Another nail in the anti-EMH coffin

I generally don’t argue that the efficient markets hypothesis is true, rather I argue it is useful, and that anti-EMH theories are not useful.  I should say that I just focus on those anti-EMH theories that assert one can spot bubbles in real time, which imply one can predict markets (to some extent) over a longer period of time.  (Researchers like Rajiv Sethi analyze market inefficiency that doesn’t imply prediction.)

One famous argument against the “markets are predictable” anti-EMH view is that mutual funds that do well one year tend to do about average the next, indicating that it was more a question of luck then skill.  A popular retort is that the smart money isn’t managing mutual funds, which are an investment for suckers.  I don’t agree with this view, as successful stock picker Peter Lynch was highly beneficial to Fidelity Investments.  Mutual funds have an incentive to forecast well.   But let’s say I’m wrong.

A recent Boston Globe article sent to me by Miguel Barredo suggests that bubble forecasting success by economists is also pure luck:

That economist was New York University’s Nouriel Roubini. And since he called the Great Recession, he has become about as close to a household name as an economist can be without writing “Freakonomics” or being Paul Krugman. He’s been called a seer, been brought in to counsel heads of state and titans of industry “” the one guy who connected the dots while the rest of us were blithely taking out third mortgages and buying investment properties in Phoenix. He’s a sought-after source for journalists, a guest on talk shows, and has even acquired a nickname, Dr. Doom. With the effects of the Great Recession still being keenly felt, Roubini is everywhere.

But here’s another thing about him: For a prophet, he’s wrong an awful lot of the time. In October 2008, he predicted that hundreds of hedge funds were on the verge of failure and that the government would have to close the markets for a week or two in the coming days to cope with the shock. That didn’t happen. In January 2009, he predicted that oil prices would stay below $40 for all of 2009, arguing that car companies should rev up production of gas-guzzling SUVs. By the end of the year, oil was a hair under $80, Hummer was on its way out, and automakers were tripping over themselves to develop electric cars. In March 2009, he predicted the S&P 500 would fall below 600 that year. It closed at over 1,115, up 23.5 percent year over year, the biggest single year gain since 2003.  . . .

But are such people really better at predicting the future than anyone else? In October of last year, Oxford economist Jerker Denrell cut directly to the heart of this question. Working with Christina Fang of New York University, Denrell dug through the data from The Wall Street Journal’s Survey of Economic Forecasts, an effort conducted every six months, in which roughly 50 economists are asked to make macroeconomic predictions about gross national product, unemployment, inflation, and so on. They wanted to see if the economists who successfully called the most unexpected events, like our Dr. Doom, had better records over the long term than those who didn’t.

To find the answer, Denrell and Fang took predictions from July 2002 to July 2005, and calculated which economists had the best record of correctly predicting “extreme” outcomes, defined for the study as either 20 percent higher or 20 percent lower than the average prediction. They compared those to figures on the economists’ overall accuracy. What they found was striking. Economists who had a better record at calling extreme events had a worse record in general. “The analyst with the largest number as well as the highest proportion of accurate and extreme forecasts,” they wrote, “had, by far, the worst forecasting record.” . . .

Their work is the latest in a long line of research dismantling the notion that predictions are really worth anything. The most notable work in the field is “Expert Political Judgment” by Philip Tetlock of the University of Pennsylvania. Tetlock analyzed more than 80,000 political predictions ventured by supposed experts over two decades to see how well they fared as a group. The answer: badly. The experts did about as well as chance. And the more in-demand the expert, the bolder, and thus the less accurate, the predictions. Research by a handful of others, Denrell included, suggests the same goes for economic forecasters. An accurate prediction “” of an extreme event or even a series of nonextreme ones “” can beget overconfidence, which can lead to making bolder and bolder bets, and thus, more and more errors.

So it has gone with Roubini. That one big call about the Great Recession gave him an unrivaled platform from which to issue ever more predictions, and a grand job title to match his prominence, but his subsequent predictions suggest that his foresight may be no better than your average man on the street. The curious nature of his fame calls to mind two of economist Edgar Fiedler’s wry rules for economic forecasters: “If you must forecast, forecast often,” he wrote. And: “If you’re ever right, never let ’em forget it.”

There’s no great, complex explanation for why people who get one big thing right get most everything else wrong, argues Denrell. It’s simple: Those who correctly predict extreme events tend to have a greater tendency to make extreme predictions; and those who make extreme predictions tend to spend most of the time being wrong “” on account of most of their predictions being, well, pretty extreme. There are few occurrences so out of the ordinary that someone, somewhere won’t have seen them coming, even if that person has seldom been right about anything else.

But that leads to a more disconcerting question: If this is true, why do we put so much stock in expert forecasters? In a saner world than ours, those who listen to forecasters would take into account all their incorrect predictions before making a judgment. But real life doesn’t work that way. The reason is known in lab parlance as “base rate neglect.” And what it means, essentially, is that when we try to predict what’s next, or determine whether to believe a prediction, we often rely too heavily on information close at hand (a recent correct prediction, a new piece of data, a hunch) and ignore the “base rate” (the overall percentage of blown calls and failures).

And success, as Denrell revealed in an earlier study, is an especially bad teacher. In 2003 he published a paper arguing that when people study success stories exclusively “” as many avid devourers of business self-help books do “” they come away with a vastly oversimplified idea of what it takes to succeed. This is because success is what economists refer to as a “noisy signal.” It’s chancy, fickle, and composed of so many moving parts that any one is basically meaningless in the context of the real world. By studying what successful ventures have in common (persistence, for instance), people miss the invaluable lessons contained in the far more common experience of failure. They ignore the high likelihood that a company will flop “” the base rate “” and wind up wildly overestimating the chances of success.

To look at Denrell’s work is to realize the extent to which our judgment can be warped by our bias toward success, even when failure is statistically the default setting for human endeavor. We want to believe success is more probable than it is, that it’s the result of a process we can wrap our heads around. That’s why we’re drawn to prophets, especially the ones who get one big thing right. We want to believe that someone, somewhere can foresee surprising and disruptive change. It means that there is a method to the madness of not just business, but human existence, and that it’s perceptible if you look at it from the right angle. It’s why we take lucky rabbits’ feet into casinos instead of putting our money in a CD, why we quit steady jobs to start risky small businesses. On paper, these too may indeed resemble sucker bets placed by people with bad judgment. But cast in a certain light, they begin to look a lot like hope.




47 Responses to “Another nail in the anti-EMH coffin”

  1. Gravatar of Jason Jason
    15. January 2011 at 14:57

    I’ve always wanted to try to understand the visceral reaction to the EMH, negative or positive. I do think the letters EMH do signal particular economic loyalties, but I think there is something deeper.

    The EMH does seem useful — if you are trying to predict the market you should always check back to the EMH and realize you are probably wrong.

    But the EMH is not a theorem, so too strong an emphasis has a thought terminating cliche quality — you can’t predict the market so why even try? But what if you could? Or at least derive probabilities? Say a certain amount of leverage increases the probability of a bubble from 5% to 30%. The reaction would be to pull back some on the leverage. And if a significant collapse happens during a time when the probability is 30%, it doesn’t mean it was definitely a bubble and the leverage level definitely caused it, but you coul mitigate them without knowing for sure.

    Sure economics is a human endeavor, but elections can be given good odds based on economic conditions. And we’ve known that for a long time. It hasn’t changed anything. People still seem to behave as if elections could come out the other way with a large probability.

    ps There is a model by Bouchaud and Mezard that links income inequality to market volatility, so it might be in the interest of the top 1% to cause bubbles to form and collapse — making their wealth share rise relative to everyone else. So we’d have a mechanism for bubbles to occur despite knowing about them keeping us in line with the EMH.

  2. Gravatar of ssumner ssumner
    15. January 2011 at 15:09

    Jason, I mostly agree, except that last part about income inequality. The income distribution data is almost meaningless, for all sorts of reasons. One reason is that it includes capital gains, and lumps them in with labor income. That makes no sense. So economic inequality looks worse when there is a stock market boom, but that inequality actually occurs because the data isn’t measuring what people assume it measures.

  3. Gravatar of Indy Indy
    15. January 2011 at 15:38

    But then there’s this and this from Calculated Risk. Money Quotes:

    “I offer one more piece of evidence that I think almost surely suggests that the end is near in this sector. While channel-surfing the other night, to the annoyance of my otherwise very patient wife, I came across a new television series on the Discovery Channel entitled ‘Flip That House,'” economist David Stockton said, prompting a roomful of laughter according to the transcript. “As far as I could tell, the gist of the show was that with some spackling, a few strategically placed azaleas and access to a bank, you too could tap into the great real-estate wealth machine. It was enough to put even the most ardent believer in market efficiency into existential crisis. [Laughter]”

    I like that EMF-faith and existential crisis line.


    “[T]there is the housing situation, which we talked about for a long time yesterday afternoon. As I’ve been reporting for several meetings, some of our markets, especially those in coastal areas of South Florida and the Florida panhandle, are experiencing a level of building activity and price increases that are clearly, in my view, unsustainable. Nearly every major Florida city now has experienced increases in the double-digit range, and some, like Miami, Palm Beach, Sarasota, and West Palm, have been reporting increases in housing prices on a year-over-year basis of between 25 and 30 percent. While our discussion yesterday did not seem to indicate a consensus on a national housing bubble, based on past experience I’m reasonably comfortable characterizing the housing feeding frenzy in some of our markets as being a bubble or a near bubble.

    For example, the number of major projects planned or under construction in Miami now totals 114, most of which are high-rise developments. That includes 61,000 condo units””eight times the number that were built in the last decade””and a total of 100,000 new parking spaces. I know we don’t have any process for introducing exhibits into the record, but I’d like to pass Dave Stockton this pictorial of the new projects in Miami, so that he can continue to worry a little bit along with me. [Laughter]

    My supervision and regulation staff thinks this is an accident waiting to happen in our area. And while the local market excesses probably do not represent systemic national risk, the shakeouts could have serious regional consequences. My bank supervision staff points out that housing-related credit risks to our bank lenders are not so much from defaults on permanent mortgage financing that we talked about yesterday, but rather from lending for land acquisition, development, and construction. The ugly picture we have seen before””and that they think we may very likely see again before long””goes something like this: the drying up of sales of new units; the painful decision of developers to go ahead and complete the construction of additional units to make them saleable, further depressing the market; and speculators who had hoped to see big capital gains walking away or defaulting on their contracts, giving their properties back to the lender. Perhaps it’s because of where I sit, but I am less comforted than some of my colleagues about the housing situation. …

    CHAIRMAN GREENSPAN. Let’s take a break for coffee.”

    Let’s say they didn’t take a break, believed him, and wanted to respond. What should the Fed have done at this point? Anything? Nothing?

    Now, when Fed President Jack Guynn makes this statement, he is saying something like “it seems to me there is something awfully bizarre going on in this market, based on deviation from usual trends, that doesn’t seem to me to be sensible and sustainable and has the potential to cause great harm.”

    Is he talking nonsense or not? If there’s no reliable way to spot bubbles – then it’s nonsense, right? “Don’t worry about it”. It seems not to be nonsense to me. It seems like his “bubble spotting” logic seems sound (though I am biased by hindsight, obviously).

    My hunch is that the EMH and Bubble-spotting are not mutually exclusive at all – which I think has to mean that a large number of players can simultaneously believe the market is overpriced and will eventually collapse, and yet still agree to participate and buy in the market, thinking they can get in and out riding an upward trend of new debt issuance before the last fool defaults on his first mortgage payment and that big pop happens.

    Meanwhile, long-term short-position players have the problem, if they are institutional and have to mark-to-market, of being out-of-the-money and having low ability to borrow using their positions as collateral for a long, indefinite period.

    Like I said, it’s just a hunch – but I think we can have both – EMH and real bubbles with real bubble-spotting but short-term focused market behavior that rationally continues to inflate the bubble. Is my claim unsound?

  4. Gravatar of Dirk Dirk
    15. January 2011 at 17:18

    Why is it the anti-EMH people seem to come out of the woodwork right after the market has done something incredibly surprising, only to argue that we should have seen this coming?

  5. Gravatar of Ted Ted
    15. January 2011 at 18:23

    I think it’s fairly obvious the EMH is wrong. There is evidence of deviations and we have really good theoretical reasons to believe that it is wrong. Computer scientists have known for a while that the complexity of arbitrage in betting games is NP-Hard. It’s believed by just about anyone (though it hasn’t been proven) that P doesn’t equal NP, so arbitrage in betting games is highly unlikely to be solvable in polynomial time – so the EMH is highly unlikely to be true.

    But that’s a separate question from if it’s an effective, useful theories. Take the idea of gravity. Newtonian gravity is a highly successful and useful theory. However, it has been displaced by General Relativity. Imagine, instead, Einstein didn’t propose any theory. Instead if Einstein just said, yeah, sure, Newtonian gravity is great for the overwhelming majority of the time – and it’s right for all practical uses 95% of the time – but it’s wrong sometimes for whatever reason. Let’s even say Einstein said, Newtonian gravity probably won’t work for Mercury and Mars. And then it doesn’t work for Mercury (but works for Mars) and Einstein went “Ha, look I proved Newtonian gravity was wrong!,” though was completely unable to explain why it worked for Mars and every planet in our solar system except Mercury – oh, and, of course, he never acknowledges he was wrong about Mars on top of that.

    Well, that wouldn’t be particularly useful. In fact, it would be worthless for practical purposes. Saying the EMH is wrong without proposing an alternative theory – or, for that matter, even an explanation for when it is wrong and why – that’s completely useless. The EMH, while most certainty wrong, is a decent and highly effective approximation to reality. Considering there is no other more effective approximation, we must resign ourself to the EMH. Now, we should work on developing such effective alternatives and I hope in my lifetime the EMH will be replaced, but, for now, it’s what works.

    Also, these bubble theories and predications aren’t even theories or predications. Yes, there are mathematically coherent bubble theories, but they are empirically unverifiable as we have no reliable, empirically sound methodology to test for the existence of a bubble (in fact, if we did – could we really have a bubble of any any real magnitude? Discovery of a technique would seem to eliminate the bubble itself). So, these aren’t scientific theories. Furthermore, there is no observation that could disprove these bubble theories further questioning their usefulness. Secondly, these predictions are just guesses. These were not done by mathematical, statistical, or technical analysis. They were driven by arbitrary sentiment, just like those who thought we didn’t have a bubble.

    By the way, I’ve actually lost faith in the idea that 2005 house prices were so massively overvalued. Prices are about where they were in 2004. While, at the same time, we are seeing massive foreclosures, high unemployment, and low growth. Something tells me the bubble was much smaller than we think it was.

  6. Gravatar of David Pearson David Pearson
    15. January 2011 at 18:32


    I agree with your EMH views. However, I think there is a better way to frame the question of what role predictions should have in policy making.

    Policy should not be about point estimates, but about taking action to improve welfare in light of the potential risks. Take bank regulation, for example. Most policy makers argued well into 2007 that the banking system was “well capitalized” and that banks had “ample liquidity”. What they were really saying was, “given what we know about the sub-prime crisis, let’s not force banks to issue more equity or pay up for term financing. To do so would unnecessarily reduce the wealth of bank shareholders, and the gain to society would be very small.” This view relied not on an incorrect point estimate, but on a blind appraisal of the risks. Had they listened to well-reasoned predictions about the true state of the banking system, they could have, for instance, forced Lehman to reduce reliance on overnight repo financing starting right after the Bear Stearns failure.

    You can believe in EMH and still think that well reasoned predictions can help policy making. In fact, you engage in this process yourself by saying that too-tight money today can have consequences that policy makers do not fully appreciate.

  7. Gravatar of Indy Indy
    15. January 2011 at 19:13

    @Ted, you said, “By the way, I’ve actually lost faith in the idea that 2005 house prices were so massively overvalued. Prices are about where they were in 2004. While, at the same time, we are seeing massive foreclosures, high unemployment, and low growth. Something tells me the bubble was much smaller than we think it was.”

    All real estate is local – so it depends on the location. Some, like Dallas and Denver, have been relatively untouched. Others have been smashed.

    Here’s the Miami situation about which the Fed President was commenting. That’s a big, um, “stunning-and-rapid-increase-and-decrease-shape” whether you want to call it a “bubble” or not. I could do worse and show you some Las Vegas and other charts that nearly tripled in five years but are now down over 50% from peak.

    By mid-2005, prices and activity in the most frenzied markets has risen sufficiently that the “housing bubble” meme was already starting to spread, The Fed, obviously, was talking about it, Calculated Risk made his famous call, and the discussion expanded to the extent that the WSJ started publishing a series of articles trying to knock it down.

    I remember reading plenty of people writing something to the effect of “Don’t worry, remember, the markets know what they’re doing.” The question remains – was that a legitimate thing to say? Or, I’ll put it differently – is it a more or less legitimate statement than the Fed’s president’s (and his staff’s) concern that one ought to be worried, regardless of what the market said?

    I won’t say that the EMH isn’t useful – but the problem is that it gets *over* used – giving people confidence and lulling regulators into insouciant passivity when that is not, as far as I understand, the kind of behavior the EMH justifies.

  8. Gravatar of Morgan Warstler Morgan Warstler
    15. January 2011 at 19:39

    The problem with egghead discussion about EMH is that to thieving liberals, what is really being discussed is whether it is all luck or not, because in their world if it is “luck” then they can go steal it.

    At issue however is that eggheads are a lesser specie than those who actually do things for a living, and if we simply repeat this in a deep awe filled baritone:

    “there is luck (randomness) in everything, but some poker players appear to be very lucky.”

    We set the thieves back on their heels, and we can have an intellectual discussion about EMH without there being any meaningful anti-capitalist effect from the discussion.

    Think of it as offering a burnt offering to JoJoBa, a way to shoo the liberals from the discussion.

    It is the shear complexity of things that means we must leave all decisions to the property owning agents and let the cards fall where they may.

  9. Gravatar of Benjamin Cole Benjamin Cole
    15. January 2011 at 20:12

    I like the digression into success as a poor teacher. A military that wins usually does not change tactics the next time around. The Spabish Armada comes to mind.

    In defeat (or setbacks) one learns more. Thanks to this mechanism, I am deeply, deeply learned man at this point. It’s amazing how much I keep learning.

  10. Gravatar of Rien Huizer Rien Huizer
    15. January 2011 at 21:57

    As someone who has practised his belief that the EMH in some form or another was plausible I have spent a lot of my employer’s resources on examining cases where some entrepreneurial spirit believed that the EMH did not apply or that he found a way to beat it that would recover the transaction costs, capital, supervision etc. We found many situations where market inperfections exist but very few that could be exploited by non-insiders (roughly speaking).

    This makes one wonder about two things (1) the enormous volume of financial assets entrusted to managers with doctrines, styles, strategies or what have you that implicitly deny the EMH in areas where many academics consider it applicable: how irrational are the principals who not only waste their transaction costs but also incur risk-adjusted opportunity losses? (2) assuming that most hedge funds have a sizeable portion of the manager’s money at risk along with the investors and many of those managers have graduated from institutions where the EMH rules, and have worked in firms where equity partners discourage stupidity with the firm’s own money, what do they do to beat the EMH? Or don’t they (I mean beyond the little that we know about hedge fund performance) and what do they do to attract investors? Probably the investors are looking at the same things as the Roubini-groupies. But then, the hedgies themselves risk their money in the same way. It does not make sense, it must be economics..

  11. Gravatar of Mike Sandifer Mike Sandifer
    16. January 2011 at 00:46

    I find it interesting that a theory that claims markets are efficient also implies the market’s mostly full of idiots, but nonetheless, depends on those idiots being idiots for the theory to be true.

  12. Gravatar of anon anon
    16. January 2011 at 05:15

    “I should say that I just focus on those anti-EMH theories that assert one can spot bubbles in real time, which imply one can predict markets (to some extent) over a longer period of time.”

    The possibility of bubbles does not actually contradict the EMH.

    A “bubble” is a pattern where the price of an asset rises following an exponential curve until it collapses at some unpredictable point. Bubbles in this sense can be detected fairly easily, since the expectation of “exponential growth and sudden collapse” will be reflected in derivative markets (such as options) on the original security.

    This pattern can arise in an “efficient” market (with some caveats: for instance, prices for the asset must be unbounded, which is a fairly unrealistic assumption). In the real world, the market is fairly efficient, but limits on arbitrage can definitely allow bubbles to occur.

    The catch is that in a “true” bubble there is no real winning strategy: riding the bubble can be a win or lose big, betting against it requires posting increasing margins as price rises, and staying out of the market entirely may forfeit an expected positive return.

    As an example, see e.g. the options markets in energy commodities in 2005-2008, which correctly forecast the possibility that a bubble would pop. Prices stayed high only because of concerns that future prices could spike even higher.

  13. Gravatar of W. Peden W. Peden
    16. January 2011 at 05:53

    Mike Sandifier,

    One can compare it with Hayek’s whole economic epistemology: we’re all ignorant of the vast majority of important information, but that doesn’t matter, because the market is a system that doesn’t require any one individual to have more than a fraction of the important information at any one time.

    If we had to depend on markets being full of geniuses or people in general possessing huge quantities of information, we’d be sunk.

  14. Gravatar of Morgan Warstler Morgan Warstler
    16. January 2011 at 07:31


    The one eyed man is king. And it is never smart to half-blind him to make things more even.

    The far more rational case for libertarianism is based on the idea that every human has a unique background that give him unique insights – incremental / marginal knowledge over others, and that by combining a bit more knowledge of X and a bit more knowledge of Y (invention is the combination of concepts) – he ALWAYS can make improvements for everyone else in the status quo.

    The “always” is the great equalizer, because all people have at their disposal unique knowledge in multiple subjects that they can combine and invent improvements to the market.

    Imagine the SlapChop is invented by a drunkard with the perfect pitch to say, “you are gonna love my nuts.”

    And since everyone has the ability to improve the world based on their background, and we define improving the world by one’s ability to bring something to the market that others simply must have….

    The real question is why we aren’t angrier at all these people who never go out of their way to invent something to improve our lot for us.

    Ok, that’s not exactly the real question, but it puts us in the mind to answer why those people don’t have more claim on those that do.

  15. Gravatar of OGT OGT
    16. January 2011 at 08:16

    As long as we are talking weak form EMH, roulette wheel markets, EMH is probably relatively unassailable. But it does not suppose that ‘bubbles’ in the form of extreme volatility with possible negative social welfare ramifications can’t take place.

    So, I would put it this way, weak form EMH is probably true, but it is dangerous because it often leads to the cognitive illusion that markets are ‘right’ and leads to a lessening of critical thought in non-market players. Sumner appears to slip into this illusion occasionally, especially when the market movements appear to support is monetary theories. (In a recent post he half-jokingly claimed that perhaps, EMH wasn’t right because interest rate movements didn’t follow his predictions!) In that case, I do not think ‘efficient’ means what you think it means.

    And, of course, even if Calculated Risk’s Bill Ritter(?) and Roubini were lucky, they were right. Greenspan and Bernanke following the correct theory misapplied it and let it lead to intellectual laziness and lack of curiosity.

    When homes in Arizona and Nevada, states with few supply restrictions, are selling for 30 times rental income with no income no money down loans, the correct response it not ‘the market knows best.’ “It is WTF?”

    I’ve read Sumner long enough to predict that he may respond by pointing to his advocacy of 20% loans. And that is fine, as long as one realizes that that is contrary to a Greenspan, the price is right approach, because one must assume that either the lender or borrower needs supervision.

  16. Gravatar of Mike Sandifer Mike Sandifer
    16. January 2011 at 13:04

    Peden and Morgan,

    Well, first that comment from me was mostly just what I saw as a quip for its own sake. Scientifically, I accept that something like semi-strong EMH can be true, and I’ve even seen people like Shiller, as a skeptic, make a strong case for it. I’ve stated before that a discussion like this is pointless, given that EMH adherents and non-adherent investors need each other. Of course, there must be arbitrage opportunities, even if relatively hard to spot and/or short-lived.

  17. Gravatar of Jim Rose Jim Rose
    16. January 2011 at 17:42

    The most sensible test is revealed preference!

    Ask the critics of EMH whether their own retirement savings portfolio is diversified or not? ask whether this savings portfolio is trying to beat the market or track the market?

    are critics of the EMH putting their money where their mouth is?

  18. Gravatar of ISLM ISLM
    16. January 2011 at 17:52

    Grossman and Stiglitz. 1987 Black Monday. Scott Sumner. Please rank.

  19. Gravatar of ISLM ISLM
    16. January 2011 at 17:52

    And you can throw in Zingles for fun.

  20. Gravatar of scott sumner scott sumner
    16. January 2011 at 18:09

    Indy, No, I don’t see how you can have bubbles and the EMH.

    You could find the same sort of housing comments in Australia 5 years ago, and they would have been totally wrong. It’s just confirmation bias, as the study I provided shows.

    Roubini seemed like he knew what he was talking about (and I used to say lots of good things about him), but now we know he was just a permi-bear who got lucky.

    Dirk, Exactly my view.

    Ted, My views exactly, And don’t forget that no one in 2005 knew the Fed would allow NGDP to fall 8% below trend. Imagine where house prices would be today if NGDP had kept growing at 5%.

    David Pearson, I agree, and have advocated much higher capital requirements. Unfortunately the bankers seem to own the policymakers.

    Morgan, Who’s Jojoba?

    Benjamin, Yes, I’ve also learned a lot that way.

    Rien, Ironically, the very foolishness that causes many to buy non-indexed funds also makes markets more efficient. It finances the salaries of lots of people who seek out information on undervalued stocks.

    Mike, Yes, that was pretty much my reply to Rien.

    anon, I don’t agree that bubbles are consistent with the EMH, because I don’t believe that prices are unbounded.

    Greenspan has nothing to do with the EMH, and shouldn’t even be in the discussion. Like Roubini, he developed a great reputation for all the wrong reasons. Nevada and Arizona did have important building restrictions in the boom years, Texas did not. That explains a lot of the price difference. I did a post on that about a year ago.

    It’s obvious Roubini just got lucky, so I see absolutely no reason to give him any credit. If you are a bear 100% of the time, then obviously you will look smart when things go really bad.

    ISLM, I’m not quite sure your point about 1987, but it is an interesting case that supports my view. It doesn’t seem consistent with the EMH, suggesting the EMH is not true. It has led to zero useful anti-EMH theories, strongly supporting my argument.

  21. Gravatar of scott sumner scott sumner
    16. January 2011 at 18:12

    Jim Rose, I read that Roubini remained fully invested in 2008. Is that right?

  22. Gravatar of Morgan Warstler Morgan Warstler
    16. January 2011 at 18:18

    “Ted, My views exactly, And don’t forget that no one in 2005 knew the Fed would allow NGDP to fall 8% below trend. Imagine where house prices would be today if NGDP had kept growing at 5%.”

    Imagine where food and gas prices would be!

  23. Gravatar of Leigh Caldwell Leigh Caldwell
    16. January 2011 at 18:34

    I read yesterday that Roubini has recently predicted “if things go well, global GDP growth in 2011 may reach 4%”.

    The most up-to-date global GDP growth estimate I could find for 2010? 3.9%.

    Maybe he has learned something from making too many extreme predictions.

  24. Gravatar of Mattias Mattias
    17. January 2011 at 01:55

    Roubini and Krugman also said in early 2009 that the US government must take over several big banks like we did in Sweden in the early 90s (which we by the way didn’t do, but why check a good story?).

    Roubini was so negative that even some pop Austrians started to like him, and that says a lot.

  25. Gravatar of Mattias Mattias
    17. January 2011 at 05:33

    A tip: Philip Tetlock gave a seminar for the Long Now Foundation which is available as a podcast at

    When I listened to this a few months ago I also made the connection with the perma bears who got one big call right and now are considered gurus. One of the really interesting things about Tetlock’s research is that expert who were wrong rarely seemed to learn from their mistakes.

  26. Gravatar of e e
    17. January 2011 at 09:49

    The fact that he remained in stocks through 08 and just bought a huge apartment really should be a knockout of Roubini, but for some reason pointing it out is considered a bit of a low blow. Its kind of amazing that a guy can have his publicly offering the housing market 20% lower while simultaneously buying a house and be taken seriously. I also thought he predicted a dollar crisis not deflation, am I getting him confused with someone else?

  27. Gravatar of David Pearson David Pearson
    17. January 2011 at 09:58


    BTW, there may be a small kernel of anti-EMH views at the core of your thinking.

    The question is, did you know something the market didn’t in 2008? For instance, why didn’t the S&P crash in August of 2008, when it was clear (in Fed Funds futures implied probabilities) that the Fed would not loosen in its September meeting? Why was the Vix (S&P implied volatility) trading at the low end of its one-year range then? Could you have used your knowledge to buy volatility (puts) and make a killing? If not, are you saying the market had efficient volatility expectations? This is the same thing as saying no one could have known the Fed was way too tight and NGDP was in fact “crashing”. But you did.

  28. Gravatar of Doc Merlin Doc Merlin
    17. January 2011 at 11:01

    David makes a good point.

  29. Gravatar of Mike Sandifer Mike Sandifer
    17. January 2011 at 11:30

    “The problem with egghead discussion about EMH is that to thieving liberals, what is really being discussed is whether it is all luck or not, because in their world if it is “luck” then they can go steal it.”

    Morgan, that’s an interesting point of view, but some of us liberals don’t mind if it’s considered stealing.

    Our morality is obviously very different. Theft from the wealthy is a far lesser crime in my mind than sitting on billions of dollars while tens of millions here go without even basic healthcare. And adding that some of these billionaires are happy to push for continuing merely paying capital gains and dividends tax rates at less than half the top rate on ordinary income, yet want government benefit cuts for poor and middle class Americans is nothing short of vile.

    You can go on supporting Sheriff of Nottingham tax policies, but you’ll only get so far with them. There’s a reason most consider Robin Hood a hero.

    The latter is a sort of innate morality written into our genes.

    I think I’ll stick with the like-minded like Buffett, Gates, and Turner who explain they have quite enough advantages in life and have demonstrated their compassion with historic donations of wealth, both relatively and absolutely.

  30. Gravatar of Morgan Warstler Morgan Warstler
    17. January 2011 at 13:20

    You see there Scott? This is why I don’t you earn the QE you argue for… if you really wanted it, Mike would be pissed off your were screaming we should gut public employee pensions, so you can print more money. Maybe you’d like to remind him you are fond of Singapore!

    “I think I’ll stick with the like-minded like Buffett, Gates, and Turner who explain they have quite enough advantages in life and have demonstrated their compassion with historic donations of wealth, both relatively and absolutely.”

    Uh yeah, rent-seekers all. When you are winning at chess, you willing to trade pawns, it increase your relative advantage. All those boys would love to trade pawns. What matters is the opinion of the top 2% of SMBs that generate 50% of smallbiz profits – from that pool all new job growth comes.

    And Mike, I advocate all kind of GOV2.0 approaches to providing services. Google “Soup Kitchen Care” or just read my stuff at Big Government. Hell, if you gave me a new kind of tax-free capital gains exclusively for SMB owner profits, I’d help you go molest BuffetGatesTurner.

    It is easy to thread the needle for guys like you. Just get you what you say you want “single payer public option” – but do it so you don’t get what you really want – to be the boss.

    Now, it’s grand that you say you are willing to steal from the rich, BECAUSE you immediately morally justify any and all devious efforts to stymie you.

    The main one (the long game) is what has happened since 1980, as the GOP has sought to spend every last available dime to bankrupt the system – just so Dems can never deliver a new benefit to their constituents. You’ll see Obamacare rolled back, you’ll probably hear lots more about Birthright Citizenship, its a very ugly future. OR, you liberals can accept a Balance Budget Amendment and then fight year in year out on Guns vs. Butter.

    Small nations know they have to follow the rules, to have any hope of getting the big guys to follow them as well.

    And your side Mike are the little guys. And frankly you should have far more faith that if you kiss the ass of the SMB / Tea Party crowd, raise them up, sing their praises; together you can put the banksters and Fortune 1000 crowd back the box long term.

    You’re betting on the wrong team there, Robin Hood, and its killing the economy.

  31. Gravatar of Jim Rose Jim Rose
    17. January 2011 at 14:04


    I do not have an answer to your very good question.

    For academics, it may be easier to test their true anti-EMH commitment as they have pension funds to which they must contribute but in the US they have limited choices on investment strategies.

    Where I am in New Zealand, there is full discretion over investment strategies for individual retirement savings made by employees and employers. Somewhat the same in Australia.

    Tyler Cowen and others recently blogged about the need for more ethics and conflict of interest disclosures by economists when pontificating on policy.

    Perhaps these ethics disclosures should extend to their savings portfolio strategies?

    BTW, I wonder how many Austrian economists pursue a buy and hold diversified portfolio strategy? I do.

  32. Gravatar of Mike Sandifer Mike Sandifer
    17. January 2011 at 14:10


    First, I favor QE, and we should replace government pensions with competitive salaries.

    And I’ve never stated I’ve wanted a public option. I have no idea where that claim comes from. I’ve long preferred High Deductible Health Plans, with HSAs and FSAs, with required coverage, no exclusions, and subsidized deductibles for the poor. It’s a more free market system than Obamacare and I was sold on it years ago when some companies, such as Safeway, moved to these plans.

    And on Obamacare, it’s hard to see how it gets rolled back during the next two years, and then opponents of the plan will be faced with trying to junk a plan that’s begun providing tens of millions with benefits.

    I can buy what you say about the Republican long game, but in the end liberals will win. The conservatives and extremist libertarians risk a socialist backlash unlike that seen for decades.

    Eventually, even people like Joe the Plumber will want to start receiving more benefits, as his dreams of becoming affluent running his own plumbing business begin to die even in his eyes. And maybe one day Democrats will start to teach people that Medicare is a government program, so that they’re not yelling at government representatives to keep their hands off it.

    With respect to a balanced budget amendment, little could be more ridiculous. I can’t think of an entity of any kind in better financial shape than the US government. If the average US family has for many decades successfully handled a mortgage at 3x or more of income, along with auto loan payments, credit card bills, and student loans in some cases, why should we be concerned with a gross debt still shy of annual GDP? Even in the present circumstances, the overwhelming majority of families are meeting their debt obligations. And the government can tax the largest tax base in the world and use monetary policy.

    The debt fears are way overblown, and politically most people don’t know what the deficit or debt even are, much less how much of a problem they may be. They only believe the stories the media tells, and conservatives have been dominating the message for some time now. I suspect that an economically successful liberal president could push deficit concerns aside.

    And anyway, with productivity growth, we can afford more socialism, ceteris paribus.

    Besides, if you happen to want lower deficits or debt, you should consider pragmatically voting for Democratic presidents. Haven’t they done better on these issues than Republicans, going back decades? How’d you like Bill Clinton? Do you think Carter was more fiscally responsible than Reagan, along with appointing the Fed chair that finally squashed inflation?

    Again, liberals will win in the long run. We keep winning on most social issues, and eventually people will want to go spending more of the wealthy’s money. This will be true as long as human nature is what it is.

  33. Gravatar of Morgan Warstler Morgan Warstler
    17. January 2011 at 15:54

    See there Mike, all the important stuff went right by you.

    Job growth ONLY comes from one place, from the top 2% of SMBs. I liken it to college ball. None of them are mere high schoolers (that’s the bottom 98% of SMBs) – and we don’t know yet which of them are going pro. But since any of them could go big time, we should take that entire crowd and treat them better than we treat anyone in the economy.

    The folks involved in these SMBs are routinely involved in multiple (often local) projects – and our current tax code forces them to treat all their profits as income.

    Instead they should be free to take the smallest salary they will live with, pay tax on that, and move money freely from one SMB to another new one.

    Nothing could more quickly force the Fortune 1000 to spend the money they are sitting on, then tripling th number of piranha in the water chewing into their hides.

    It makes no sense to look at capital gains from investors (or worse real estate investors) as something different from what SMB owners do.

    And while we’re at it, we ought to tax all luxury perks in the corporate space (from bizclass to fine dining) as personal consumption and taxable as income.


    So glad you buy into HSAs, that makes you not a liberal. The group most aggressive in campaigning against them are the unions…. once someone’s got $30K in a HSA account, thyey don’t care much about gold plated medical.

    But, I have no clue why if you really get HSAs you wouldn’t want to see how real price shopping shakes out before you go after a mutant of federally mandated rentseeking coverage.

    And you missed my point, since 1980 (and forever in the future), Dems will only get to be President when it is time to cut spending – end welfare as we know it, etc. So, the BBA is your new best friend.

  34. Gravatar of scott sumner scott sumner
    17. January 2011 at 19:30

    Morgan, I wish those prices were up there.

    Leigh, Yes, maybe he’s tired of being wrong. I made a small fortune in the past 20 months by do exactly the opposite of what he recommended.

    Mattias, Yes, that’s probably right. I’ll try to watch that sometime.

    e, The stock investments seem worse than housing, because there can be complicated reasons why someone might not want to sell a house. But stocks are pretty liquid.

    David, That’s a good question and I don’t know the full answer, but here’s the best I can do. As I recall stocks were already far below the 2007 peaks by August 2008. So I think they had priced in a mild recession, and some risk of further financial problems. But they still didn’t realize the economy would plunge sharply, that this would make the financial crisis much worse, and that this would cause a further plunge, and that the Fed would not act aggressively enough to prop up NGDP expectations during the fall. In hindsight it does look like the oncoming disaster should have been foreseeable (as it should have been but wasn’t in 1929) but at the time I don’t recall expecting a severe recession, just a mild one.

    Next time the exact same set of events occur I’ll be ready!! But then next time the exact same set of events occur the Fed will act more aggressively. Forecasting is hard. 🙂

    Morgan, I’ve already had post calling for abolishing all taxes on capital, and yet Mike still comes back here for monetary policy posts. That show’s he has an open mind, which I think is a good quality.

    Jim, I don’t follow my own advice, I’m heavily over-weighted in Asia. I figure life’s too short to not have some fun taking chances. So far it’s worked out well, although there were times (1997) when I thought I was crazy.

    I don’t think we have enough influence where we’d need to list our investments, but I would have no objection. Indeed I just did–mostly Asia funds, plus US index funds.

  35. Gravatar of Mike Sandifer Mike Sandifer
    17. January 2011 at 22:26


    Several years ago an economist convinced me that the best tax system is based on consumption taxes. Get the biggest economic pie, and then redistribute toward the bottom as needed.

    I’m in no way against having the private markets do what they show they do best, and sufficiently. But, there’s no reason to believe the private market will meet all of the needs of the less fortunate, so government has a definite role to play.

    This doesn’t have to be government as it’s been in the past. We can pay federal employees competitive wages to get the best and brightest. We can base pay upon performance metrics. We can privatize, but do so wisely by making sure we appoint first rate managers to oversee all privatized efforts to ensure efficient performance, with bonuses as rewards.

    I do want more distribution of income under the current tax system, but of course it’d be far better to replace it. As things stand now, I just want those in need to get help now.

  36. Gravatar of anon anon
    18. January 2011 at 05:47

    “Several years ago an economist convinced me that the best tax system is based on consumption taxes. Get the biggest economic pie, and then redistribute toward the bottom as needed.”

    This is quite OT, but taxes should also fall on socially harmful activity, extraction of exhaustible resources (because property rights are uncertain, so resource owners extract more than is socially optimal) and the ground-rent component of real estate. Probably some others as well that I forgot about.

  37. Gravatar of Doc Merlin Doc Merlin
    18. January 2011 at 06:02

    ‘This is quite OT, but taxes should also fall on socially harmful activity, extraction of exhaustible resources (because property rights are uncertain, so resource owners extract more than is socially optimal) and the ground-rent component of real estate. Probably some others as well that I forgot about.’

    Wouldn’t taxing extraction of exhaustible resources count as making their property rights more uncertain by adding future-tax-rate uncertainty to ownership uncertainty?

  38. Gravatar of Doc Merlin Doc Merlin
    18. January 2011 at 06:15

    @Jim Rose
    ‘BTW, I wonder how many Austrian economists pursue a buy and hold diversified portfolio strategy? I do.’

    Hrm, buy and hold is a really bad long term strategy, as many have shown, empirically. You want buy+occasionally readjust. A good example of this is compare the companies in the DJIA over the last 4 decades to the dollar value of a basket of cap-weighted set of companies making up DJIA from 4 decades ago. The index consistently beats the basket, because bad companies leave the index and goods companies are added to it.

  39. Gravatar of anon anon
    18. January 2011 at 07:26

    “Wouldn’t taxing extraction of exhaustible resources count as making their property rights more uncertain”

    Looks like a second order effect to me, especially given that severance taxes exist already, at both state and federal level. But my main point is that proposals to “base the whole tax system on X” are overly simplistic. For instance, we all know that corporate taxes are stupid and inefficient–except that a sizable fraction of corporate taxes falls on rent from land, natural resources, spectrum rights etc. and is capitalized in the value of firm-specific assets! So corporate taxation is at least partially efficient, and shifting away from it might well hinder economic performance unless corrective action is taken.

  40. Gravatar of Morgan Warstler Morgan Warstler
    18. January 2011 at 10:15


    I have one issue off the bat.

    You can’t have the best and brightest. You can price to get a nice collection in middle… but unless you will pay Federal Employees based on their ability to automate and grow productivity (fire people)…. then the kind of salaries the best and brightest command are simply outside the boundaries of public service.

    Until then, you’ll just have to help us decimate the Public Employee Unions. That means 401K, SS, and HSAs for EVERYONE.

    I actually think a campaign of this type from within the progressive left would win over a huge swath of Independents and folks who call themselves Libertarians / Republicans.

    F,S & L public employee compensation in 98: $918B
    F,S & L public employee compensation in 10: $1.7T

    That’s $500B per year OVER inflation.

    Repeat that with me, “$500B over inflation.”

    When you get us back that $500B ANNUALLY we can talk about what else gets cut, you’ll be back on the morally righteous side, until then it is platitudes.

    It’s rough road for your team, that smartest play is turn on the unions and fire with everything you got, because if the first cuts save the most expensive older slowest people (like GM) in government, your productivity will tumble and people will hate government even more.

  41. Gravatar of scott sumner scott sumner
    18. January 2011 at 15:27

    anon, I agree about taxing land and externalities.

  42. Gravatar of Mike Sandifer Mike Sandifer
    18. January 2011 at 15:34


    I favor doing what we can to get rid of unions and actually pay results-oriented, competitive wages and bonuses. Not only might this increase the efficiency of government, but could also help reduce things like regulatory capture, in which some regulators ordinarily might be swayed by possible future private sector job opportunities with regulated entities. Going further by disallowing regulators from working in sectors they once regulated could help too.

    And it comes to winning over independents, most of these fools will support anything that looks like success. If the economy’s good, they will put up with a great deal that goes wrong. Look how long it took voters to turn on W. He was a disaster from the moment he was born.

    Where do you get your numbers on public employee pay? Even if they’re true, so what? What’s a bit under $42 billion dollars in what is now a nearly $15 trillion dollar economy? Do people really have to act like such misers in the wealthiest country in the history of the world, by far? It’s not enough of a real cost to even mention.

    Yes, it’s a tough road for my team, but only because we don’t have the right players.

  43. Gravatar of Morgan Warstler Morgan Warstler
    18. January 2011 at 19:31

    Mike, from the BLS. Line 86:

    $500B PER YEAR (not $42BN) is near what we spend on SS or Medicare. It’s 4x the size of yearly Iraq war spending.

    So what? Don’t be disgusting. It makes you not the right player for your team.

    Public employees were paid just fine in 1998, if it grew with inflation it’d be $1.2 in 2010… And we’d have NO Budget deficit to speak of. That was categorically

    You can’t be a Keynesian, if you can’t claw back that $500BN. Even if we’re going to print to inflate their gains away… then you have to advocate a brutal freeze, in order to PROVE you deserve the printing.

  44. Gravatar of Mike Sandifer Mike Sandifer
    18. January 2011 at 21:02


    $500 billion/year? Hmmm, that’s about 3.3 percent of GDP. Who cares? Do you want to but your grandma’s Social Security check and/or her medical benefits?

    Military spending over half the federal budget at over $900 billion. Our military spending is around 50% of the world total, and nearly as much as every other country’s in the world, combined. I think we can cut a lot there.

  45. Gravatar of Mike Sandifer Mike Sandifer
    18. January 2011 at 21:03

    “cut” grandma’s check, that is

  46. Gravatar of e e
    21. January 2011 at 16:04

    whoops i didnt see your reply, well i hope I havent missed my chance but I would agree with you if he didnt sell a house, but I think he actually bought one in which case the liquidity issues are on my side. But even if you don’t agree with me I would say doing both and making the public predictions he has made cannot be rational. I’m just a little frustrated with people claiming to have predicted bubbles saying they saw a billion dollars on the ground but didnt bother to pick it up. Or in Roubini’s case didn’t bother to not throw away additional money.

  47. Gravatar of scott sumner scott sumner
    22. January 2011 at 07:12

    e, Yes, if he bought one that’s worse.

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