentionally contractionary in 2008. Then, read Izabella Kaminsky on monetary policy today in Europe.

the central bank transmission mechanism has been compromised because expansion or contraction of high-powered money makes no difference to the overall amount of money which is multiplied into the system.

Pointer from Tyler Cowen.

One way to look at the U.S. case is that the Fed bailed out the banks but carried out a contractionary monetary policy. The result was a steep recession. Is Europe going down that path?

Charles Murray writes,

As recently as half a century ago, Americans across all classes showed only minor differences on the Founding virtues. When Americans resisted the idea of being thought part of an upper class or lower class, they were responding to a reality: there really was such a thing as a civic culture that embraced all of them. Today, that is no longer true. Americans have formed a new lower class and a new upper class that have no precedent in our history.

Murray is (in)famously the co-author of The Bell Curve. Its thesis is that intelligence matters for many outcomes. If intelligence is normally distributed and it largely determines one's position in the class structure, then we should observe a class structure that also is normally distributed. Yet Murray today seems to be saying that the class structure is bimodal. At some point, I would like to directly ask Murray how he reconciles his new view with the bell curve.

The story I tell for bimodalism is mating behavior. When high earners marry high earners, class divisions will emerge. But this has implications for the IQ distribution. One would expect bimodalism to appear in the IQ distribution, with the children of high-IQ parents tending centered around one mode and the children of low-IQ parents centered around another.

What does the distribution of IQ scores among today's Americans of age, say 15-24, look like? Are the 75th and 25th percentiles farther apart in terms of IQ than they were fifty years ago? If so, then I would think it is big news. If not, then I do not think that we can tell a story of class divergence in which IQ is a major factor.

I just finished Daniel Kahneman's Thinking, Fast and Slow.  The book is a masterpiece.  Most popular science books are 10% substance, 90% fluff.  Kahneman reverses those percentages - yet remains a breezy joy to read.  Thinking taught me much about material I already thought I knew well. 

There's plenty to argue with, of course. But let me start with some common ground.  A while back, I hypothesized that differences in greed (or "materialism" or "orientation toward money" if you prefer) have a big effect on income.  Kahneman has fascinating data to back me up:

A large-scale study of the impact of higher education... revealed striking evidence of the lifelong effects of the goals that young people set for themselves.  The relevant data were drawn from questionnaires collected in 1995-1997 from approximately 12,000 people who had started their higher education in elite schools in 1976. When they were 17 or 18, the participants had filled out a questionnaire in which they rated the goal of "being very well-off financially" on a 4-point scale ranging from "not important" to "essential."...

Goals make a large difference. Nineteen years after they stated their financial aspirations, many of the people who wanted a high income had achieved it. Among the 597 physicians and other medical professionals in the sample, for example, each additional point on the money-importance scale was associated with an increment of over $14,000 of job income in 1995 dollars! Nonworking married women were also likely to have satisfied their financial ambitions. Each point on the scale translated into more than $12,000 of added household income for these women, evidently through the earnings of their spouse.

People's life satisfaction heavily depended on whether they achieved their personal ambitions:

The importance that people attached to income at age 18 also anticipated their satisfaction with their income as adults. We compared life satisfaction in a high-income group (more than $200,000 household income) to a low- to moderate-income group (less than $50,000). The effect of income on life satisfaction was larger for those who had listed being well-off financially as an essential goal: .57 point on a 5-point scale. The corresponding difference for those who had indicated that money was not important was only .12. The people who wanted money and got it were significantly more satisfied than average; those who wanted money and didn't get it were significantly more dissatisfied.

Kahneman's insinuation to the wise: Be careful when you wish for the highly improbable.

The same principle applies to other goals--one recipe for a dissatisfied adulthood is setting goals that are especially difficult to attain. Measured by life satisfaction 20 years later, the least promising goal that a young person could have was "becoming accomplished in a performing art."

By the way, I take Kahneman's evidence here as yet another counter-example to George Loewenstein's view that happiness research and leftist politics are natural bedfellows. Kahneman highlights an important, neglected reason why some people are rich and others are poor: some people care about money more than the rest of us.  People who want to be rich make the choices and sacrifices conducive to that end - and on average they succeed.  "People who care more about X try harder to get X and as a result get more X": This hardly seems like a "problem" in need of a political "solution."*

What about the "losers"?  Bite your tongue.  When you call lower-income people "losers," you're falsely assuming that we're all racing for the same finish line: material success.  But to a large extent, lower-income people are just racing for other finish lines.  Leftist outrage over income inequality is therefore deeply misguided.  To a large extent, incomes differ because priorities differ.  And if poor they don't consider their lack of riches a big deal, why should anyone else?

* My point is not that Kahneman's evidence refutes all arguments for income redistribution, but merely that his evidence is a good reason for reduced concern about material inequality.

But couldn't economic productivity be increased by targeting federal spending on hiring the unemployed either directly to work for government or by subsidizing private firms to hire them? Such an approach makes sense only if it produces more value than it costs, and there are several reasons for doubting that it does. First, with the federal government spending well over 20 percent of GDP, and most of this spending reducing economic productivity (spending additional dollars creates less value than it costs), it is unlikely that there are many government jobs left in which additional workers would add to the net productivity of the economy.

Second, assuming that there are government jobs in which the right people could create more value than their opportunity costs, without reliable market prices and wages guiding political decisions, it is very unlikely that political authorities would identify those jobs and match them with the right workers. This would be a problem even if the information were available to place government workers in jobs where they would be most productive. Political influence is far more important than economic productivity when officials decide what government jobs to create and on how much to pay those who are hired. This political influence is also dominant when private firms are subsidized to reduce unemployment by hiring more workers. Those subsidies are more likely to go to firms in politically favored industries that have been generous campaign contributors. Also, workers hired for federally funded or assisted construction projects are required by the 1931 Davis-Bacon Act to be paid the prevailing union wage, which is invariably higher than the market wage.

This is from this Dwight Lee, "Reducing Real Output by Increasing Federal Spending," this month's Featured Article on Econlib. The whole thing is worth reading.

She writes,

We already have a blueprint for a bipartisan solution. The Bowles-Simpson Commission hashed out a sensible plan of spending cuts, entitlement program reforms and revenue increases that would shave $4 trillion off the deficit over the next decade. It shares the pain of needed deficit reduction, while protecting the most vulnerable and maintaining investments in our future productivity. Congress should take up the commission's recommendation the first day it returns in January.

She was the first chair of President Obama's Council of Economic Advisers. He threw Bowles-Simpson under the bus.

Overall, the Times asked six economists for "blue-sky thinking" and what they got was familiar hobby-horse riding. (David Henderson has already discussed Robert Frank's contribution to the symposium.) If they set the bar, then James Pethokoukis cleared it pretty easily.

Pointer from Greg Mankiw, who also informs us that John Cochrane has joined the blogosphere with his bracing commentary.

There are two conceptually distinct problems with standard estimates of the return to education (see here, here, and here for more).

Problem #1: Ability bias.  People with traits the labor market values (intelligence, work ethic, conformity, etc.) tend to get more education.  Since employers have some ability to detect these valued traits, people with more education would have earned above-average incomes even if their education were only average.  Punchline: Standard estimates overstate the effect of education on worker productivity and income.

Problem #2: Signaling.  People with traits the labor market values (intelligence, work ethic, conformity, etc.) tend to get more education.  Since employers have imperfect ability to detect these valued traits, people with more education earn above-average incomes even if they personally lack these valued traits.  Punchline: Standard estimates overstate the effect of education on worker productivity, but not the effect on income.

Neither of these stories enjoys much support from labor economists.  They usually just ignore the signaling model - but when they're being careful they'll off-handedly admit that "Standard empirical tests can't distinguish between the human capital and signaling hypotheses."  If you mention ability bias, however, labor economists will quickly point you to a massive literature that supposedly debunks it. 

But if you pay close attention, there's a bizarre omission.  Despite their mighty debunking efforts, labor economists almost never test for ability bias in the most obvious way: Measure ability, then re-estimate the return to education after controlling for measured ability.  For example, you could measure IQ, then estimate the return to education after controlling for IQ.

When I ask labor economists about their omission, they have a puzzling response: "IQ is a very incomplete measure of ability."  True enough.  But the right lesson to draw is that controlling for IQ provides a lower bound for the severity of ability bias.  After all, if the estimated return to education falls sharply after controlling for just one measure of ability, imagine how much it might fall after controlling for measures of all ability.

What happens to the return to education after controlling for IQ?  I've done the statistics myself on the NLSY, and found that the estimated return to education falls by about 40%.  I've talked to several other economists of widely varying political persuasions who reached very similar results.  Only yesterday, though, did I discover an excellent publication that replicates this 40% figure - and shows it to be extremely robust: McKinley Blackburn and David Neumark's "Are OLS Estimates of the Return to Education Biased Downward? Another Look" (Review of Economics and Statistics, 1995).  Their conclusion:

Thus, in our NLSY data, OLS estimation of the standard log wage equation, including test scores, appears to provide an appropriate estimate of the return to schooling. Such estimates indicate an upward bias of roughly 40% in the usual OLS estimate of the return to schooling (that omits proxies for ability). In contrast to evidence from other recent research using different statistical experiments to purge schooling of its correlation with the wage equation error, our results show that one can address the issues of omitted-ability bias, measurement error, and endogeneity, and still conclude that OLS estimation omitting ability measures overstates the economic return to schooling.

Call me cynical, but I'm confident that if Blackburn and Neumark's work had come out the other way, defenders of education would loudly include it on their list of reasons to ignore ability bias.  Indeed, I wonder if their list would have grown half as long if the obvious test undermined education skepticism instead of supporting it.

To repeat: The straightforward way to test for ability bias is to measure ability, then control for it.  If this approach failed to reveal ability bias, it would be reasonable to dismiss it.  In practice, though, the straightforward test finds ability bias to be not merely real, but large.  I'm not going to let anyone forget it.  Expect me to invoke Blackburn-Neumark on a regular basis from now on.

Michael Mandel writes,

Let me repeat that: Government net investment as a share of net domestic product is at a 40-year low. I had to check this last one a couple of times to make sure it was really true. This is a true failure of national economic policy. Government is punking out, just at the time when a public investment surge is needed to make up for the private investment drought. As a country, we should be investing more, not less.

Read the whole thing. Pointer from Tyler Cowen. David Henderson and others expressed skepticism about my paradox of thrift. I count Mandel's chart and analysis as evidence in my favor.

When I posted on Facebook a link to my recent blog post and book review [scroll down to the third page] of Robert Frank's latest book, a George Mason University economist friend wrote, "David, your critique is spot on, but he [Frank] won't engage them, nor will his views reflect them in five years." So far, this friend is right. Of course, five years isn't close to being up yet but Robert Frank has certainly not engaged. And his op/ed in the New York Times today shows no evidence that he has reconsidered one of his most tenuous bits of thinking.

In his NYT op/ed today, he writes:

Why do many middle-class families now struggle to get by on two paychecks, whereas most got by on just one back in the 1950s and '60s?

The answer, according to "The Two-Income Trap," by Elizabeth Warren and Amelia Warren Tyagi, is that many second paychecks today go toward financing a largely fruitless bidding war for homes in good school districts.

Parents naturally want to send their kids to good schools. But quality is relative. Because the best schools tend to be those serving expensive neighborhoods, parents must outbid 50 percent of other parents with the same goal just to send their children to a school of average quality.

Here's what I wrote in my review about two other solutions to the problem. He seems not to have considered either:

Why do people have to buy nice houses to get nice schools? It's because government provides schools. Governments insist, with few exceptions, that the only people allowed to attend schools in a school district are the children who live in that district. Private schools, by contrast, rarely discriminate geographically. A straightforward way to get around this wasteful competition for houses in nice school districts is to get government out of the business of providing schools. But Frank does not consider that option.

Frank states that "school quality is an inherently relative concept." In other words, what matters to parents, according to Frank, is not the absolute quality of the school, but how good it is relative to other schools. But if that's so, then one obvious way to save resources, so that people can have more non-positional goods, is for the government to spend less on schools. Just as a progressive consumption tax would, in Frank's view, make no rich people worse off, a 50 percent cut in school funding should make no students worse off. Yet Frank never considers cutting government spending on schools.

Let's start the new year with a quote from April of 2010.

If you do wish to break or limit the power of the major banks, running a balanced budget is probably the most important step we could take.

And, more recently, from Brad DeLong,

There are two sustainable ways to make money in finance: find people with risks that need to be carried and match them with people with unused risk-bearing capacity, or find people with such risks and match them with people who are clueless but who have money.

This reminded me of the 1980s, when CMO residuals were very risky assets and they were matched with S&Ls; who had money and were clueless. Taxpayers were the ultimate clueless suppliers of money, as has been the case ever since. To understand why banks have to be bailed out, go back to Tyler's quote.

In terms of enjoyment, 2011 has been my favorite year of blogging since I started in late October 2008. In late November I hit 1,000 posts and certainly hope to make it to at least 2,000. I went quickly through many of my posts for the year and here are some of my favorite posts.

The Wonder of Markets:
This one on how well things work in New York.

Book Reviews:
My favorite posts that were critical of the books I reviewed are this one that links to my review of Robert Frank and this one that links to my review of Tyler Cowen's The Great Stagnation. You can't do justice to my reviews by reading just the posts, though.
My favorite post that was positive about the author's basic thesis is this one on my review of Alex Field's book on technological change in the 1930s.

Disagreements with Other Economists and Economic Bloggers:
Here my favorites are on Bob Barro's flawed analogy, John Nyman's non sequitur, Steve Levitt's deficient Daughter Test, and Megan McArdle's defense of massive tax increases in Illinois.

Pointing out Where People Agree:
Here I particularly like two: this one showing that Austin Frakt, even though apparently criticizing Ron Paul, really is agreeing with him and this one pointing out where Uwe Reinhardt is agreeing with John Goodman about supply restrictions in health care.

Going After Destructive Regulation:
This one on how the FDA is preventing us from getting even legal, approved drugs.

Going After Bureacrats Who Tell Falsehoods:
This one on California bureaucrat Betty Yee, although I should have also criticized the op/ed editor who let the falsehood through.

My favorite posts for the discussions were this one where I nastily went after David Cay Johnston and then, after seeing his comment, apologized for my tone and this one, where I think not a lot of minds were changed but the quality of the discussion was high. Although I don't know how to categorize this, I always like connecting Hayek's local knowledge with relevant stories.

Regrets, I've Had A Few, and Here I'll Mention Two:
I didn't know enough when I criticized Greg Mankiw on Japan (sorry, Greg) or when I talked about the Federal Reserve's "Secret Handout."

Happy New Year, everyone.

He writes,

it is not just craven financial elites that clamor for stabilization policies that invariably benefit craven financial elites: it is virtually everyone in the crisis-plagued societies, as financialization gives everyone a stake, direct or indirect, in the fate of asset prices, etc.

Not sure I buy that entirely. Anyway, en passant, Salam calls Engineering the Financial Crisis "one of the most brilliant books I've read in years."

Salam cites Arpit Gupta, who also channels Jeffrey Friedman and Wladimir Kraus.

The global "shortgage" or demand for safe assets was really a demand for ways to conduct regulatory arbitrage; and the growth in structured products (as well as sovereign European debt) was a supply-side response to that demand.

Salam also cites a very provocative post from Ashwin Parameswaran, who tries to make a general point:

The fundamental reason why interventions fail in complex adaptive systems is the adaptive response triggered by the intervention that subverts the aim of the intervention. Moreover once the system is artificially stabilised and system agents have adapted to this new stability, the system cannot cope with any abrupt withdrawal of the stabilising force.

when a central bank protects incumbent banks against liquidity risk, the banks choose to hold progressively more illiquid portfolios. When central banks provide incumbent banks with cheap funding in times of crisis to prevent failure and creditor losses, the banks choose to take on more leverage. This is similar to what John Adams has termed the 'risk thermostat' - the system readjusts to get back to its preferred risk profile. The protection once provided is almost impossible to withdraw without causing systemic havoc as agents adapt to the new stabilised reality and lose the ability to survive in an unstabilised environment.

He appropriately cites Hyman Minsky, who was known for saying that stability breeds instability. My line is that instead of trying to make the financial system harder to break, we need to try to make it easier to fix.

With this, Matt Yglesias instantly enters my sadly short list of good Keynesians:

The depressing truth is that the easiest way to bring good, high-paying manufacturing jobs back to America is to make them less good and less well-paying...

More goodness:

[T]he reality is that story that begins with mass unemployment is inevitably going to end with lower average real wages. The hope is that the increase in the number of employed people and the increased availability of full-time work leads to higher real incomes.

Matt's inspiration?  Another apparently good Keynesian at the New York Times:

Manufacturers are hiring again in America, softening a long slide in factory employment. But for a new generation of blue-collar workers, even those protected by unions, the price of employment is likely to be lower wages stretching to retirement.

The NYT details the erosion of dysfunctional fairness norms:

The shrunken pay scale for newcomers -- $12 to $19 an hour versus $21 to $32 an hour for longtime workers -- threatens to undo the middle-class status of even the best-paid blue-collar jobs still left in manufacturing...

[...]

In an earlier era, that would have been a source of friction, perhaps protest. Now it isn't, and in an interview William Masden, 62, earning $31.78 an hour after 42 years at Appliance Park, attempted an explanation. The younger workers still get annual raises, he noted, and by the time they top out, he and his peers -- the oldest baby boomers -- "won't be here any longer to remind them of what they are missing."

My proposed New Year's resolution for all Keynesians: Learn from Matt Yglesias and the New York Times.  Say it with me, my Keynesian brothers and sisters: Wages must fall!

James Hamilton writes,

My suggestion is that America should try to return to what some scholars maintain was the original source of America's success, which came from using North America's abundant natural resources as a basis for a competitive advantage in manufacturing.

He notes that shale gas and rare earth elements are resources that we could exploit. It seems to me that these offer opportunities for patterns of sustainable specialization and trade.

Tyler Cowen has a thoughtful answer to the question, "Does wealth equal power?" (Of course, the obvious answer is "Yes, it equals power over material things but no, it doesn't equal power over other things. It might give one power over other things, that doesn't mean it equals power." But I think everyone understands the questioner to mean, "Does wealth give power?")

There's little in his response that I would disagree with and one thing I strongly agree with and want to expand on. Tyler writes:

Wealth does protect you from the depredations of others, such as being treated very badly by the police or legal system. In this defensive sense wealth can give you a good deal of power.

Here's what I said in a 2003 episode of "Uncommon Knowledge" when I was arguing with Arianna Huffington:

Well, I think I actually have a better example for you [Arianna] of what you are saying, okay [I know, I know, I sound like some guy on The Simpsons], and that is the drug war. In the drug war, most of the people who go to prison for often very minor offenses are poor people because they can't afford to defend themselves. And if you look, the children of politicians and the children--like Al Gore's kids for example and Richard Shelby's kids from Alabama, his son who was caught smuggling cocaine--they get very light sentences, they don't even get sentences, they just get let off and other people go to prison for the rest of their life when they're twenty years old for doing the same thing. So I absolutely agree that there are just these huge inequalities in the way the rules are applied, but my solution is so different from yours. My solution is to get the government out of most of these things so that these won't be issues. Some person can have marijuana and use marijuana and not get thrown in prison because it's legal.

UPDATE: Commenter Lewis points out below that I was wrong about Senator Richard Shelby's son. He was caught with hashish, not cocaine. I won't change the quote from the TV show, of course, because that is what I said. But thanks, Lewis, for your correction. For other examples of politicians' kids getting off lightly, see here. If you go to that site, you'll notice that many of the examples are from one investigative journalist, James Bovard, who, in my opinion, is one of the best investigative journalists out there.

Following up on last year's post on long-term trends (which in turn followed up on a post from 2005:

1. Productivity growth has tailed off in recent quarters. It varies so much on a year-to-year basis that it takes quite a while to discern a long-term trend (a point I can recall Alan Blinder making years ago).

2. I have said to keep an eye on cognitive neuroscience. IBM's Kevin Brown writes,

progress has been made in understanding and reading electrical brain activity were we can use computers to see how the brain responds to facial expressions, excitement and concentration levels, and the thoughts of a person without them physically taking any actions.

So the idea is to use these electrical synapses to also do everyday activities such as placing a phone call, turning on the lights or even in the healthcare space for rehabilitation.

3. On solar power, I view 2011 as a setback year. Part of the reason that Solyndra and First Solar cratered is that the price of solar panels has come down quite a bit. That would be great news, except that it appears to me to be due to aggressive subsidies, as opposed to technological progress per se. I will believe that solar is ready for prime time when it can compete without subsidies.

4. On cancer therapy, I continue to believe that we are seeing progress. But a cure is not yet in sight.

5. On the meltdown of mainstream media, I believe that it is proceeding on schedule.

Last year, I added sovereign debt as an issue to watch. That was a correct call, if an easy one. The governments that were in trouble a year ago have basically wasted the last year, while the problems generally got worse.

This year, let me add a trend that probably should have been there before: factor-price equalization. That is, I see incomes of median-IQ workers in different countries tending to converge. That means higher incomes in underdeveloped countries while there is downward pressure on median incomes in developed countries.

Related to that, let me add a trend toward the Diamond Age scenario, in which people with Victorian values (marriage, thrift) accumulate wealth, while people who lack those values can address their basic material needs but otherwise fall behind. I discussed this scenario in What if middle-class jobs disappear? and also in my dancing presentation at the Kauffman bloggers conference. The issue of the causes and consequences of inequality came up a lot this year, from the Occupy movement to the e-books by Tyler Cowen and Erik Brynjolfsson.

By the way, I now can break my self-imposed silence on the OWS movement. I think that enough time has passed to see where it is headed.

If you think of income redistribution as civil rights, on a scale of 1 to 10, how does OWS compare with the Montgomery Bus Boycott? A 10 would mean that history will view the two as equivalent sparks that ultimately produced major change. I will put OWS as a -1 (that is, minus one) on that scale. I think that the income inequality issue would have gotten more traction this year had it not been linked to the anarchist-romantic OWSers. America has seen many anarchist-romantic movements over the years, and they have never done well. I think that OWS movement will fade into oblivion having achieved nothing; the inequality issue will come back, but it will no longer be linked to OWS.

Timothy Taylor writes,

The Milgrom, Levin, and Eilat argument is also intriguing because it points out an inherent conflict between property rights and innovation. For example, those who invent something today and seek out a patent must often be concerned that they are potentially overlapping with other patents that have already been granted to others. In some cases, the property rights of already-existing patents can choke off innovation from new competitors. As another example, when many people own property rights to many different plots of land, it may be difficult for a new use of that land to arise--whether it be a nature preserve or a natural gas pipeline--because the existing splintered property rights make it difficult to negotiate for an alternative use of the land. Property rights and market exchange are excellent at finding efficient ways for existing uses, but when it comes to certain kinds of change and innovation, they can sometimes pose drawbacks.

Taylor refers to a paper that looks at radio spectrum as a common-pool resource. The quoted paragraph suggests that ideas also can be viewed as a common-pool resource.

Timothy Taylor writes,

When it comes to textbooks, all choices are equally "free" to the actual decision-maker, who in this case is the professor rather than the student. If students at the college bookstore could choose among equivalent books by price, the outcome might be rather different. Indeed, professors who are interested can get a few free lunches, a conference or two, and a few hundred dollars for reviewing intro econ textbooks.

When professors choose a textbook, they are spending other people's money. If a portion of textbook costs were deducted from a professor's salary, the results would be different.

Arnold makes an intriguing remark about education:

If college were truly a utilitarian good, all it would take to turn these edifice-complex campuses into ghost towns is a good hack for the accreditation process.

But he's skeptical because:

[A]t the high levels, college is a status good. Let me repeat that going to a top college today is like belonging to the right church in 1850 or the right country club in 1950. When you are supplying a status good, ostentatiously wasting money on buildings can increase demand.

Arnold is dangerously close to a variant on the signaling model of education - a model he's previously rejected because:

[I]t suggests that there is a huge unexploited profit opportunity for employers and employees who can come up with alternative signals. And yet nobody tries to set up a system for identifying and hiring smart high school graduates.

Notice that you can use Arnold's objection to the standard signaling model of education to attack Arnold's "status good" story: Why oh why hasn't anyone come up with alternative, low-cost ways to signal status?

A big part of my answer to Arnold, as I've said before, is that education doesn't just signal intelligence and conscientiousness; it's also signals another character trait employers pragmatically cherish: conformity.  This leaves us in a catch-22, because experimenting with new ways to signal conformity is a strong signal of... non-conformity!

On my list of potential topics to blog about in the last few days was Megan McArdle's excellent post in which she advises people to save more. I've gone after her here, here, and here and so I like to balance things because she really is a very sharp, informed, analytic blogger.

I didn't get around to it, but having read Arnold's critical post on hers this morning, I need to.

Yes, Arnold is right that if saving doesn't lead to more capital formation, then one person's saving is another person's dissaving. (Arnold's claim that it's zero sum doesn't follow, by the way, because, as commenter Fralupo pointed out, people gain from trade and in this case they are trading on different discount rates.)

Commenter Bob Murphy implicitly points out the problem: the assumption that an increase in saving nationwide would not lead to an increase in capital formation is highly implausible. This is, essentially, a Klingian paradox of thrift.

Johnn Cochrane makes the case that bank regulators are not up to the job.

The last generation of smart MBAs got around capital requirements by pooling risky assets into "AAA" securities that had lower risk weights, and then putting those securities in special-purpose vehicles with off-balance-sheet credit guarantees. Voilà! Same risk, no capital. I can't wait to see what they come up with this time. Diligently following risk weights, European banks built capital ratios by selling good loans and keeping "risk-free" sovereign debt.

Read the whole thing. Pointer from Kevin D. Williamson, who writes,

if it's conspiracy kookery to suggest that Wall Street likes having access to easy money at concessionary rates, bailouts, and the privilege of being too big too fail, then the grassy knolls are going to get awfully crowded.

They will get even more crowded to the extent that it becomes clear that U.S. taxpayers, via the Fed and the IMF, are engaged in another bailout.