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The moral hazard presidency?, by Scott Sumner

When I used to teach moral hazard to my students, I used the following example:

Suppose you want to get rich.  Here’s how:

1.  Borrow $30 million from Bill Gates.

2.  Go to Vegas, put $1 million on each number from 1 to 30 on the roulette wheel.

3.  If you win, most casinos will pay out $35 million or $36 million.  Pay back Gates, and pocket your profit of $5 million or $6 million.

There’s a 30/38 chance you will win, which is pretty good.  (Otherwise, default on the loan.)

In my view, this sort of “moral hazard” is basically the cause of the banking crises of the 1980s and 2007-12.  Banks got aggressive with depositor money, knowing that FDIC would be on the hook for a part of any loses.

Moral hazard also seems like one way to make sense out of the seemingly random series of moves taken by President Trump.  Consider:

1. Trump seems to pursue high risk negotiating tactics on everything from Iran to North Korea to Putin to international trade wars.  It’s hard to find any common thread here, other than risk taking.  Note that his Iran policy is quite hawkish, and his Korea policy is dovish.  Suppose Trump is trying to maximize the chance that he can obtain some sort of bold breakthrough.  It might pay to be a bit reckless.  Yes, there’s a small chance of some sort of catastrophic outcome, but the cost of that would be widely shared.  If the daredevil tactics achieve a breakthrough, he can take personal credit.  Importantly, Trump has arranged things so that the GOP more broadly would not share in that success.  This sort of risky approach would be difficult to pull off in a European-style parliamentary system.

2.  Trump recently recommended that the Fed refrain from raising rates.  That’s the sort of policy that would help the economy in the short run, at the cost of increasing the risk of recession after the next election.

3.  Trump favors a wildly expansionary fiscal policy.  The administration just raised the forecast of the 2019 fiscal deficit by roughly another $100 billion, up to nearly $1.1 trillion.  To put that number into perspective, just a few years ago the deficit was $500 billion.  And deficits are supposed to fall when the unemployment rate falls to very low levels.  Even under Reagan, the budget deficit fell substantially as the economy recovered.  Trump’s fiscal policy can be seen as a program to make the economy look good right now, at the cost of higher taxes and slower growth for future generations.  A sugar rush.

Also keep in mind that if Trump actually wanted to reduce the trade deficit he’d call for fiscal austerity, not stimulus.

4.  Trump favors weaker financial regulation, which will boost growth in the short run at the cost of an increased risk of financial calamity down the road.  Actually, there are good arguments for financial deregulation, but it needs to be combined with a reduction in moral hazard.  Trump doesn’t favor that.

5.  Trump doesn’t want to do anything about global warming, which adversely affects later generations.

6.  Trump is trying to reduce immigration of highly skilled workers, a policy shift that will cause the economy to slow very gradually over time.  The big costs occur later.

Perhaps I am missing some important administration initiatives.  Which of his policies call for sacrifices that would make Trump less popular today, in order to achieve important gains for future generations?

PS.  Yes, this sort of thing is always a problem with American presidents, but has it ever been quite this extreme?