More evidence that the BOJ is not trying to create inflation

I frequently assert that no fiat-money central bank ever tried to inflate and failed.  Some people respond by pointing to the long period of mild deflation in Japan.  I won’t repeat all my arguments that the BOJ was intentionally pursuing a highly contractionary monetary policy.  Instead, I’d like to cite the findings of a new study by three Japanese economists, who use a New Keynesian DSGE model to estimate the Taylor rule.  The study by Koiti Yano, Yasuyuki Iida, and Hajime Wago, found that the BOJ seemed to shift from a roughly 2% inflation target in the 1980s and early 1990s, to a roughly negative 1% target after 1995. 

Unfortunately, I went to grad school back in the stone age when we mostly taught economic intuition, not math and econometric skills.  So I’m hoping my very smart commenters will help me out with this paper.  I wasn’t quite able to figure out how they got the estimate of minus 1% inflation target.  Does their method seem reasonable?

Part 2:  Three from The Economist

I’ve been so busy that I haven’t had time to link to my last three essays for The Economist.

The ECB has made the European debt crisis much worse

There’s little risk of inflation

QE has helped raise commodity prices

I should have an article in the National Review very soon.  I’ll let you know.

Part 3:  No one should pay any attention to my political forecasts.

I said Obama was unlikely to get more fiscal stimulus, and he got a lot more.   I would have thought if he got a lot more, the Keynesians would have been ecstatic.  Instead they are outraged.  The announcement seemed to raise the expected rate of inflation by about 8 basis points per year over 5 years.  There’s two ways of looking at that.  On the plus side, it shows fiscal stimulus does have a positive multiplier.  On the minus side, it’s not much bang for the buck, as I was under the impression that the FICA tax cut was a surprise.  Real interest rates rose by 13 basis points, and nominal rates rose by 21 basis points.  (So much for Ricardian equivalence.) 

But I also believe Obama missed an opportunity.  If you believe as I do that sticky wages explain part of the high unemployment, it would have made much more sense to cut the employer’s share of payroll taxes, not the employee share.  Still, if we need to do fiscal stimulus, I favor tax cuts both for small government reasons, and for stimulus reasons.  I agree with Christina Romer that tax cuts are much more stimulative than spending increases. 

Part 4:  The endless, pointless, debate over the EMH

A few reactions to comments on my recent post on the EMH.  Some people get extremely angry when you defend the EMH.  The debate reminds me of arguments I have over free will.  I point out that either events have causes, or they are random.  In either case there is no room for free will.  My opponent responds that he is free to pick up either the salt or pepper shaker in front of him.  The debate never really gets joined, and is thus largely a waste of time.  I’ve decided I shouldn’t waste any more time arguing against free will, or defending the EMH.

I must have done at least 6 posts on the EMH and I always get the following responses, even if they have nothing to do with the specific arguments that I make in the post:

1.  It is noted that some people correctly predicted this or that bubble.  The way I look at it, you have roughly a fifty/fifty chance of being right if you predict prices will fall.  Given there are 7 billion people on planet Earth, I’m not blown away by the finding that some of them predicted this or that bubble would pop.  What does blow me away is that some people who have become world famous predicting bubbles, have done so despite also making important false predictions.

2.  Some commenters point to anomalies.  I point out the EMH predicts there will be millions of anomalies.  Some respond that a few anomalies have even done well in out-of-sample forecasts.  That’s great, but you’d expect that.  I recall reading about studies showing many anomalies failed to do well after they were published.  Was I misinformed?

3.  Some point to experimental economics.  I point out that studies have found experimental results do not always hold up in the real world.  Some commenters found the experimental evidence against the EMH to be irrefutable.  But this is also part of that evidence:

But people do learn. By the third time the same group goes through a 15-round market, the bubble usually disappears.

I’m guessing that real world traders are more savvy than college students playing a game for only the third time.

4.  Don’t get me wrong, I think there is evidence against the EMH (such as the 1987 stock crash), my real argument all along has been that the anti-EMH view is literally useless.  And that which has no practical value has no theoretical value.  In contrast, the EMH has been very useful in my research on the Great Depression.

5.  Several people mentioned market observers who denied bubbles, but no one provided me with a specific example of a bubble denier who became famous because his or her prediction was correct.  During bubbles, I find all the sophisticated people I talk to are pessimists, arguing it’s a bubble and it must burst at some point.  I rarely find people who say it’s going much higher.  So I think a successful bubble denial ought to earn some praise from the intellectual elites.  Given that pessimism is the only fashionable stance if one wants to be viewed as a SERIOUS THINKER, the bubble deniers ought to be viewed as being the ones going against the grain. 

So I feel it’s hopeless, I get way more comments than I have time to answer, and only 10% or 20% actually address the specific arguments in my post.  So I’ll just give up, and stop doing bubble posts.  Of course as soon as I find another interesting way of denying the existence of bubbles, I’ll break my vow and post another EMH defense.  After all, it can be logically shown that I don’t have any free will.

PS.  I will be super busy until after New Year’s Day, not doing as much blogging.  (Although I’ll try to do some.)  Apologies to those who used to get Christmas cards from me.  Consider this:  “Merry Christmas,” to be my holiday greeting.

PPS:  I just noticed that Bryan Caplan and Arnold Kling commented on my post.  In response to Bryan Caplan, I think Fama became famous for inventing and defending the EMH, not making a specific correct forecast that a specific bubble would keep inflating.  I don’t know the other guy.  Arnold Kling’s definition of a bubble is one of many out there.  My problem is not that it is wrong, but rather that even if true, it is a useless concept.  I insist that unless a bubble call is an implied prediction, it is useless.

PPPS.  Thanks to Yasuyuki Iida for sending me the paper.  He indicated it was presented at this year’s Econometric Society World Congress (ESWC2010).


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56 Responses to “More evidence that the BOJ is not trying to create inflation”

  1. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. December 2010 at 18:43

    Scott wrote:
    “Unfortunately, I went to grad school back in the stone age when we mostly taught economic intuition, not math and econometric skills.”

    I like to think I have a good dollop of both. My math background more than helped me compete with my colleagues in my econometric centered department. But I’ve often thought my economic intuition was far more important (and I truly admire yours).

    I’ve read all three of your Economist articles and especially enjoyed the ECB article as it holds special interest for me.

    Scott wrote:
    “If you believe as I do that sticky wages explain part of the high unemployment, it would have made much more sense to cut the employer’s share of payroll taxes, not the employee share.”

    Agreed, but it was obviously done for political rather than economic reasons.

    And wrote:
    “I agree with Christina Romer that tax cuts are much more stimulative than spending increases.”

    That’s a low blow Scott. I expect better of you. You know she doesn’t believe that. She used innovative techniques on tax changes that probably cannot be applied to spending changes. She believes that the fiscal multiplier is much higher than previously estimated regardless of the type of fiscal stimulus.

    Scott wrote:
    “The endless, pointless, debate over the EMH”

    Enough said. Will somebody please define “bubble”!

    Merry Christmas (or whatever) to all at The Money Illusion!

  2. Gravatar of JimP JimP
    9. December 2010 at 19:23

    Yes – Merry Christmas to all.

  3. Gravatar of JimP JimP
    9. December 2010 at 19:25

    BTW this is the only blog I know is which the real loonies haven’t tried to drive normal people away. Thats a testament to Scott I think.

  4. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. December 2010 at 19:36

    JimP,
    Who around here do you consider a real loonie? (Just askin’.)

  5. Gravatar of scott sumner scott sumner
    9. December 2010 at 19:45

    Mark, Actually I didn’t know Romer didn’t really believe that. As so often with this blog, I was relying on second hand sources that indicated she had found the tax multiplier was larger than the spending multiplier. If you say my sources were wrong, I’ll take your word for it. But it wasn’t intentional on my part.

    Mark and JimP, Merry Christmas to two of my most loyal readers, from a fellow loony. :)

  6. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. December 2010 at 20:23

    Scott wrote:
    “As so often with this blog, I was relying on second hand sources that indicated she had found the tax multiplier was larger than the spending multiplier.”

    She found that the fiscal multiplier was larger when using the techniques she had developed specifically to tax changes. It was actually considered somewhat revolutionary in Neo-Keynesian circles.

    But I personally question those results. What if one took into question the Fed’s implicit reaction function? Then you end up in Scott Sumner’s universe.

  7. Gravatar of scott sumner scott sumner
    9. December 2010 at 20:35

    Mark, My reaction function argument applies to AD changes. I assumed that if the tax effect was larger, then it must be due to supply-side effects. But now that I read your explanation, that doesn’t seem to have been her interpretation.

  8. Gravatar of Mark A. Sadowski Mark A. Sadowski
    9. December 2010 at 20:46

    Scott,
    Precisely. Romer’s viewing such changes as an AD event only. And therefore she thinks that spending changes would show similar effect if the same techniques could be applied.

    My research (on my other economist’s hand) on tax structure has a completely different intent. I’m attempting to show that tax structure has an important impact on long term growth. But I’m inspired by your site to shift my focus to monetary policy.

  9. Gravatar of Joe Joe
    9. December 2010 at 20:54

    When you say “If you believe as I do that sticky wages explain part of the high unemployment,” are you saying here that the problem is nominal AD that the fed can successfully fix, as opposed to the arguments of people at Cato, Cowen, and Kling that the problem is structural?

    Joe

  10. Gravatar of Ram Ram
    9. December 2010 at 21:02

    If you look at the (approximately monotonic) decline in the price of Intrade’s top dividend rate hike contract over the last week or so, it seems to track reasonably well a roughly 5 point decline in the price of its 2011 recession contract. One interpretation is that the tax cut deal reduced the chances of a recession next year by 5 percent. That’s not a lot to say for fiscal stimulus, I suppose, but it’s not nothing either. Notably, however, the payroll cut surprise seemed to explain little of this 5 point decline. What that suggests is that the proposal by some to roll back the high-end tax cuts and use them to finance a bigger payroll tax cut may have been less stimulative than keeping all of the Bush tax cuts in place. But then, I’m starting to sound like the blowhards on CNBC, reasoning from price changes…

  11. Gravatar of Joe Joe
    9. December 2010 at 21:12

    Professor Sumner,

    I’d like to add my own non-PHD view. Bubbles are generally treated as an example of a “failure of capitalism” that causes much harm that must be fixed. Like we think of negative externalities. But it should not be though so. It is merely an example of a group of people, or us individually making a mistake. We do not say that me developing a coke addiction is a failure of human nature.

    But more importantly, the reason we all talk about bubbles is because when they crash they cause economic crises. But I now believe that this is false. Bubbles are only dangerous because in the rush towards liquidity as it breaks the money supply cannot expand. The problem is nominal not real! If we had your variety of NGDP monetary rules, bubbles might come and go and do much less harm than before. Correct?

  12. Gravatar of OneEyedMan OneEyedMan
    9. December 2010 at 21:27

    I like the idea of a bubble as when someone buys an asset knowing that the net present value of future cash flows and services from the asset are less than the price paid but they believe they’ll be able to see it for more later.

    If you want to know if you are in this sort of bubble you just have to ask people why they are buying assets. That at least makes it falsifiable in any given suspected bubble.

    If we found ourselves in such a bubble and it was large enough to do serious damage, one could imagine a roll for regulatory intervention.

    I think by this measure the recent housing market run-up would count as a bubble and the tech-boom would not have.

    I think this counts as a theory of bubbles that is not economically useless.

  13. Gravatar of Lorenzo from Oz Lorenzo from Oz
    9. December 2010 at 22:48

    The debate reminds me of arguments I have over free will. I point out that either events have causes, or they are random. In either case there is no room for free will. My opponent responds that he is free to pick up either the salt or pepper shaker in front of him. The debate never really gets joined, and is thus largely a waste of time. That is a good analogy, since so much seems to turn on definitions and fears about consequences and implications. Though I am with you on EMH and not on free will.

    For free will does not imply decisions are uncaused: the debate turns on one’s notion of causation–you clearly believe people make decisions, otherwise why try and blog to influence them? I take the ‘determinism is true but it does not matter’ view of the debate — try and formulate a notion of free will that does not involve causes: the exercise is instructive.

    Similarly, we can challenge folk to try and formulate a notion of (reasonably open) markets where available information systematically does not get reflected in prices. Again, the exercise is instructive.

    As previously noted, I have no problem with some notion of bubbles: it is just that if we already had the information which demonstrated they were bubbles diverging from prices based on rational expectations, they wouldn’t be any more. After all, the capital gain involved is real until it’s not. Expectations about expectations just collapse into expectations.

  14. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    10. December 2010 at 04:04

    Scott, you said:
    “The mistakes made in Ireland (poor quality bank regulation) were quite different from those made in Greece (severe fiscal imbalances). Spain seemed to have avoided either of those extremes, and yet is being punished by the bond market speculators. ”

    The problem is that bank regulation before the crisis in Spain was as bad as in Ireland. Although the current regulation in Spain is much better (i.e. countercyclical) – extend and pretend has reached the phenomenal proportions.

    You said:
    “But I also believe Obama missed an opportunity. If you believe as I do that sticky wages explain part of the high unemployment, it would have made much more sense to cut the employer’s share of payroll taxes, not the employee share. Still, if we need to do fiscal stimulus, I favor tax cuts both for small government reasons, and for stimulus reasons. I agree with Christina Romer that tax cuts are much more stimulative than spending increases.”

    High unemployment is the result of sticky wages and bad monetary policy at the zero bound. Cutting employer’s share addresses the first issue, cutting employee’s share addresses the second issue (weak household balance sheets are the most constrained by the zero rate bound, and the lower employees’ share of the tax increases the natural interest rate).

    When corporations are credit constrained by the zero bound (as in late 2008 – early 2009), fiscal deficit should be increased by reducing the employer’s share. The current constraints are elsewhere, and Obama has chosen the right policy.

    You said:
    “Several people mentioned market observers who denied bubbles, but no one provided me with a specific example of a bubble denier who became famous because his or her prediction was correct. During bubbles, I find all the sophisticated people I talk to are pessimists, arguing it’s a bubble and it must burst at some point. ”
    Your focus on famous bubble deniers suffers from a social circle bias. Every London tabloid reader knows the name of the plumber (or was he a janitor?) who has amassed 100-apartment empire by denying the bubble. Bubble-denialist TV reality-shows had the excellent time slots when I visited Scotland this summer.
    Academic bubble deniers are not famous because they are boring, not because they are right. Bubble denialist TV-shows are famous, because they are entertaining, not because they are right. Academic bubble theorists are famous because they are rare and entertaining (Nassim Taleb is almost as funny as Sarah Silverman). Bubble theory TV-shows would be very offensive to the accepted dogma “housing prices never go down on the nationwide basis”, that’s why there are no such shows.

    You said:
    “anti-EMH view is literally useless”
    There are wrong and right anti-EMH views. The correct interpretation is to focus on net ex-ante benefit of additional collection and processing of information. It is true that the economy devotes a lot of resources in determining the relative price of WMT and SHLD, so most folks should stick with the market portfolio as any additional effort to collect and process information will give them no net edge (just as the efficient households should split their shopping 50/50 between Wal-Mart and Sears if the transportation costs to both stores are equal).
    But the EMH argument does not apply to you, Scott. The reason is that you have already expended lots of effort in doing useful, original and obscure (the 1957 issue of Farm economics) research. The theory says you should be able to partially recoup the cost of your research program by deviating from the market portfolio. It is a good thing that university administrators believe in EMH, because if they knew that good macroeconomists could cash-in the fruits of their research by speculating in the markets, they would reduce the salaries (and provide a subsidized margin account in return).
    EMH is also not applicable to those cases where government nationalizes the information processing activities, for example by creating Eurozone or Basel capital standards. Surprisingly there was a very little competition to the bureaucrats in the information processing business, even though bureaucrats are the noise traders par-excellence, and those funds who bet against the Basel (see John Paulson’s greatest trade ever) or the PIGS have reaped the enormous profits.

  15. Gravatar of himaginary himaginary
    10. December 2010 at 05:36

    “The study by Koiti Jano, Yasuyuki Iida, and Hajime Wago”

    It’s Koiti Yano, not Jano.

  16. Gravatar of Tom CZ Tom CZ
    10. December 2010 at 05:52

    Professor Sumner,

    maybe I can help you with this DSGE math as I’m doing my PhD in this field. The authors use standard method to estimate the inflation target, but employ novel algorithm instead of standard Kalman filter, which is probably better.
    The question is how much information about unobserved inflation target there is in the observed variables. I know a study that used the same method to estimate the unobserved inflation target here in the Czech Republic using the model that our central bank uses as its prime tool. The result was slightly below the official target and had the same trend (we lowered the target several times during the period of interest). This makes me believe the method.
    So I think the results of the paper you link to are plausible. I wish the paper said more details.

  17. Gravatar of Cameron Cameron
    10. December 2010 at 06:17

    RE: Part 3

    “The announcement seemed to raise the expected rate of inflation by about 8 basis points per year over 5 years. There’s two ways of looking at that. On the plus side, it shows fiscal stimulus does have a positive multiplier.”

    At the same time, Fed Fund futures for 2012 have shown a significant(although not enormous) increase in expected rates. May 2012 has gone from a 0.5% expected FF rate on December 6th to a 0.75% rate on Wednesday. That’s the biggest movement seen recently, and it’s clearly in response to the tax cuts.

    I read the markets as saying:
    a) fiscal stimulus works BUT…
    b) the Fed is targeting inflation
    c) current Fed policy won’t meet its target(otherwise expected inflation shouldn’t change), but it isn’t too far off
    d) The Fed has lowered its inflation target(otherwise expected FF rates shouldn’t increase when expected inflation is this low).

  18. Gravatar of Ram Ram
    10. December 2010 at 06:28

    A beer or two may have colored my reading of the Intrade charts mentioned in my previous comment. Looking at them again, I see something very different. Between Nov 23rd and Dec 9th, the “Top dividend tax rate to be greater than 21% at midnight ET on 01 Jan 2011″ contract’s price was non-increasing except on Dec 2, when the price rose slightly. During that period, the price fell roughly 55 points. During that same period, the “US Economy will go into Recession during 2011″ contract’s price started and ended in the same place. A sharp price increase in the latter contract occurred on Nov 25th, despite no change occurring in the former contract between Nov 24th-26th. Oddly, a sharp price DECREASE in the latter contract occurred on Dec 3rd, the day following a significant price INCREASE in the former contract.

    This surprises me quite a bit. First, it suggests that a sharp drop in the probability of the Bush tax cuts being rolled back (either the high-end cuts or the lot of them) had roughly no effect on the probability of a recession next year. Second, the only day in which some effect seems to have been present suggests that the continuation of the cuts RAISED the probability of a recession next year. I’m more suspicious of this possibility. If I had to guess, the lesson is that the stance of fiscal policy had roughly zero impact on the probability of a recession next year, and the one apparent correlation is just a coincidence.

    As for the payroll tax cut, it seemed to have had no effect on the probability of a recession next year the day it was announced or the day after, but the day AFTER that (yesterday) did see a drop in that probability of a few points. Some may wish to argue that the two day delay involved people studying the details of the package before making their call, but I’m skeptical. Seems to me like Prof. Sumner’s contention that, in practical terms, the fiscal policy multiplier is zero is more or less verified. See for yourself:

    http://data.intrade.com/graphing/temp/chart12913891868102684.png

    http://data.intrade.com/graphing/temp/chart12913891868102686.png

  19. Gravatar of Dan Carroll Dan Carroll
    10. December 2010 at 07:20

    The free will argument is one of theory versus observation. In theory and logically, it is impossible to defend free will, though determinism is circular. Yet, we observe free will in everyday life. So either our theoretical model is wrong (ie, missing something), or we are being deceived (I think therefore I am not).

    EMH follows a similar tract: EMH is both sound theoretically, but also circular and unprovable, while common sense observation suggests that it is wrong. Your typical academic thinks it is a great idea and extremely useful (mostly because it makes his or her models work). Your typical professional investor thinks it’s stupid and completely useless (mostly because it renders him or her irrelevant).

    A priori assumptions are usually what is being debated, though not explicitly. Thus, the debaters often just talk past each other.

  20. Gravatar of Contemplationist Contemplationist
    10. December 2010 at 07:34

    Scott

    Can you help a lay person (me) who is an avid reader of econ blogs (especially yours) think of how to evaluate placing a bet on inflation with people who are adamant that high inflation is “around the corner” ?

    Say, what all circumstances or mechanisms do I need to think about, or probabilistically evaluate that might produce inflation? I know Milton Friedman said that inflation is everywhere a monetary phenomenon, but I’m thinking of second order effects – like external shocks forcing or tying fed’s hands. So we know a negative demand shock will produce deflation/disinflation. Is it the case that only a positive demand shock can produce inflation assuming the fed does no more QE?

  21. Gravatar of spencer spencer
    10. December 2010 at 09:31

    There is a constant stream of comments that labor cost are too high.

    But if yu look at the productivity data it shows that labor compensation is now at 57% of nonfarm output– by far the lowest level ever recorded since the data started in 1948.

    Interestingly from WW II to 1980 labor compensation bounced around 66% of output and labor demand was strong. Since 1980 the trend has been on a significant downward slope and the growth in labor demand has weakened significantly.

    This data clearly and strongly contradicts the thesis that lowering labor compensation leads to stronger employment.

  22. Gravatar of rob rob
    10. December 2010 at 09:37

    Not quite a fair argument you make that famous bubble deniers must also be famous for specific bubbles they have denied. After all, they don’t believe in bubbles: why would they go out of their way to deny *specific* bubbles they don’t believe in? Particularly since the *bubbles* themselves generally only become famous with the benefit of hindsight. If I don’t believe in ghosts does it seem likely I would name specific ghosts?

    Niederhoffer has written extensively about how no matter what the conditions are there are always plenty of people predicting the stock market is about to crash. They are usually wrong and you are usually better off betting against those people. He also wrote an anti-Shiller chapter in his book Practical Speculation which claims to show you are better off buying when P/E ratios are on the high side not the low side.

    Admittedly, Niederhoffer is most famous on Wall Street as the Blow-Up Artist because both of his hedge funds crashed and burned due to using excessive leverage on short-term positions. So his spectacular failures will always overshadow his anti-bubble position in the history books — but it wasn’t the bursting of bubbles that got him.

  23. Gravatar of Benjamin Cole Benjamin Cole
    10. December 2010 at 09:57

    What a fascinating study on the BOJ. Hey, I went to school when slide rules ruled (btw, if you have ever seen a large, very well-made slide rule, they are a thing of beauty).

    Imagine the harm the BOJ has done to Japan–property and equity values down 75 percent in 20 years, and a nation becoming eclipsed, in many regards, by smaller Korea.

    Now imagine if the Nipponista anti-QE crowd assumes power at the Fed.

    Can we have 20 years of falling equity and property values? Did anyone in Japan expect 20 years of falling equity and property values in 1990?

    Somewhere in the last couple decades, many economic observers have developed fetishes for tight money, zero inflation, gold etc. Maybe they are bond holders, and they dress up their naked self-interest in high-minded sounding principles. Maybe they hate Obama, and prefer a couple more years to gloom to an Obama re-election.

    For the life of me, I do not understand why anyone, liberal or conservative, favors tight money now, with a weak recovery, declining unit labor costs, high unemployment, and real estate values so low some large fraction of property onwers would do well to walk away from their properties (thus harming banks).

    Keep writing, Scott Sumner.

  24. Gravatar of james in london james in london
    10. December 2010 at 10:54

    Benjamin
    “Imagine the harm the BOJ has done to Japan–property and equity values down 75 percent in 20 years, and a nation becoming eclipsed, in many regards, by smaller Korea.”

    To you it’s all a great competitive game, one nation against another. The US mustn’t “fall behind” China. Germany “sucks” for not growing fast enough, and “cheats” by not rescuing the rest of Eurozone and keeping the Euro weak.

    What a lot of statist nonsense I think you think.

    In any case demographics play a big role in all this. Japan is out through the other side of the demograhphic transition from high population growth into negative population growth. This doesn’t make them “losers” as your theory of competitive nations seems to claim. It just makes them different, or like the majority of the baby-boom generation in the US probably think.

    The oldies out there in Japan probably prefer a quiet, clean, contemplative lifestyle. Their island did get way too crowded during that demographic transition when unexpected improvements in life-expectancy led to their population booming (just as it did/does everywhere).

    I think a shrinking population and a probably shrinking economy, but modestly rising per capita GDP growth is not bad result – and not to be ridiculed by uber-competitive national statists like you, young(?) Benjamin!

  25. Gravatar of John John
    10. December 2010 at 11:01

    Not on topic, but I thought I would chime in.

    St. Thomas Aquinas — Summa Theologicae

    First part, a, Question 83, Article 1 (FREE WILL)

    Reply to Objection 3. free will is the cause of its own movement, because by his free will man moves himself to act. But it does not of necessity belong to liberty that what is free should be the first cause of itself, as neither for one thing to be cause of another need it be the first cause. God, therefore, is the first cause, Who moves causes both natural and voluntary. And just as by moving natural causes He does not prevent their acts being natural, so by moving voluntary causes He does not deprive their actions of being voluntary: but rather is He the cause of this very thing in them; for He operates in each thing according to its own nature.

    Only Aristotle/Thomist metaphysics can address the question regarding free will and causation.

  26. Gravatar of Alexander Hudson Alexander Hudson
    10. December 2010 at 11:17

    Contemplationist, A negative supply shock (like the oil shock in the early 70′s) could also produce inflation.

  27. Gravatar of Bill Gee Bill Gee
    10. December 2010 at 12:13

    Regarding political forecasts…

    You would think that once an economist has a grasp (albeit a shaky one at best) of how macroeconomics plays with fiscal policy, they could reasonably predict the changes in the political tides. Alas, that is not the case.

    For example, I have serious doubts that the Obama Administration’s sudden embrace of extending the Bush Era tax cuts has anything to do with what we would call “sound fiscal policy”. While one can argue that it makes sense from a Keynsian perspective, which the President has gambled in spades, I honestly believe that he wouldn’t have given his last-minute support if he wasn’t afraid that sticking to his guns was going to cost him his reelection. (It may cost him in either case, but that’s beside the point.)

    As we learned from every President since Truman, economic policy and political success has little or nothing to do with actual economics.

  28. Gravatar of W. Peden W. Peden
    10. December 2010 at 13:08

    Bill Gee,

    Even though there are plenty of tools for analysing political profitability, political capital and so on, the kind of consequential knowledge required to make predictions of the political market is less accessible than in the economic market. There are no quantitative estimates that are equivalent to inflation figures for party clout, for instance. I for one didn’t forsee this compromise by President Obama.

    The philosophy in me wants to jump into the free will debate, but the lover of wisdom in me knows that this is not the best context to discuss such an issue. I think the EMH is similar: the kind of patient defining of terms and relaxed or formal argumentation that are required to have a proper discussion of either topic can arise in a dinnertime conversation or an academic paper, but are hard to achieve in the context of a blog.

    The BoJ’s policy of Comfortable Decline reminds me a lot of British history in the post-war period, when a sort of cosy falling behind took place and the political sacrifices to change were too great for our political masters. The main difference, of course, was that Britain’s problems were mostly supply side issues of labour disputes and capital investment, combined with the occasional exchange crisis, while the Japanese problem is more demographic and nominal. Are there Japanese equivalents of Callaghan and Thatcher to change the fundamentals of Japanese economic policy?

    @ Contemplationist

    Supply and demand factors can affect the Fed’s behaviour, but of course this is a matter of the human factor. There are also factors that can affect inflation in the short run e.g. rising import prices or supply shortages. The quantity of money usually manifests itself during the long run, which is why it was so ignored by most economists for a surprisingly large period of the history of economic thoguht.

  29. Gravatar of W. Peden W. Peden
    10. December 2010 at 16:02

    Many will have seen this (it’s five months old) but it’s new to me-

    http://www.youtube.com/watch?v=cQjD2sw_eg4

    Sense on TV is not entirely in short supply.

  30. Gravatar of Benjamin Cole Benjamin Cole
    10. December 2010 at 20:49

    James In London-

    Well, I am young if you consider a man who learned on slide rules to be young. Are you old enough to know what is a slide rule? If so, I hoist a beer to you.

    Actually, I am not very nationalistic, and plan to live soon on Thailand with my wife.

    My point was that BOJ’s monetary policy has been a disaster. Equity and property values down 75 percent in 20 years, and some say the reason the population is shrinking is that younger people have no optimism.

    The Koreans have become world beaters.

    No, not everything is monetary policy. I believe deeply in culture–a Sweden, whether socialist or capitalistic, will have a higher living standard than Nigeria, whether capitalists or socialistic. Ethics, corruption, work ethics, all play in.

    That said, I find (in America) many people who fume about the Fed and blame all ills on the Fed then turn around and say, “Well, in Japan there are factors besides monetary policy.”

    Oh! I see, in Japan monetary policy does not dictate all; but in the USA it does.

    Cheers to you James, I have always wanted to see the British Museum and drink stout in a London pub, but now my plane tickets always have “BKK” stamped on them. Go to the museum, a have a brew for me.

    And see if you can figure out a slide rule.

  31. Gravatar of Doc Merlin Doc Merlin
    10. December 2010 at 23:16

    If your problem is that “bubble” definitions aren’t useful, then you haven’t read through Didier Sornette’s theory papers, or through similar physics papers on predicting other self-similar, random phenomena like earthquakes.

  32. Gravatar of johnleemk johnleemk
    11. December 2010 at 00:19

    spencer,

    If I am not wrong, productivity (in terms of output per worker) tends to rise in recessions because it is the marginal workers who get laid off. Both output and number of workers employed will fall. I think this is just as consistent with your observation. Real wages might in fact be higher for those who are employed, but overall compensation might be lower because so many people were laid off.

  33. Gravatar of Yoko Yoko
    11. December 2010 at 01:05

    They are famous economists in Japan who are insisting that Bernanke’s helicopter money and Krugman’s inflation target are the same, have continued to insist that BOJ made Japan the deflation & recession by intention and BoJ is a cause also in the deflation that started again in 2008.
    Koiti Yano blog (Japanese) http://d.hatena.ne.jp/koiti_yano/
    iida_yasuyuki (Japanese) http://d.hatena.ne.jp/Yasuyuki-Iida/

  34. Gravatar of james in london james in london
    11. December 2010 at 06:34

    Benjamin
    I was born in the slide rule era,and enjoyed playing with them. I kept my maths simple enough so as not to need slide rules or (later) caluclators.

    To be fair, Japan’s 75% real estate price fall was from a riduculous peak. didn’t the land value of the Imperial Palace in Central Tokyo exceed the land value of all of California or Manhattan. It was a bubble and needed 75% deflation in US$ terms. The recovery was always going to be difficult given the home population demographics and the general refusal to allow immigration. But as I said, population growth when already so densely populated is a real challenge, especially with a diet so biased to very fresh fish. The fact that Korea has become such a well-developed country and reasonably democratic too is great. no need for the “world-beater” stuff though, it’s not a competition. All can win, that’s what’s so great about the market, it’s not a zero-sum game.

    Thailand is fascinating given it is through the demograhpic transition and actually has an almost mature country demographic structure. It is a shame the politics is quite immature, but maybe that will improve.

    The US in contrast seems to be getting increasingly immature. Milton Friedman’s entertaining scepticism about Congressional fiscal responsbility would be well justified by the flip-flop from Erskine-Bowles reform one minute to a $900bn “let’s party” agreement the next. No wonder US Treasury yields shot up as sovereign risk worries trumped any Sumnerian “good” move around QE2. Scott is surprisingly silent given his crowing around the earlier justification of his Put.

    A good pint of Stout in a London pub is a pleasure indeed, although I generally prefer Bitter!

  35. Gravatar of JTapp JTapp
    11. December 2010 at 10:15

    I’ve been away from comments for a few days, but just wanted Scott to know John Cochrane has a new post up on quantitative easing that has gotten some praise from Reihan Salam and others who are skeptical of QE.

  36. Gravatar of Benjamin Cole Benjamin Cole
    11. December 2010 at 11:38

    James in London–

    I am disappointed in Thai’s leadership too–they do seem to have a free press, but the recent assassinations of 91 Red Shirt leaders, about which the Royal-Establishment Yellow Shirts and government profess to know nothing, is a daunting reality.
    Democratic processes in Thailand have been short-circuited. (My own very strong suspicion is that only a government could have organized such an awful and sustained campaign of assassinations).
    That said, the Thai people are great, hard-working, generally honest to a fault, and the economy is growing, though I suspect Thais will never have the incessant drive and pride of the Koreans.
    As for the future it appears bright, as Commie China needs raw materials and commodities and food, and that Thailand has.
    Thais still have families, not careers, a positive sign. I also suspect that China in 10-20 years will offshore manufacturing to Thailand, as China evolves ala Japan.
    Relatively stable and cheap, Thailand may become an offshore manufacturing platform of choice in the East. Given the huge scale of Far East manufacturing, only a slice has to come to Thailand to make a huge boom there, and I think that will happen.
    If Commie China becomes imperialistic, all bets are off.

    People forget the lethal grip the CP has on China, and even that the CP owns majority of voting shares in all publicly traded China companies. The CP has famously jailed a Peace Prize winner for speaking his mind.

    We want to believe that China will modernize, but the CP may believe political modernization is a threat to its control. We can only hope that sensible elements will prevail, as they ultimately did in Eastern Europe.

    The collapse Soviet Union and the evolution of Russia into a thug state is an example that not all goes according to the wishes of the West, even when things look auspicious.

    Enjoy that bitters, and hoist a second one for me!

    And don’t join the monetary Nipponistas!!!

  37. Gravatar of Benjamin Cole Benjamin Cole
    11. December 2010 at 11:47

    JTapp-

    Evidently, although he is a Nipponista, Mr. Cochrane has never heard of Japan.

    Mild deflation is good? And who would lend on property or to small businesses in deflation?

    The 1980s and 1990s (both mildly inflationary periods in the USA) were not good?

    I will take the 1990s for the rest of my life. We had tremendous growth, excellent increases in real living standards, wonderful job growth, mild inflation around 3 percent, surging exports, and ran federal surpluses. I guess Mr. Cochrane was out of the country in that decade. What a boob.

    If it gets any better than the 1990s, let me know….maybe in Mr. Cochrane’s fantasy world.

    Cochrane and the Nipponistas are the biggest threat to American prosperity and security on the globe. They make the Taliban look microscopic in terms of threats to our well-being.

  38. Gravatar of scott sumner scott sumner
    11. December 2010 at 14:36

    Mark, I’d encourage you to shift back to taxes and growth–which is more important in the long run.

    Joe, Yes, I believe that monetary policy can fix part of the problem, as does Tyler Cowen.

    Ram, I’d want to look at the timing of those recession contracts price changes. How much occurred the day after the announcement?

    Joe, That’s right, if we target NGDP expectations, we stop worrying about bubbles.

    Oneeyedman, The problem is that if we had such a model, the banks would use it and we never would have had the orgy of sub-prime lending. So there are no policy implications.

    Lorenzo, You said;

    “For free will does not imply decisions are uncaused: the debate turns on one’s notion of causation–you clearly believe people make decisions, otherwise why try and blog to influence them?”

    How can you even ask this question of someone who denies the existence of free will? :)

    Seriously, if I change minds, they are not changed by “free will,” they are changed by ME, i.e. my arguments.

    I agree about bubbles.

    123, I’m confused. I was claiming that Spain does not face a huge budget cost of bailing out the bank creditors. Is that wrong?

    I don’t follow your comment on corporations not being credit constrained. How is that related to sticky wages? And I don’t think tax cuts do much to make monetary policy more stimulative. That’s up to the Fed.

    I’m not sure that Shiller and Roubini are “entertaining.” I guess I am taking an academic perspective, as I simply don’t know enough about pop culture. I wonder if your comments about Britain also apply to America. Are there famous American bubble deniers? And is the plumber you mentioned famous because he got rich, or famous from making predictions that denied any bubble was occurring.

    Yes, it’s possible some people may be able to beat the markets. I doubt whether I am in that category.

    Himaginary, Thanks, I corrected it.

    Tom CZ, Thanks for the info.

    Cameron, Yes, but interest rate data is always ambiguous. It could indicate tighter money, or that fiscal stimulus is working. The expected inflation number is a less ambiguous indicator of expected AD changes.

    Ram, One other question about Intrade. Is the liquidity high enough where we can have confidence that these numbers show market expectations? I recall some contracts have very low volume.

    Dan Carroll, Those are good analogies between the two debates.

    Contemplationist, I would suggest taking an inflation bet, as long as they were predicting a high rate—say over 8%. It would be like taking candy from a baby. There would be very little risk of losing. There’s no zero bound on the upside, so the Fed can always prevent high inflation.

    Spencer, You are confusing cyclical and secular issues. I am not arguing workers are earning too much in total; I believe that with a more expansionary monetary policy total wages would rise, even as real hourly wages fell.

    More to come . . .

  39. Gravatar of scott sumner scott sumner
    11. December 2010 at 14:53

    rob, If he has a bad reputation for spectacular investing failures, then he is not the sort of character I had in mind.

    I am simply asking for people who got famous for making bullish forecasts when prices had already risen so high that lots of people were crying bubble. It doesn’t really matter what they think of the academic debate on bubbles, just that they were right in predicting still higher prices.

    Benjamin, Thanks. BTW, lets not forget that the tight money of late 2008 also sank the McCain campaign–so it’s not just partisanship.

    John, Thanks, I guess God is one answer to the free will puzzle.

    Bill Gee, I suppose Obama thought he had no choice. (Once again, a lack of free will.)

    W. Peden, Thanks, I agree with Hendry.

    Doc Merlin, No I haven’t read them. If someone has a good argument, please present it in the comment section.

    Yoko, That’s good to hear–thanks for the link.

    JTapp, Thanks for the link.

  40. Gravatar of Cameron Cameron
    11. December 2010 at 22:04

    “Cameron, Yes, but interest rate data is always ambiguous. It could indicate tighter money, or that fiscal stimulus is working. The expected inflation number is a less ambiguous indicator of expected AD changes.”

    I agree, but doesn’t the fact that expected inflation increased along with expected FF rates indicate that markets see the fed as having lowered its inflation target? Otherwise why would increases in AD lead the fed to tighten more when expected inflation is <2%?

    In other words, not only will the Fed not do enough to get sufficient NGDP growth, it will actually sabotage fiscal policy which pushes growth towards its old target.

  41. Gravatar of Cameron Cameron
    11. December 2010 at 22:14

    Clarification : The Fed won’t completely sabotage effects of fiscal stimulus, but is expected to at least partially do so. Unless you think growth was just a tiny bit off track before the fiscal stimulus, that’s upsetting to see.

  42. Gravatar of Lorenzo from Oz Lorenzo from Oz
    11. December 2010 at 23:07

    Scott: it is an almighty responsibility you are taking on — everyone who fails to agree with your arguments is your fault :)

    People change their behaviour depending on how accountable they are for them. Incentives matter. So behaviour is caused and people are morally responsible. Determinism is true but does not matter in that it does not change moral implications. Moreover, a notion of free will that somehow subvents causation is pointless.

    As an aside, we so often agree on economics but disagree on philosophy: that says something interesting in itself!

  43. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    12. December 2010 at 05:49

    Scott, You said:
    “I’m confused. I was claiming that Spain does not face a huge budget cost of bailing out the bank creditors. Is that wrong?”
    Poor regulation of bank activity has caused the excess economic activity in the construction sector, as this has dried up, the fiscal picture in Spain has deteriorated. So far Spain is fortunate that has not grown into the financial panic. The cost of bailing out the bank creditors is off-budget in Spain, as the primary tools used by Spain are “extend and pretend” and “don’t use fair market values”, while Ireland has taken more explicit route in recognizing bailout costs.

    You said:
    “I don’t follow your comment on corporations not being credit constrained. How is that related to sticky wages? And I don’t think tax cuts do much to make monetary policy more stimulative. That’s up to the Fed.”

    Sticky wages are harmful because AD is too low. AD is too low because the zero rate bound has severely diminished the quality of monetary policy. We know that the fed funds rate should be negative. The costs of distortion caused by the fed funds rate that is too high are different across various economic agents. Economic agents who are financially distressed suffer a lot from the zero interest rate bound, and the harm for those economic agents who are financially sound is much smaller. So it makes sense to design a tax cut that addresses the harm created by the zero interest rate bound. Such tax cut should flow to economic sectors that have higher levels of financial distress, currently such sector is the household sector, so it was a good idea to cut the employee’s share of the payroll tax.

    We know that in practice the Fed is much more effective when working with above zero interest rates, and the Fed makes a lot of mistakes when zero interest rate constraint is binding. By raising the natural interest rate, fiscal stimulus reduces the risk of monetary policy errors.

    Bernanke has indicated that tax cuts are a great idea needed to increase AD. As a signal, Bernanke’s statement is monetary stimulus that works even if there is no follow up from Obama. If fiscal authorities comply and pass a tax cut, this tax cut works as a monetary stimulus as it strengthens the signal – monetization of additional debt will tell the markets that Bernanke’s words are not just the cheap talk. In addition, as payroll tax cut is directed to households, credit channel of monetary policy is strengthened as tax cut flows to financially distressed households – keeping rates at zero for an extended period when credit channel is strengthened is an additional signal that Bernanke is serious.

    You said:
    “I’m not sure that Shiller and Roubini are “entertaining.” I guess I am taking an academic perspective, as I simply don’t know enough about pop culture. I wonder if your comments about Britain also apply to America. Are there famous American bubble deniers? And is the plumber you mentioned famous because he got rich, or famous from making predictions that denied any bubble was occurring.”

    Shiller and Roubini are much more entertaining than Fama. Fama’s blog is very boring. Now Krugman has used Fama as an example of bubble-denialism, but of course he had in mind that there is a vast right-wing conspiracy of bubble-denialists in academia. The reason that this conspiracy is invisible is that EMH is simple and boring common sense.
    Plumbers became famous after they demonstrate housing profits, not when they make predictions. There were too many plumbers who thought that housing was a good investment before the crisis, so only the most successful got famous.

    You said:
    “Yes, it’s possible some people may be able to beat the markets. I doubt whether I am in that category.”
    “Beat the markets” is too dramatic. Nobody says “Beat the grocery store” when their above-average knowledge about coupon promotions lets them lower their shopping costs a bit. If you have sunk costs in developing useful but obscure research, you should be able to partially recoup those costs by deviating from the market portfolio, but this does not mean you should expect dramatic outperformance implied by “beating the markets”.

  44. Gravatar of scott sumner scott sumner
    12. December 2010 at 10:20

    Cameron, The Fed presumably sets policy at a level that is expected to produce the AD it thinks is optimal. If something raises expected NGDP growth, it will raise rates to offset his. In this case the market merely expected the Fed to partially offset the stimulus, as perhaps they believe the Fed didn’t set policy at the optimal level, but rather has a policy that is expected to fall somewhat short.

    I see your point however, it certainly indicates the market believes the Fed is not out of ammunition. The market expects the fed to tighten sooner, and that does weaken the effect of fiscal stimulus. I suppose I should do a post on that sometime.

    Lorenzo, You said;

    “Scott: it is an almighty responsibility you are taking on — everyone who fails to agree with your arguments is your fault”

    Au contraire. Some people have faulty brain wiring (another deterministic factor) and hence my brilliant arguments cannot penetrate into their belief system.

    You said:

    “People change their behaviour depending on how accountable they are for them. Incentives matter. So behaviour is caused and people are morally responsible. Determinism is true but does not matter in that it does not change moral implications. Moreover, a notion of free will that somehow subvents causation is pointless.”

    I agree, I’m not sure why you thinks we disagree.

    123, So is the Spanish government going to bail out the bank creditors, or not?

    Households are suffering because they lack jobs. They lack jobs because of sticky wages. And one way to reduce sticky labor costs is to cut the employer share of FICA. Cutting the employee share might boost AD, but probably not much when you consider the Fed reaction function (as Cameron shows above.)

    You said;

    “We know that in practice the Fed is much more effective when working with above zero interest rates, and the Fed makes a lot of mistakes when zero interest rate constraint is binding. By raising the natural interest rate, fiscal stimulus reduces the risk of monetary policy errors.”

    I agree, but the natural rate of interest is more likely to rise if real economic growth rises, and that requires more employment, which is helped by lower labor costs.

    I’m not sure whether you’re comments about Shiller and Fama support my argument, or undercut it. I argued that people see what they want to see. If people find the pro-bubble arguments to be more “entertaining” then this tends to confirm my view that people have cognitive biases–they see what they want to see.

    I have a new post on Mishkin that discusses conspiracy theories. This is another area where people have cognitive biases–they accept conspiracy theories too readily. Hence very good rebuttals to conspiracy theories attract much less attention that the actual conspiracy theories.

    Your last point suggests we agree. Grocery store are approximately perfect competition, but not exactly. Markets are approximately efficient, but not exactly.

  45. Gravatar of OneEyedMan OneEyedMan
    12. December 2010 at 10:24

    @Scott
    “Oneeyedman, The problem is that if we had such a model, the banks would use it and we never would have had the orgy of sub-prime lending. So there are no policy implications.”

    That suggests that the banks 1) employed such a technique and 2) that was also not simultaneous overconfidence in their ability to hedge their sub-prime risks

    We know that the banks tried to hedge their mortgage risk. Many of those hedges did not hold up in the market crisis. But if they tried to hedge and failed, you cannot clearly infer from the consequences about the motivations of the actors.

    In markets of strategic importance where we have strong reason to think inefficiencies exist because of lack of shorting and high transaction costs (housing specifically but there may be others), it would be a useful to have survey evidence of buyers and sellers asking them why they are transacting. Good survey design could elicit appreciation expectations, dividends and service flows, transaction costs, expected asset holding period and other detailed motivations for transactions.

    In the stock market this data would be nearly or completely worthless to market participants and regulators. In the housing or commercial real estate markets, it could be quite useful.

  46. Gravatar of OneEyedMan OneEyedMan
    12. December 2010 at 10:37

    Continued…
    Given the dis-economies of scale in banking, I’m not sure there was a mechanism for grass roots information about transactor motivations to reach banks and investors.

    Given the the incentive problems in the housing markets, I’m not sure that many of the people involved in the housing market would have cared even if they knew.

    I shouldn’t have to accept that firms are perfectly efficient or that all markets are perfectly efficient to assume that the stock market is efficient. Housing markets exhibit all sorts of statistical and behavioral data that suggests they are far less efficient than the stock market. The large banks have special regulatory treatment and high barriers to entry that suggests they may not be run as well as perfectly competitive firms without agency costs or problems.

    As such, I see a role for data on transactor motivation to inform real estate finance regulation.

  47. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    12. December 2010 at 14:06

    Scott, You said:
    “So is the Spanish government going to bail out the bank creditors, or not?”
    The Spanish government is bailing out the bank creditors. Banks would be insolvent if banks had to pay realistic cost for deposit insurance. Bond markets are starting to price these costs in.

    You said:
    “Households are suffering because they lack jobs. They lack jobs because of sticky wages. And one way to reduce sticky labor costs is to cut the employer share of FICA. Cutting the employee share might boost AD, but probably not much when you consider the Fed reaction function (as Cameron shows above.)”

    This is all very interesting, as it all depends on the relative importance of the sticky wage channel and the credit channel. Households are suffering because they lack jobs, and because they cannot engage in intertemporal optimization of consumption because of the financial distress.

    I don’t agree with Cameron’s analysis. As I said above, it is the monetary policy that works. Fiscal stimulus works via monetary policy by solving signalling problems. It may look like Bernanke is partially neutralizing the fiscal stimulus, but it is only an illusion, as Bernanke’s statement “Tax cuts are needed” provides one part of the stimulus immediately, and the actual tax cuts are able to supply only the remaining part of the stimulus.

    You said:
    “I agree, but the natural rate of interest is more likely to rise if real economic growth rises, and that requires more employment, which is helped by lower labor costs.”
    Employment is also helped by higher spending driven by the tax cut.

    You said:
    “I’m not sure whether you’re comments about Shiller and Fama support my argument, or undercut it. I argued that people see what they want to see. If people find the pro-bubble arguments to be more “entertaining” then this tends to confirm my view that people have cognitive biases–they see what they want to see.”
    No, it is just a bad luck on Fama’s part. It is easier to turn Shiller’s ideas into an accessible story. In the battle of scientific ideas it may lead some people to overestimate the extent of market inefficiency (on the other hand Fama underestimates it). In the investment marketplace, the inaccessibility of Fama’s ideas leads to unrealistic expectations of asset returns, and this generates actual bubbles.

    In any case both Fama and Shiller should try harder. Fama will save you 1 percentage point in fund management fees, Shiller will save you from bankruptcy caused by leveraged investments in overpriced equities or housing. Both Fama and Shiller will prevent the psychological damage caused by the unrealistic expectations of asset returns, Fama will deny that excess returns exit, and Shiller will persuade you that people are prone to imagining that they exist where there are none.

    You said:
    “Your last point suggests we agree. Grocery store are approximately perfect competition, but not exactly. Markets are approximately efficient, but not exactly.”
    Imagine that the government takes over some key retail process nationwide, for example by making TSA agents in charge for negotiations with suppliers. Your investment in search for good grocery store should increase. It is the same with financial markets – if government passes Basel capital standards or creates the Eurozone, it makes sense to search longer for good investments.

  48. Gravatar of Doc Merlin Doc Merlin
    13. December 2010 at 03:00

    @Scott
    ” Doc Merlin, No I haven’t read them. If someone has a good argument, please present it in the comment section.”

    I can’t really post his argument as its mostly pages of math, so I will post my own, which is quite different from his:

    Here goes the first argument:

    If weak EMH is true and one cannot extract more than the risk free rate (adjusted for risk) from stocks over the long term using buy and hold based on fundamentals, then stock prices should be mean revering towards whatever the fundamentals are.
    If stock prices are mean revering and weak EMH is true then you shouldn’t be able to extract more than the risk free rate (adjusted for risk) using a mean reversion strategy. This means that price rises, much, higher than the fundamentals should persist for some time to add risk to the mean reversion strategy.
    This is itself a bubble, but it isn’t easy to identify it yet, that comes with a bit of work. Every stock has substitutability with money for expected store of value. When money supply increases (note this isn’t the same as what you call easy money) by the substitution effect, stock prices should rise as people arbitrage from expected increases in the supply of money. Note: this is no different than what you did in the 70′s, buying silver then selling it off before the Fed raised rates and crashed the silver market. Also, Note: this identification method only works because money supply isn’t free market, but involves fixing by a central planner.

    Identification method 2:
    This is the identification method that works in real estate and agriculture. Look for restrictions in supply that raise barriers to new entry of supply that are sub-linear with scale. What that means is that it the barrier to building 1000 new houses in this kind of market is a lot less than 1000 times building 1 new house (this allows the crash to happen). In addition, you want to look for the a market where demand has a much higher discounting rate than supply (this allows the initial price rises to happen).
    ———————————–

    Such markets where these things happens naturally, are rare, it usually takes institutional (usually government) messing with the market in some way to make it happen. Identifying bubbles in this manner is NOT a violation of EMH, but is regulatory arbitrage, and is collecting rents that result from institutional restrictions.

  49. Gravatar of Doc Merlin Doc Merlin
    13. December 2010 at 03:04

    @123
    “No, it is just a bad luck on Fama’s part. It is easier to turn Shiller’s ideas into an accessible story. In the battle of scientific ideas it may lead some people to overestimate the extent of market inefficiency (on the other hand Fama underestimates it). In the investment marketplace, the inaccessibility of Fama’s ideas leads to unrealistic expectations of asset returns, and this generates actual bubbles.”

    Agreed!

    So true, if many investors assume market efficiency when investing, then it leads to market inefficiency. Scott, Nick Rowe, and I talked about this about a year ago. When investing it is better to assume inefficiency, when doing academic research it is better to assume efficiency.

  50. Gravatar of Doc Merlin Doc Merlin
    13. December 2010 at 03:06

    I think I got it!

    Bubble definitions are very useful in investment, but Scott is an academic and bubble ideas aren’t that useful in academics. That may be why Scott is saying they are not useful.

  51. Gravatar of scott sumner scott sumner
    13. December 2010 at 17:53

    OneEyedMan, Every single market failure you discussed for the housing/banking market is even worse in the political market. So there is no argument for regulation from failures in the EMH. There is an argument for regulation–but it is to offset moral hazard, not to try to stop private actors from buying high and selling low. Government will never be able to do that. I’m not saying no one can do that. I’m happy to entertain the theory that Krugman is smart enough to do that. What I deny is that government can do that.

    123, I still think you are dodging the issue. I’m not trying to claim the Spanish government is not subsidizing banks through deposit insurance; all governments do that. I said the situation was different from Ireland. Even if the Irish had decided not to bail out the banks, they’d still be doing the deposit insurance implicit subsidy. But that’s small potatoes compared to the bailout of creditors.

    123, Either type of FICA tax cut boosts AD, by boosting the government deficit. But cutting the employer share also boosts AS. That is, for any given nominal GDP, cutting the employer share means a bigger real GDP. You don’t need to get households to spend more–they can buy more with what they spend.

    You said;

    “Employment is also helped by higher spending driven by the tax cut.”

    Yes, but both are tax cuts, both boost AD. It’s just that the employer cut also boosts AS.

    You said;

    “No, it is just a bad luck on Fama’s part. It is easier to turn Shiller’s ideas into an accessible story. In the battle of scientific ideas it may lead some people to overestimate the extent of market inefficiency (on the other hand Fama underestimates it). In the investment marketplace, the inaccessibility of Fama’s ideas leads to unrealistic expectations of asset returns, and this generates actual bubbles.”

    Oddly, I once made this argument from the opposite direction. I said that the very same behavioral biases that allegedly create bubbles, also cause us to see bubbles that aren’t really there. You mention “accessible stories” that’s what I mean by cognitive biases.

    Bottom line, no one knows. So I look for empirical evidence that the anti-EMH view is useful, and I don’t see it.

    We agree that government market distortions affect efficiency. Usually it is for the worst, but if market distortions already exit, then things like capital standards can improve welfare.

    Doc Merlin, So you think bubble theories are useful in investment? Say your mom is thinking of investing in the stock market. Should she put her money in a Vanguard index fund, or a managed fund run on Shillerian principles with a 1% expense ratio. I presume you know where I’d recommend my mom put her money.

  52. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    14. December 2010 at 04:03

    Scott, You said:
    “I still think you are dodging the issue. I’m not trying to claim the Spanish government is not subsidizing banks through deposit insurance; all governments do that. I said the situation was different from Ireland. Even if the Irish had decided not to bail out the banks, they’d still be doing the deposit insurance implicit subsidy. But that’s small potatoes compared to the bailout of creditors.”

    The deposit insurance subsidy is so huge in Spain these days, that the value of bank’s assets is increased by 20-30%, this is fully equivalent to the bailout of creditors.

    You said:
    “Either type of FICA tax cut boosts AD, by boosting the government deficit. But cutting the employer share also boosts AS. That is, for any given nominal GDP, cutting the employer share means a bigger real GDP. You don’t need to get households to spend more–they can buy more with what they spend.”

    In both cases deficit increases AD. Beyond that, cutting the employer share increases AS, but cutting the employee share provides the additional boost to AD via the credit channel, and today the credit channel is very powerful when it is operating on the household balance sheets.

    You said:
    “Oddly, I once made this argument from the opposite direction. I said that the very same behavioral biases that allegedly create bubbles, also cause us to see bubbles that aren’t really there. You mention “accessible stories” that’s what I mean by cognitive biases.”

    I’m not sure whether the bubbles are created by the behavioural biases or are they created by the agency costs or other frictions. In any case most people either underestimate the size of the bubbles by clinging too closely to EMH, or they overestimate the size of the bubbles by ignoring the impact of random and unpredictable shocks.

  53. Gravatar of scott sumner scott sumner
    18. December 2010 at 05:34

    123, You said;

    “The deposit insurance subsidy is so huge in Spain these days, that the value of bank’s assets is increased by 20-30%, this is fully equivalent to the bailout of creditors.”

    This comment makes no sense, a deposit insurance subsidy is completely unrelated to a bailout. One requires massive distortionary taxes, the other doesn’t.

    Second, you have no way of knowing how much the deposit insurance increased the value of bank assets.

    Third, where is your evidence that the deposit insurance subsidy in Spain is a much larger share of GDP than in Ireland. Because if it isn’t, your argument falls flat.

    As far as bubbles are concerned, all I can do is repeat the line that these anti-bubble theories are pure speculation, with no pragmatic value.

  54. Gravatar of 123 – TheMoneyDemand Blog 123 - TheMoneyDemand Blog
    18. December 2010 at 06:16

    Scott, You said:
    “Third, where is your evidence that the deposit insurance subsidy in Spain is a much larger share of GDP than in Ireland. Because if it isn’t, your argument falls flat.”

    The main piece of evidence is the relative price of Spanish and German bonds. Another piece of evidence is a very different bank regulatory regime in Spain and Ireland. Ireland has made the losses of real estate investments explicit, thus easing the load on the deposit insurance scheme, this has not happened in Spain.

    You said:
    “This comment makes no sense, a deposit insurance subsidy is completely unrelated to a bailout. One requires massive distortionary taxes, the other doesn’t.”
    Both the regular bailout and the hidden “extend and pretend” bailout via the lax deposit insurance regime will require massive distortionary taxes in the future. Fear of such taxes is an important determinant of poor economic outlook in Ireland and Spain.

  55. Gravatar of ssumner ssumner
    18. December 2010 at 10:46

    123, You said;

    “The main piece of evidence is the relative price of Spanish and German bonds. Another piece of evidence is a very different bank regulatory regime in Spain and Ireland. Ireland has made the losses of real estate investments explicit, thus easing the load on the deposit insurance scheme, this has not happened in Spain.”

    That’s not even close to being evidence. Spanish bonds are worth more than Irish bonds, but less than German bonds. So what? What does that tell us about deposit insurance? Absolutely nothing unless I am missing something. Lots of things influence bond prices.

    And your second argument is completely beside the point unless you can show that the deposit insurance losses in Spain will be far higher than in Ireland. And I don’t see any data to back that up. The fact that Spanish bonds are worth far more than Irish bonds suggests that the markets agree with me about Spain.

  56. Gravatar of 日銀がインフレを起こそうとしていない更なる証拠 by Scott Sumner – 道草 日銀がインフレを起こそうとしていない更なる証拠 by Scott Sumner – 道草
    22. December 2010 at 08:30

    [...] by Scott Sumner // 原文はScott SumnerのMore evidence that the BOJ is not trying to create inflation(December 09th, [...]

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