Statements that make no sense
Frank McCormick sent me a couple of interesting NYT columns. First one on inflation:
The Fed, in a break from its historic focus on suppressing inflation, has tried since the financial crisis to keep prices rising about 2 percent a year. Some Fed officials cite the slower pace of inflation as a reason, alongside reducing unemployment, to continue the central bank’s stimulus campaign.
Critics, including Professor Rogoff, say the Fed is being much too meek.
This makes me want to pull my hair out. The Fed adopts a policy that it expects to produce 2% inflation. The policy fails, inflation comes in below 2%. And Fed officials respond by saying we ought to continue the same failed policy!?!?!?! Can someone explain that to me? Even worse, the Fed officials that disagree want an even lower inflation rate!
I’ll give Rogoff credit; at least he understands that policy needs to be more expansionary. But 6% inflation is also a horrible idea. We shouldn’t target inflation at all. If we had targeted NGDP growth at 5% over the past 4 years we’d be out of recession by now and inflation would have averaged about 2%. Is that too much to ask of the Fed? Apparently so.
Here’s the second article, by Robert Shiller:
But the [EMH] theory is commonly thought, at least by enthusiasts, to imply much more. Notably, it has been argued that regular movements in the markets reflect a wisdom that transcends the best understanding of even the top professionals, and that it is hopeless for an ordinary mortal, even with a lifetime of work and preparation, to question pricing. Market prices are esteemed as if they were oracles.
This view grew to dominate much professional thinking in economics, and its implications are dangerous. It is a substantial reason for the economic crisis we have been stuck in for the past five years, for it led authorities in the United States and elsewhere to be complacent about asset mispricing, about growing leverage in financial markets and about the instability of the global system. In fact, markets are not perfect, and really need regulation, much more than Professor Fama’s theories would allow.
This makes absolutely no sense at all. If the implication is that we need regulation because banks take too much risk, then even Fama would agree. The banking market is distorted by government-created moral hazard, and hence banks will take too much risk if they behave in the interests of their shareholders. But that has nothing to do with the EMH.
If Shiller is claiming that we need more regulation because banks will become irrationally exuberant about MBSs, and hold too many in their portfolio because they don’t understands they are irrationally priced, and that $90,000/year Federal bureaucrats need to visit the Wall Street banks and tell million dollar a year bankers that they are making irrational and foolish decisions, well then . . . I’m speechless.
Perhaps Shiller is assuming that the relevant federal regulatory agency is composed of 100 John Paulsons. But can you attract those people on Federal pay scales? Isn’t it more likely we end up with the bozos at the SEC who missed the Madoff scandal, even after they were told about it, because they didn’t understand that theory predicts that Madoff’s consistently high and stable returns were almost impossible? Oh wait, that would imply regulators need to rely more heavily on the EMH.
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27. October 2013 at 06:36
No response to the criticism of “treating market prices as though they are oracles, transcending the best understanding of even the top professionals”, I see. That’s kind of the assumption behind this blog.
27. October 2013 at 06:40
It is a bit strange how rarely the moral hazard point is raised in recent popular/journalistic economics articles. The orthodox monetary theorists/historians widely consider (a) the Fed to have departed from the received wisdom of last-resort lending and (b) moral hazard, rather than animal spirits, explains a significant portion of the crisis narrative. I understand technical economic issues rarely make their way into the popular press, but given the consensus in the money and banking subfields, it seems surprising that it isn’t being talked about more (except in outlets of a certain ideological persuasion).
27. October 2013 at 07:00
“(T)reating market prices as though they are oracles” is not a problem with “answers” the oracles give, it is a problem with the “questions” we (think we) are asking the oracle. (“A great empire will fall…”)
27. October 2013 at 07:20
It’s all government…..right.
http://www.youtube.com/watch?v=1bX_vhojH8c
27. October 2013 at 07:35
I get that financial markets may have feedback effects. What I don’t get is the notion that regulators would be immune. One of the problems is that regulation tends to be pro-cyclical rather than counter-cyclical precisely because they aren’t.
Hmm, maybe there is an idea somewhere in there that there is not much in the way of reliable, persistent, unused information …
27. October 2013 at 08:18
Isn’t it more likely we end up with the bozos at the SEC who missed the Madoff scandal, even after they were told about it…
And who actually dropped their resumes off in Madoff’s office!
…because they didn’t understand that theory predicts that Madoff’s consistently high and stable returns were almost impossible? Oh wait, that would imply regulators need to rely more heavily on the EMH.
27. October 2013 at 08:27
“I’ll give Rogoff credit; at least he understands that policy needs to be more expansionary.”
Policy needs to be laissez-faire. You don’t know if policy itself is too tight or too loose. You’re not omniscient.
27. October 2013 at 08:28
Sharing Nobel Honors, and Agreeing to Disagree
When Myrdal and Hayek shared their prize, did they get to write pieces in the Times shooting at each other? I’d have enjoyed reading that.
An economist friend sent me this, attributing it to Charles Evans:
“Fama won the Nobel Prize for showing that financial markets are efficient. Shiller won for showing that they are inefficient. Hansen won for creating the econometric tools that allowed them to reach their conclusions.”
27. October 2013 at 08:32
“If we had targeted NGDP growth at 5% over the past 4 years we’d be out of recession by now and inflation would have averaged about 2%.”
If we had abolished the central bank, we would be out of recession by now and inflation would be an outcome of individual subjective preferences put into action through the market process. The statistic itself would be irrelevant to the health of the economy.
“The banking market is distorted by government-created moral hazard, and hence banks will take to much risk if they behave in the interests of their shareholders.”
NGDPLT would create a moral hazard as well, because whenever there is a possible fall in total spending, only the banks will receive an influx of instant purchasing power. This will benefit them according to us observing the banks choosing to sell treasuries and other securities to the Fed, instead of holding onto them, or selling them in the private market only. As a result, the banks can receive an influx of money by choosing to reduce their rate of credit expansion. That would put downward pressure on total spending. The larger, more politically connected banks can easily bring about more inflation from the Fed by agreeing to reduce lending to the private market.
27. October 2013 at 08:54
Saturos, Yes, that’s wrong too.
Alex. I agree.
Jim, That’s amusing. I was disappointed to see Shiller so dismissive of Fama’s EMH.
27. October 2013 at 11:53
Prof Summers, since you are a man who is working for far less money than his true worth (and what great teacher isn’t) because you hold values deeper than your paycheck, I am surprised at your pot shot at government professionals, which I have no doubt was unintended. They work for relatively low pay for many of the same reasons you do. I think the SEC is awful, but it’s largely due to regulatory/political capture.
27. October 2013 at 12:40
First, monatarily asphxiate the economy…then watch real estate go into bear market…then say EMH is crazy and add layers of regulation…keep money tight
27. October 2013 at 16:12
‘They work for relatively low pay for many of the same reasons you do. ‘
If govt. employees work for such low pay, why are there so many applicants who’d love to have those jobs?
27. October 2013 at 17:13
Does Shiller not realise that if his criticism of EMH was valid, then it would already have been quickly monetized by the financial services industry and arbitraged away? Lots of people monetized the EMH approach.
Actually, in a funny way, Shiller is his own best proof. It is incredibly arrogant to think you can second guess the weighted average of millions of investors, but as Shiller points out many people are a lot more arrogant than they should be (for their own good).
The thing I least like about Shiller is that he is giving false hope to many people who are over confident in their abilities (or worse, perpetuation a financial industry scam – “Nobel Professor says we are able to beat the market!”). Also, he is encouraging those meddlers in the Government who like to try to “improve” market outcomes . We all know what happens with that approach. Really I wish everyone would be a lot more humble about decisions involving others.
27. October 2013 at 18:54
Well, Shiller just won a Nobel for arguing there isn’t enough evidence to treat markets as oracles, so unless you know more…
27. October 2013 at 19:08
The lead examiners at the big banks make a lot more than 90k, although still a lot less than the bankers do.
27. October 2013 at 20:42
Scott,
On the subject of regulating wall street:
I grew up around these people, and I have worked among them my whole life and I will tell you this: Wall street attracts a lot of high IQ sociopaths !
I have worked alongside people who , I am convinced, would have commited murder if they thought they would A: not get caught and B: get a bigger place in Nantucket!
I get your point, just look at the failure of the ratings agencies in ’05 ’06, bamboozled by quants and Armani clad smooth talkers. But really Scott, these guys need to be watched by someone,somehow.
P.S. You chose John Paulson as an example of wall street smarts. My hero in this biz is a guy in Westport CT. called Ray Dalio. He’s not a household name, but he’s the real deal! A brilliant guy who has done a lot of good for a lot of people over a very long time horizon.
28. October 2013 at 05:22
maynard, Yes, unintended.
Chris, Yes, his track record in recent years has not been good.
Saturos, A Nobel he deserved.
Andy, I’m always out of date on salaries, check out my “reactionary” post.
I get confused because liberals tell me that government bureaucrats are not highly paid, and liberals tell me that people in the top 10% are rich.
Paul, You are confusing two types of regulation. One is aimed at preventing fraud, which we all support. But this post was concerned with regulations trying to protect bankers from their own stupidity. As you say they are very smart, and hence I don’t think that sort of regulation will work.
28. October 2013 at 07:28
“The banking market is distorted by government-created moral hazard, and hence banks will take too much risk if they behave in the interests of their shareholders.”
Gary Gorton contends moral hazard is deliberate and necessary for the banking system. The only way that the liabilities of different banks can always trade at par is by suppressing information that would allow invidious comparisons. No FDIC and no moral hazard and bank liabilities would have to trade trade at discounts.
He notes that while in the free banking era the market in banknotes was efficient, the result for the market in products purchased with banknotes was made cumbersome by the need to know and apply all the necessary discounts.
It’s clear Bernanke knew this stuff from things like TALF and stress tests – right out of the 1900s banking playbook. Just replace the clearinghouse with the Fed.
http://papers.nber.org/tmp/8080-w19540.pdf
courtesy of the estimable Izabella Kaminska
http://ftalphaville.ft.com/2013/10/28/1679132/gortons-battle-of-light-and-dark-money/
28. October 2013 at 09:52
This quote is funny. “The Fed, in a break from its historic focus on suppressing inflation, has tried since the financial crisis to keep prices rising about 2 percent a year.”
To say that the Fed focuses on suppressing inflation is like saying that a steel factory focuses on suppressing the creation of steel. Only the Fed is in charge of creating money. If they were really focused on suppressing inflation, they could cease making asset purchases forever and you would never see inflation again.
28. October 2013 at 09:57
ChrisA,
Great comment. Schiller is very guilty of the fatal conceit as Hayek calls it. If academics really knew more than markets, they could all make fabulous amounts of money in their portfolios and would be some of the richest people on the planet.
28. October 2013 at 11:28
“If Shiller is claiming that we need more regulation because banks will become irrationally exuberant about MBSs, and hold too many in their portfolio because they don’t understands they are irrationally priced”
I suspect that if asked, Shiller would cite problems of agency and incentive. Banks make their profit by using OPM Other Peoples Money. Given a way keep the profits and offload the losses, they will.
Even the top people at Lehman and Bear Stearns aren’t exactly starving.
“From 2000 through 2007, Fuld took home as much as $529 million from his Lehman job. That includes his salary and cash bonuses, as well as the Lehman shares granted him by the company that he sold before the bankruptcy in September 2008.”
Say you were offered $5 million a year for 10 years, but there was a 1 in 25 chance in any given year you would lose half of your cumulative earnings and be unemployed would you take the job?
28. October 2013 at 11:29
Schiller’s political views are really quite bizarre to me. There are, I think, some very important conclusions that we can draw from his empirical work and also some very important conclusions to draw from his theory, if you think his story is more persuasive than Fama’s. The bizarre part is that I don’t see how you can conclude from his academic work that the government should have done something about the housing bubble or that it would have prevented the recession.
28. October 2013 at 14:38
There is nothing nonsensical to me in thinking that a 90,0000 per year bureacrat (whose income does not depend on the value of a bank asset) having a better view of that asset’s valuation than a 1,000,000 per year bnaker whose income does depend on its (high) valuation.