Has California lost another centi-millionaire because of its high tax rates? Washington Nationals superstar Bryce Harper just signed a 13-year, $330 million contract with the Philadelphia Phillies, the largest contract in the history of major North American sports. (Though not the largest when adjusted for inflation.) Some reports say that the San Francisco Giants came very close in the competition but lost out because of California’s taxes. Alex Pavlovic of NBC tweeted:

I’m told Giants made a 12-year, $310 million offer to Bryce Harper. They were willing to go higher but would have had to go well over $330 million to get it done because of California taxes.

If taxes did keep Harper on the East Coast, he wouldn’t be the first sports star to make such a decision. Trevor Ariza, a member of the Los Angeles Lakers’ 2009 NBA championship team and by 2014 “a key part of the Wizards’ playoff run,” decided to leave Washington and join the Houston Rockets. Why?

Washington was disappointed but hardly shaken when Ariza chose to accept the same four-year, $32 million contract offer in Houston, where the 29-year-old could pocket more money because the state doesn’t tax income.

As I wrote then, yes, a $32 million salary – or indeed a $32,000 salary – goes further in Texas than in the District of Columbia. What economists call the “tax wedge” is the gap between what an employer pays for an employee’s services and what the employee receives after taxes. It causes some jobs to disappear entirely, as employees and employers may not be able to agree on a wage once taxes are taken out of the paycheck. It causes some employees to flee to lower-tax countries, states, or cities. The Beatles, the Rolling Stones, Bono, and Gerard Depardieu are some of the better-known “tax exiles.”

It isn’t just entertainers and athletes, of course. A 2018 study found that 138 millionaires left California after a 2012 tax increase. Millionaires have also been seen leaving Connecticut, New York, and New Jersey. Last fall Chris Edwards wrote about the impact of taxes on interstate moves.

As taxes rise in many states, no-income-tax states like Texas, Florida, Washington, Tennessee, and Nevada may become increasingly attractive to athletes, entertainers, and other high-income producers.

John Dingell, who represented southeastern Michigan for 59 years in the House of Representatives, died on 7^th February. While I disagreed with virtually all of Rep. Dingell’s policy preferences, I very much admired the man for the institutional pride he took in Congress. It’s a quality sorely lacking in contemporary lawmakers.

Rep. Dingell was a master parliamentarian. He is famous in Washington D.C. for his steady accumulation of power as chairman of the Energy & Commerce Committee during the 1980s. Due to his efforts, Energy & Commerce presently exercises the broadest jurisdiction of any authorizing committee in Congress. 

From this perch, he regulated the regulators. His use of agency “details”—i.e., commandeering executive branch officials to assist in oversight—was legendary. His investigations were feared. Again, I disagreed with his policy preferences, but, undoubtedly, he was effective in competing with the president (and his colleagues) for control over agency policymaking.

Today, alas, the president calls the shots at regulatory agencies, largely unfettered by Congress. As described by then-Prof. Elena Kagan in a celebrated law review article, we live in a time of “presidential administration.”

Over the last few decades, the president has developed powerful mechanisms, including budget management and White House regulatory review, to superintend the administrative state. Yet, in the face of growing executive power, Congress declined to compete. As I explain further below, party allegiance trumps institutional pride in today’s Congresses. Most congressional Democrats looked the other way, or even cheered, when “their guy” used a “phone and pen” to circumvent Congress and unilaterally impose a deferred action immigration policy. And most congressional Republicans looked the other way, or even cheered, when “their guy” declared a “national emergency” to circumvent Congress and unilaterally build a wall. I’m confident that such obsequiousness would’ve been anathema to a Congress full of John Dingells.

What made Rep. Dingell different? He was a product of his times. Whatever else their flaws, lawmakers of his era abided certain norms that made for a more competent Congress. Under the “apprenticeship” norm, new members of Congress were expected to keep a low profile and instead devote themselves to committee work. Under the “specialization norm,” lawmakers were expected to master one to two narrow issues within their committee’s jurisdiction. To be sure, Dingell’s generation engaged in overbroad delegations of lawmaking functions to agencies, but these lawmakers at least felt a duty to counterbalance such grants by taking the time to understand the inner workings of the agencies they created and funded. The 1946 Legislative Reorganization Act, for example, requires congressional committees to exercise “continuous watchfulness” over regulatory agencies.

Moreover, lawmakers of Dingell’s era genuinely cared about Congress as an institution. To the Congresses that legislated the administrative state into existence, the president was a competitor, and oversight was a primary means for ensuring that laws were faithfully executed. To a large extent, the legislature’s oversight role was codified in various enabling statutes, which often required agencies to consult with appropriate committees before implementing proposed policies. Back then, agencies usually acknowledged and honored objections voiced by members. Congresses of yesteryear also authorized lawmakers to check regulations after they already had been issued. From the New Deal until the early 1980s, Congress legislated 295 veto provisions in 196 statutes, pertaining to every field of governmental concern. In 1983, however, the Supreme Court ruled that this sort of legislative oversight is unconstitutional.

At about the same time that the Supreme Court rejected the legislative veto, Congress began a structural change that further undermined its capacity to compete with the president. Specifically, there was a shift from committee-control to party-control over both chambers of Congress, such that, again, party affiliation currently takes priority over institutional affiliation. In large part, this centralization of power resulted from demographic shifts that homogenized the Democratic and Republican parties, primarily the decline of northeastern Republicans and southern Democrats. Another major factor contributing to this trend is the “fiscalization” of politics in Washington D.C., by which scholars mean that congressional affairs are now dominated by periodic high-stakes negotiations over budget deficits, debt ceilings, and government shutdowns. In these recurrent crises, congressional leadership naturally assumes a greater hand. Congressional leaders accelerated the centralization of power by slashing professional support staff at committees and Article I agencies.

In this environment, Congress has had insufficient political will to reinstitute a viable mechanism for checking administrative policymaking. In 1996, Congress partially revived the legislative veto, but its scope was limited to resolutions of disapproval rather than resolutions of approval, which meant that a sitting president could use his constitutional veto power to protect regulations promulgated during his term. As a result, Congress gained veto power over only a small subset of some presidents’ regulations—basically, those rules promulgated in the final five months of an outgoing presidency, where the incoming president is from a different party. The crucial point is that the legislative veto is a shell of former self.

Obviously, norms like specialization and apprenticeship have fallen by the wayside—just look at the AOC phenomenon. Less than two months into her first term, she has basked in the political limelight and even introduced a sweeping proposal that would fundamentally overhaul the American economy. “Apprenticeship” plainly does not apply. Nor does “specialization.” In modern Congresses, members tend to be generalists when they enter, and they are content to remain generalists while they stay.

Compared to members from Dingell’s time, lawmakers today know less and have fewer resources. They also work fewer days. Effective oversight has suffered accordingly. Consider the House Natural Resources subcommittee hearing on climate change last Tuesday, which was adjourned by the minority party because too few Democrats bothered to attend. Mind you, it’s a Democrat party plank that climate change is the most pressing problem of our time. Quality of oversight isn’t any better in a cleanly divided government, where both chambers are held by the party in opposition to the president, as was demonstrated amply by the Republicans during the Obama era.

To be clear, I’m wide-eyed about the realities of power. I understand that Dingell wielded his authority to benefit his constituents—in particular, the Big Three automakers in Detroit. While there are those who genuinely believe that “what is good for GM is good for America,” I’d no more want Rep. John Dingell than anyone else to wield the powers of the modern president. Rather, my preference is for Congress and the president to battle to manage the administrative state—like they used to—and thereby tame the leviathan. That’s how the system is supposed to work. 

What will it take to make Congress great again? We’re going to need a few score more members like John Dingell, in both houses and on both sides of the aisle. R.I.P.

Some conservatives seem to be getting the wrong impression, and believe zoning is a progressive issue. Although this view is somewhat understandable given that many cities and states engaged in zoning reform are politically blue, the idea that zoning is a progressive issue is wrong and couldn’t be further from the truth.

The impacts of zoning reform are frequently described in terms that appeal to the left, which may be throwing some conservatives off. However, the impacts of successful zoning reform could just as easily be described in terms that appeal to the right. For example, done correctly, zoning reform can restore property rights and basic freedoms that the US Constitution promises American citizens, freedoms that have been eroding for years.

The Constitution requires that “private property [shall not] be taken for public use without just compensation,” and as the Cato Policy Handbook explains, regulation is one way governments effectively “take” property by arbitrarily limiting their development and use. Conservatives may not realize just how far American property rights have already eroded, but no doubt a quick glance at their local zoning code will remedy that. 

The zoning code often limits such small and personal freedoms as what type of tree a person can plant in his/​her yard, whether building a shed or mother-in-law apartment is allowed, whether growing a vegetable garden or changing the color of the shutters is possible, and whether it’s acceptable to use a family farm to host weddings or other events. The zoning code may forbid a person from starting a business in their own home, may limit the type of people living in a house to only relatives, and it frequently decides the number of parking spaces a business must provide to visitors. 

In fact, almost any small freedom that conservatives would expect to be entitled to by virtue of property rights can be reduced or eliminated by local bureaucrats in conjunction with busybody neighbors via the local zoning code. Most conservatives would likely be appalled by the many petty and arbitrary limits on their freedoms that their local zoning code imposes on them. 

Finally, even if conservatives aren’t motivated by limits on their freedom, they should know that zoning hurts “their people” from Republican states by limiting their economic opportunity. For instance, zoning affects low-skill workers in places like Mississippi and West Virginia by limiting their ability to move to high opportunity areas, and it impacts everyone by reducing economic growth overall.

As Danny Shoag and Peter Ganong’s work suggests, rich and poor state incomes have stopped converging as a result of restrictive zoning. In other words, Trump supporters in interior and southern states like Mississippi and West Virginia aren’t able to immigrate to high opportunity areas because the cost of housing is too high as a result of restrictive zoning, and they remain stuck in low-opportunity areas instead. 

Republished via WSJ 

These are just a few of the reasons skeptical conservatives should reconsider their position toward zoning regulations and zoning reform. It goes without saying that conservatives shouldn’t agree with misguided proposals put forward by Democrats that include more regulation, developer mandates, additional taxes, and increased spending. But Republicans would be wrong to confuse bad proposals with the issue of zoning regulation itself, or the need for reform in general. 

Today, Sen. Ted Cruz (R‑TX) and Rep. Bradley Byrne (R‑AL), in conjunction with U.S. Secretary of Education Betsy DeVos, will unveil a bill to create a $5 billion scholarship tax credit, an unprecedented federal school choice effort. An op-ed all three have in USA Today spells out both the good of federal school choice, and inadvertently, the potential bad which makes it too dangerous to justify.

First, the good. DeVos, Cruz, and Byrne argue, quite rightly, that “education isn’t about school systems. It is about school children.” If you recognize basic reality, you’ll know that all children and families are different—different talents, values, dreams—hence it makes no sense to say all should get uniform education. But opposing school choice is de facto endorsing the idea that education should be largely uniform. One size must fit all.

They also make another crucial point, one that is starting to elicit push-back from public schooling advocates who insist that public schooling and public education are synonymous. DeVos, Cruz, and Byrne write that their proposal is not “an attack on public education.” Of course it isn’t. For one, they say their proposal would allow credit-eligible funds to be used for public school options. More broadly, just as public assistance doesn’t mean every recipient of help must go to a government grocery store, nothing about public education implies government must supply the schools. Indeed, we’ve been moving away from things like government housing projects for decades.

Now the bad. School choice is about individualization and freedom, and almost certainly that is what DeVos, Cruz, and Byrne want. But federal initiatives are a terrible way to deliver that. The reality is that what the feds fund, even indirectly, they inevitably want to control. DeVos, Cruz, and Byrne specifically acknowledge that historical reality in federal education policy. They write, “A series of administrations on both sides of the aisle have tried to fill in the blank with more money and more control, each time expecting a different result.” Note that the primary vehicle for that control, the Elementary and Secondary Education Act, started aimed just at funding low-income districts. It eventually became the uber-controlling No Child Left Behind Act.

DeVos, Cruz, and Byrne are looking to skirt the control problem, sticking with tax credits instead of vouchers, and letting states opt in. But not only is this unconstitutional—taxes are authorized to execute specific, enumerated powers, not to lightly engineer state policy—it won’t, ultimately, prevent encroaching federal control. If enacted, the credit would spur people to demand their states participate, and as more schools benefited from federally connected scholarships all schools would be financially pressured to use them. But the federal government will have the power to decide which state programs are or are not eligible, and on what grounds. As Corey DeAngelis and others have noted, what happens when, instead of a President Trump, we have a President Sanders or Harris and they don’t like the policies of religious schools, or maybe how economics is taught? Suddenly lots of private schools and other options will be federally pressured to look very similar—shape up or credit eligibility goes away—and true choice will be curtailed.

Even the roll out of the proposal raises the specter of federal control. Though the great benefit of tax credits is they do not use government money, and hence are less prone to regulation than vouchers, DeVos, Cruz, and Byrne write that through their proposal they “are putting forward a historic investment in America’s students.” That sure sounds like the federal government is doing the funding, and what government funds it tends to control. Also, that Secretary DeVos is so prominent in the proposal release at least symbolizes not only federal intervention in education policy, but a strong connection to the executive—the dangerously regulatory—branch of the federal government.

School choice is great, and DeVos, Cruz, and Byrne recognize that. But as with so many policies, we cannot let our hearts overcome either our adherence to the rule of law—the Constitution—or make us underestimate the potentially crushing unintended consequences that the product of our pure motives may have.

Barronelle Stutzman owns and operates Arlene’s Flowers, where she designs floral arrangements for a variety of occasions, including weddings. Mrs. Stutzman is also a practicing Christian; she believes that marriage is a spiritual union between a man and a woman and will not create floral arrangements for same-sex ceremonies. For this reason, when long-time clients Robert Ingersoll and Curt Freed asked Mrs. Stutzman to create floral arrangements for their wedding, she respectfully declined and referred them to several nearby florists.

To be clear, Mrs. Stutzman serves everyone. She gladly created Valentine’s Day and anniversary floral arrangements for Messrs. Ingersoll and Freed for nearly a decade before this litigation, all the while knowing they were a same-sex couple. She just has a sincere religious objection to creating her expressive floral works for same-sex weddings.

Nevertheless Ingersoll and Freed sued Stutzman, which suit was later consolidated with another one brought by the state of Washington. The state trial court ruled against Arlene’s Flowers and the state supreme court affirmed, holding that floral design did not constitute First Amendment-protected artistic expression. Stutzman took her case to the U.S. Supreme Court, which held it pending its decision in the factually similar Masterpiece Cakeshop case last year. The Supreme Court then remanded Arlene’s Flowers v. Washington back to the Washington Supreme Court for reconsideration. As it has in previous stages of this litigation, Cato has filed an amicus brief supporting Arlene’s Flowers, urging the Washington Supreme Court to revise its earlier ruling and hold that floral design is constitutionally protected expression.

The plaintiffs here simply fail to recognize the difference between discrimination based on sexual orientation and refusing to create messages that violate one’s conscience, which is an important First Amendment right that the Supreme Court has repeatedly affirmed. Floristry, like painting, dance, or music, is art, and art is speech protected by the First Amendment. The Court declared in Wooley v. Maynard (1977) that the government can’t force people to speak, even when the message is simply a state motto, and the means of speaking is just displaying the motto on one’s license plate. The First Amendment protects “freedom of the individual mind,” which the government violates whenever it tells a person what she must or must not say. Forcing a florist to create a unique piece of art similarly intrudes on that freedom of mind.

Just last year, the U.S. Supreme Court in NIFLA v. Becerra and Janus v. AFSCME reaffirmed its commitment to striking down laws that compel speech. Justice Clarence Thomas’s concurrence in Masterpiece Cakeshop also illustrates the unique danger of forcing someone to speak against his or her conscience.

While Wooley provides important constitutional protection, it also offers an important limiting principle to that protection: Although florists, writers, singers, actors, painters, and others who create speech must have the right to decide which commissions to take and which to reject, this right does not apply to others who do not engage in protected speech. The court can rule in favor of Arlene’s Flowers on First Amendment grounds without blocking the enforcement of antidiscrimi­na­tion law against denials of service by caterers, hotels, limousine drivers, and the like.

In sum, the government should not be allowed to persecute expressive professionals for declining to create the government’s preferred messages.

Advocates of marijuana legalization, and owners of cannabis-oriented companies, received a positive boost this week when Jerome Powell, the Federal Reserve Chair, testified to Congress that providing clarity to banks dealing with the cannabis industry would be desirable:

“I think it would be great to have clarity,” Powell said from Capitol Hill. “It puts financial institutions in a very difficult place and puts the supervisors in a difficult place, too. It would be nice to have clarity on that supervisory relationship.” (CNBC)

Powell’s testimony comes as a new draft of the Secure And Fair Enforcement Banking Act of 2019 (SAFE Act) is circulating. The legislation would expand dispensary and other cannabis company access to formal banking – allowing a shift away from cash-based operation – and protect investors and bankers from the current potential legal consequences of providing financial services to the cannabis industry.

Expanding these legal protections will not only allow banks and investors to participate in a rapidly growing market; it might also increase pressure on the federal government to legalize – or at least de-schedule – marijuana.

 

Research assistant Erin Partin co-authored this blog post.

The Winter 2019 edition of the Cato Journal, the Cato Institute’s interdisciplinary journal of public policy, is now available online! In this latest issue, CJ editor and Cato’s vice president for monetary studies James A. Dorn includes six articles and one book review on topics related to financial regulation and monetary policy. Here’s a brief rundown with links to the full-text articles.

“Motherhood and Humble Pie: Some Lessons for the SEC”

The lead article in this edition of the Cato Journal is based on SEC Commissioner Hester Peirce’s keynote address at the Cato Institute Summit on Financial Regulation, held in San Francisco in September 2018. (A full summary of that event is available here, with video of Peirce’s speech available here.) Both the speech and the article liken the role of a regulator to that of a parent and encourage “free range” over “helicopter” regulating—with Peirce urging regulators to allow for greater risk-taking, which she argues is a vital element of financial market. Peirce’s attitude, which was also at the root of her critical dissent of the SEC’s decision to the deny the Winklevoss twins’ application for a Bitcoin ETF, has earned her the nickname “Crypto Mom” on Twitter.

Peirce also reflects on five lessons she has learned from dealing with the rapid development of cryptocurrencies. First, regulators should respond to attempts to bring innovative solutions into financial markets with an appropriate degree of humility. Second, efforts to protect investors from the risks of innovative financial technologies are not like likely to quell their desire for those technologies. Third, providing innovators with greater clarity and certainty in their interactions with the SEC is essential to encouraging innovation. Fourth, the SEC’s investor protection role needs to incorporate a commitment to expanding investor access to financial markets. And, fifth, regulators play a role in determining just how revolutionary technological innovations become in our financial markets and should be innovative themselves to adjust.

“From Real Bills to Too Big to Fail: H. Parker Willis and the Fed’s First Century”

This article is a lightly edited version of former Richmond Federal Reserve president Jeffrey M. Lacker’s H. Parker Willis Lecture at the Washington and Lee University. Lacker discusses Willis’s legacy and his impact on the history of the Federal Reserve, while simultaneously arguing that the Fed’s lending authority has since become “more of a hindrance than a help.”

Lacker begins by describing the circumstances surrounding the U.S. Federal Reserve’s founding in December 1913. At that time, the economy suffered from the fundamental problem of an inelastic supply of currency, which had contributed to a series of bank panics that plagued the economy. To solve this problem, Willis and others designed the Federal Reserve Act, which would establish a series of regional Reserve Banks with authority to lend directly to commercial banks as a means of conducting monetary policy.

The article goes on to explain how the “reals bills doctrine”—which had a major influence on Willis and was a central tenet of the early Federal Reserve System’s operations—contributed to the Great Depression, as well as how Fed lending and conduct of monetary policy evolved after that doctrine was abandoned. Over time, Lacker argues, Fed lending has become “divorced from monetary policy and untethered from the Fed’s fundamental mission.” Moreover, the Fed’s lending has gradually fostered “fragile financial arrangements.” Lacker closes by outlining his views on how to improve financial institutions’ incentives, which may ultimately include repealing the Fed’s remaining emergency lending powers and restricting the Fed’s conduct of monetary policy to a portfolio consisting only of Treasuries.

“Monetary Policy, Fiscal Dominance, Contracts, and Populism”

Sebastian Edwards, the Henry Ford II Distinguished Professor of International Economics at UCLA, analyzes two cases of contract conversions during currency policy shifts—the United States’ abandonment of the gold standard in 1933, and Argentina’s devaluation of the peso in 2002. Studying those cases provides clues on the “likely consequences of decisions to ditch a monetary regime that constrains discretionary monetary policy, replacing it by one that allows, at least in principle, for the emergence of some form of fiscal dominance.”

Such fiscal dominance—i.e. when monetary policy and central banks’ conduct are neither independent nor discretionary but are instead dominated by fiscal policy at the behest of the state—has resulted in hyperinflations in countries like Peru, Venezuela, and Argentina. Yet, it also enables countries to make their exports more competitive in hard economic times via devaluation.

As Edwards points out, however, countries that are dollarized, have a currency board, or are in a monetary union like the Eurozone, are not able to practice fiscal dominance unless they exit their current monetary regime and reintroduce a domestic currency. By examining in detail the cases of the United States and Argentina, Edwards demonstrates that in both instances, “conversion of massive contracts from one currency to another was cumbersome, logistically difficult, legally problematic, and, at the end of the road, costly for society.” Thus, this oft-overlooked reality of abandoning an existing regime—for example, if Italy or Greece would leave the eurozone or if Ecuador discarded dollarization—should not be ignored.

“Economic Conditions and Policy Strategies: A Monetarist View”

Peter Ireland, the Murray and Monti Professor of Economics at Boston College, comments on Fed Chair Jerome Powell’s August 2018 Jackson Hole speech on the state of the economy, while making the case for rules-based monetary policy.

Ireland compares the economic outlook outlined by Powell, based on the traditional Phillips Curve framework, with a nominal GDP growth-based forecast, which according to Ireland “provides another useful index of the effects that monetary policy is having on the economy.” NGDP growth—the sum of real GDP growth and nominal price inflation—captures, “in a single number, the Fed’s performance in satisfying both sides of its dual mandate for maximum sustainable growth with stable prices,” without depending on the increasingly unreliable Phillips Curve relationship between unemployment and inflation.

The author then turns to the relationship between the natural rate of interest and monetary policy implementation and lays out the Federal Reserve’s policy challenges going forward. He suggests that switching to a rules-based monetary policy would enable the Fed to communicate their actions more transparently, and to deal more effectively with the what Chairman Powell presented as the risk and uncertainties of the global economy.

“Assessing China’s Financial Reform: Changing Roles of the Repressive Financial Policies”

In this article, Yiping Huang, Professor of Economics and Deputy Dean of the National School of Development and Director of the Institute of Digital Finance at Peking University, and Tingting Ge, a PhD scholar at the National School of Development at Peking University, evaluate the present impact and future of Chinese financial reform and development.

First, Huang and Ge describe China’s process of prior financial reforms, summarizing its distinctive features and the logic behind it. The authors then assess the impact of the policies, distinguishing whether they had a negative “McKinnon effect,” hindering financial efficiency and development, or a positive “Stiglitz effect,” helping effectively convert saving into investment and supporting financial stability. They conclude that financial repression in China—which enabled the growth of financial institutions and financial assets but constrained free market mechanisms for resource allocation—had positive effects on economic growth and financial stability during the country’s earlier stages of development. More recently, however, China’s repressive financial policies have begun to hurt its economic and financial performance as the country has entered the later stages of economic development and come to “rely more on innovation and industrial upgrading instead of mobilization of more inputs.”

Finally, Huang and Ge discuss how their findings on the relationship between financial repression and economic development might guide China’s and other countries’ fiscal policies going forward. They recommend the Chinese government “push ahead with further financial reforms, especially increasing the role of the market and opening the financial sector to the outside world.”

“An Analysis of the PBOC’s New Mobile Payment Regulation”

Andrew Liu, a senior at Dartmouth College, writes about the People’s Bank of China’s June 2018 payments regulation, which requires all mobile payments be cleared through the PBOC and, by extension, the Chinese Communist Party.

Liu begins with a survey of China’s past and present mobile payments landscape: in 2016, $9 trillion worth of mobile payments were made in China, compared to $112 billion worth in the United States. After reviewing China’s history of regulating mobile payments and examining the effects of its most recent law, Liu questions the necessity of the PBOC’s move given their stated motives: making mobile payments more secure and curbing criminal activity.

Ultimately, Liu finds that this new regulation will not improve mobile payment security, rather it will compromise “the incentives of mobile payment providers and funnel mobile payment transactions into more illicit and unsecure channels.” Moreover, he warns that the “new regulation provides the government with unprecedented access to data detailing the lives of its citizens and will assist it in taking down political opponents, extracting additional rents, and closely monitoring its citizens and implementing its social credit system.”

Book Review: A Crisis of Beliefs: Investor Psychology and Financial Fragility by Nicola Gennaioli and Andrei Shleifer

CMFA policy analyst Diego Zuluaga reviews A Crisis of Beliefs: Investor Psychology and Financial Fragility by Nicola Gennaioli and Andrei Shleifer. Published in August 2018, the book follows an already sizable canon of literature about “periodic bouts of ‘irrationality in security markets.’” In particular, the authors focus on the concept of diagnostic expectations—the idea that investors fail to incorporate all available information and rely excessively on news stories when making decisions, which distorts their likelihood of accurately predicting future outcomes. Thus, investors become overly enthusiastic in good times, and overly pessimistic in bad.

According to Zuluaga, the authors offer “a rigorous theory of financial crises and credit bubbles grounded in the findings of behavioral psychology,” but fall short in applying their model of diagnostic expectation to any events other than the 2008 financial crisis, which they posit can be explained by their model. In the end, per Zuluaga, “the reader is left hoping for a theoretical breakthrough” that will provide an answer as to whether so-called irrational exuberance can be “diagnosed, quantified, and acted upon.” Such an answer never comes in A Crisis of Beliefs, but the book “opens new vistas for finance researchers”—and “holds out the hope that we can learn something from the despondency and euphoria that intermittently grip financial markets.”