Related posts

I didn’t have time to blog today, so here are some interesting posts that relate to issues I’ve been discussing.

James Hamilton on the implications of the oil spill:

I agree with Ed [Dolan] that intra-organizational incentives contributed to the problem in both cases, and that government policy allowed the firms that created the problems to pass some of the costs on to others in many details of the financial debacle. But I am less persuaded that limited liability explains BP’s decisions at the corporate level. The company’s market value has declined by over $75 billion since April. Here was an entity with more than just skin in the game and looking more than just flayed at the moment. And yet, the company opted not to invest $500,000 in a secondary acoustic shut-off switch, which is essentially required in Norway and Brazil, and which Royal Dutch Shell and France’s Total SA sometimes use even when not required. BP’s backup plans B, C, and D all seemed to come out of the playbook for dealing with the 1979 Ixtoc disaster— none of them worked that well there, either. So why did the company take such risks?

I think part of the answer, for both toxic assets and toxic oil, has to do with a kind of groupthink that can take over among the smart folks who are supposed to be evaluating these risks. It’s so hard to be the one raising the possibility that real estate prices could decline nationally by 25% when it’s never happened before and all the guys who say it won’t are making money hand over fist. And this interacts with the forces mentioned above. When the probability of spectacular failure appears remote, and moreover it hasn’t happened yet, it’s hard to set up incentives, whether you’re talking about a corporation or a regulatory body, in which the person who makes sure that the risks stay contained is the person who gets rewarded. When everyone around you starts thinking that nothing can go wrong, it’s hard for you not to do the same. It can become awfully lonely in those environments to try to be the voice of prudence.

And yet, prudent judgment is the thing I most desperately wish decision-makers had more of in these times of dazzling new technological capabilities.

That was the point I was trying to make, but Hamilton makes it much more eloquently.  Here is Ryan Avent:

After having a look at the Fed’s new Beige Book and at Ben Bernanke’s testimony to Congress, it’s impressive the extent to which the Fed acknowledges the economic headwinds facing the economy, only to basically repeat the forecast it’s been touting (with small nudges one way or another) for the past nine months””American economic growth of between 3% and 4% this year and next, settling down thereafter. I’m not sure if that’s reassuring or troubling.

The whole post is worth reading, but I’d like to comment on why I think the Fed’s view is troubling.  Given the current inflation rate of 1%, the Fed is essentially forecasting 4.5% NGDP growth as far as the eye can see.  That’s trend growth, if we assume that trend real GDP growth has fallen to 2.5% (a widely held view.)  OK, so what does trend NGDP growth mean?  It means the Fed is contributing nothing to the economic recovery.  AD expansion is at rates you’d expect if we were at full employment.  The entire recovery must be “financed” by below trend inflation.  Alternatively, by shifts in the SRAS curve due to wage and price cuts.  And recall that NGDP recently fell nearly 8% below trend.  Even if half that was a permanent real shock, surely with 9.7% unemployment there must be some slack?  Couldn’t the Fed just help us out a little bit?  A tiny bit?  Is there really nothing they can do?

Here is Tim Duy:

To summarize, the Fed believes we are facing another threat to demand, either via financial or real trade linkages, at a time when lending activity continues to fall, suggesting that monetary policy is too tight to begin with.  But the Fed stance is to believe that monetary policy is on the verge of being too loose, and, if anything, planning needs to be made to tighten policy.  At the same time, Fed policymakers also believe fiscal policy needs to turn toward tightening as well. Meanwhile, unemployment hovers just below 10%, nor is it expected to decline rapidly,  and inflation continues to trend downward.

All of which together suggests that the Fed’s policy stance is seriously out of whack with policymaker’s interpretation of actual and potential economic developments.  And I have trouble explaining the disconnect.

As I read Duy’s entire post, I tried to imagine what a Fed official might say in their defense.  Usually I can do that, even when reading something with which I disagree.  For instance, people often send me Krugman articles they object to.  Even when I agree with Krugman, I can usually imagine how he could defend his argument against a critique.  Tim Duy’s post seemed so persuasive that I can even imagine a credible counterargument.

Arnold Kling has some of his usual excellent posts on the housing crisis (here and here.)  I learned that my anti-Fannie and Freddie views are considered racist among some members of the liberal elite.  Ah yes, the racism accusation.  The McCarthyism of the left.  My reaction?  Only a left-wing  pinko commie would make that kind of accusation.

BTW, the McCarthy era was already ancient history by the time I was a teenager in 1970.  I have to think we are rapidly approaching the time when people who recklessly throw out the charge of “racism” will look just as silly as those who accuse Obama of being a communist.

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15 Responses to “Related posts”

  1. Gravatar of q q
    10. June 2010 at 20:05

    could you name one member of the “liberal elite” (whoever they are) who considers being anti fannie/freddie as racist?

    (i’m sure you can find one if you try hard enough — there are plenty of people who cry racism at the slightest thing — but this sort of thinking belongs to a small, powerless fringe who think almost everything that happens to disadvantages a minority group is racist.)

    (i can relate in a way: if my grandparents were still alive they would have been able to tell me whether the GSEs were good or bad for the Jews. i personally would never see it that way — or it would take a lot of direct evidence for me to think something was not “kosher”.)

  2. Gravatar of Ted Ted
    10. June 2010 at 21:25

    A few points.

    (i) I think there is an alternative hypothesis to “groupthink.” Humans are notoriously difficult at assessing and rationally planning for low probability events. Often times, at least in experimental settings, people will treat low probability events as zero and won’t even take modest actions to prevent them from happening since they are viewed as 0% likely to occur. It’s controversial among psychologists whether this should be a psychological bias of its own or if it’s just a sub-set of other biases, but suffice to say this is fairly well established. I wouldn’t expect executives to be much different.

    (ii) The Federal Reserve can do nothing, lest we go down the path of Zimbabwe!

    (iii) Of course it’s silly to call people racists for being against Fannie and Freddie (which I am). But, considering many conservative congressman (e.g. Michelle Bachmann) and pundits (e.g. Neil Cavuto) have blatantly said that lending to minorities through the CRA, Fannie, and Freddie “caused” the crisis they certainty aren’t helping to dissuade the racist charge. At a minimum these people are stupid if they don’t realize the obvious bad publicity that would come with charging “minorities” with the crisis.

  3. Gravatar of D. Thomas D. Thomas
    10. June 2010 at 21:43

    Yeah, that’s right. Zimbabwe.

    I thank the Lord every night that we have Bernanke in charge to save us from turning into another Zimbabwe.

  4. Gravatar of Doc Merlin Doc Merlin
    11. June 2010 at 02:30

    If fiscal policy has a multiplier smaller than one, but the fed thinks it is larger than one, then their policy will be excessively tight during periods of fiscal expansion.

  5. Gravatar of scott sumner scott sumner
    11. June 2010 at 04:22

    q, Here is Edmund Andrews:

    “Of all the canards that have been offered about the financial crisis, few are more repellant than the claim that the “real cause” of the mortgage meltdown was blacks and Hispanics.

    Oh, excuse me — did I just accuse someone of racism? Sorry. Proponents of the above actually blame the crisis on “government policy” to boost home-ownership among low-income families, who just happened to be disproportionately non-white and immigrant. Specifically, the Community Reinvestment Act “forced” banks to make bad loans to irresponsible borrowers, while Fannie Mae and Freddie Mac provided the financial torque by purchasing billions worth of subprime paper.”

    Arnold Kling provides the link. I’ve read a number of other similar accusations, but I don’t have them at my fingertips.

    Ted, Your first point makes sense as from an evolutionary perspective it would be wise to ignore low probability risks. But in a world of 6.8 billion people, those risks can’t be avoided

    Blaming the CRA is hardly the same as blaming minorities. First of all, only about 30% of poor Americans are black. Second, blacks aren’t to blame for the CRA, Congress is. And last time I looked Congress was 90% white. So it’s hardly racist to blame the CRA (and by implications Congress) for the crisis. Is it sensible? No. The CRA was a minor factor. But that charge isn’t a sign of racism, it is a sign of dogmatic anti-government libertarianism. There is a big difference.

    Here’s an analogy. I know lots of Americans who hate capitalism and voted for Obama. Does that make Obama a communist? Obviously not. Just because odious person X makes an argument, doesn’t make it a bad argument. In fact the CRA should be repealed, and F&F should be abolished.

    D. Thomas, Yeah, I’m not too worried about the Zimbabwe outcome–I’ll give credit to Bernanke for that.

    Doc Merlin, That’s a good point, and may be part of the problem.

  6. Gravatar of StatsGuy StatsGuy
    11. June 2010 at 06:04

    “It can become awfully lonely in those environments to try to be the voice of prudence.”

    This is true everywhere – academia too. Condorcet’s Theorem only works well when voices are less correlated. Reality rewards independent thought, but social reality does not.

    We often hear of the politically correct left; the right has it’s own brand of group-think.

    It doesn’t help that rational voices of prudence often find unwanted friends among the paranoid.

  7. Gravatar of ssumner ssumner
    11. June 2010 at 09:52

    Statsguy, Good point. I understand what it’s like to be in the minority.

  8. Gravatar of Ted Ted
    12. June 2010 at 06:54

    I was actually saying many conservatives aren’t helping when they blame the CRA, Fannie, and Freddie and in the same sentence blame the crisis on “minorities.” They are just asking for the racial connection to be made. If they just said CRA, Fannie, and Freddie “caused” the crisis no charge of racism would likely be launched. But when they immediately tag on that minorities caused the crisis (and they say minorities specifically caused it) by being given loans – then the racist charges are going to come up. I’m not saying the claims are valid (though I think it’s outrageous to blame minorities for the crisis), but it’s going to be said when you make statements like that.

  9. Gravatar of ssumner ssumner
    12. June 2010 at 08:21

    Ted, Conservatives will be accused of racism for saying the sky is blue. That’s just he way the world works. I’ve seen conservatives called racust for advocating tax cuts.

    I doubt many conservatives are so stupid as to blame minorities. They know minorities didn’t create Fannie and Freddie, they were a product of our corrupt political system.

  10. Gravatar of Mike Sandifer Mike Sandifer
    13. June 2010 at 05:46

    Much like the cases with the banks, I think the idea that corporations generally have incentives to avoid going out of business is at least somewhat oversold.

    While cognitive biases could certainly be part of the problem, need we even go far from basic microeconomics? As an example, how about the individual’s labor supply curve? I recall it being applied to hours worked, but if it’s the equivalent of the Yerkes-Dodson law in psychology, it can perhaps been seen as merely a slice of a more general principle.

    That is, that the more non-immediately contingent reinforcement received, the lower the performance along some number of several dimensions, including conscious effort.

    So, could this argue for pay caps, and if so, is it practical to try to apply them effciiently?

  11. Gravatar of ssumner ssumner
    13. June 2010 at 10:16

    Mike, All the biases you could identifiy get multiplied 10 fold with government bureaucrats. I think pay caps is a bad idea. Encourage more competition–remove barriers to entry. That’s the best way to keep pay in line.

    I don’t think BP is like big banks, as I don’t expect them to be bailed out.

  12. Gravatar of Mike Sandifer Mike Sandifer
    13. June 2010 at 15:38

    There seem to be some clear benefits to flexible salary caps, but perhaps more progressive income taxes could better address this issue. Of course, these would have to be synchronized on a global level,which may not be practical.

    As Krugman’s pointed out, we’ve had some economic success with much lower disparities in wealth and income and far higher income tax rates. This does not an argument for such policies make, but it at least demonstrates that we won’t fall apart if we play with these ideas.

    Those things said, I’m sure you have a vastly superior empirical data to refer to.

  13. Gravatar of ssumner ssumner
    14. June 2010 at 06:28

    Mike, I doubt whether those high tax rates did any good. I think there is a reason why almost all countries slashed their top rates in the 1980s, they realized the high MTRs were counterproductive. They don’t raise much revenue, and they lead to massive and wasteful tax avoidance.

    Krugman talks about the 90% rates of the 1950s, but actually the economy did much better in the 1964-73 period, than in the previous 20 years. The top rate was cut from 90% to 70% in 1964.

  14. Gravatar of Mike Sandifer Mike Sandifer
    14. June 2010 at 15:35

    I guess I should sum up by saying that the relatively quite recent advents of mass media and mega corporations within relatively free markets have led to hyper-distortions of social strata and accompanying wealth. They’ve allowed for the astronomical bidding up of compensation for people like Lindsay Lohan, Kobe Bryant, and any Goldman CEO.

    Surely, such wealth accumulation was impossible for people for most of our 200,000 year prehistory, and our treat-no-one-as-a-permanent-stranger nature further feeds such distortions, via the reverence for celebrities.

    Yet, that it’s natural to have markets determine compensation was drilled into my head by both of my liberal intro to macro and micro professors. I adopted this conclusion and had thought little about it for the last 14 years. It now occurs to me that some basic tenets of conventional economic thought might be wrong.

    There are clear examples of people who are driven to excel in their given occupations primarily by the love of the work they do. This doesn’t seem to the be case for most(they have vastly smaller salaries and show up to work anyway), but is certainly true of some academics, engineers, and artists. It certainly seems to have been true for sports stars, before free agency and huge television contracts. Should I really think that people like Neil Young primarly produce for the money, or that outlandish monetary compensation is required to recruit those who would seek corporate power? Are there not plenty of “natural” incentives for excellence?

    That our present system is superior to some of the aristocratic ones it replaced is beyond doubt, but is it the best we can do? Do we really know if some kind of flexible, but hard and fast compensation caps would make things worse, and if so, by even non-monetary metrics?

  15. Gravatar of ssumner ssumner
    15. June 2010 at 06:23

    Mike, If wealth is a big problem (and I don’t think it is) then progressive payroll taxes are the best response, not wage controls.

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