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Showing posts from March, 2009

The economics of economics blogging, part 1

Today: consumer perceptions of value in blog postings, and its relation to the evolution of judgment.
I have noticed recently a lot of blog posts which set out basically to shoot down other bloggers. I'm sure you share my lack of surprise at this phenomenon: it's been a staple of Internet debate for decades.
Could this be because economists (or people in general) are just disagreeable? Or is it because these postings serve a real or perceived consumer demand for conflict?
A minor tangent: Such a demand, if it exists, might arise from an evolutionary or learned response to the marginal value of information. A single new item of knowledge which acts towards confirmation of existing data is probably less valuable than one which contradicts it. This would be explained by an effect of diminishing marginal authority of data in each direction.
Let's say that Paul Krugman says the stimulus is too small. You may, for the sake of argument, infer that there's a 50% chance the stimulu…

(Ir)rational protectionism

Paul Mason points out that world trade (more precisely exports from the developed world) is down by 40% on an annualised basis.
We can imagine rational reasons for people to trade less with each other - for example an increased desire for saving reduces the resources available to devote to the slightly risky activity of exchanging with distant parties. But what appears at first sight not to be rational is the distinction between local and foreign trade.
Trade within the UK, for example, is certainly not down by 40%. Of course the idea of "trade" within a country is not a very well-defined concept - one could perhaps look at interstate trade in the US, but I assume that such data is not collected comprehensively. But if we generalise to the idea of economic exchange in general, then GDP is essentially the measure we are looking for. And GDP, of course, has not fallen by 40% or anywhere close.
So why has international trade fallen so much more? There are several proximate reasons…

Zeitgeist analysis, 29 March 2009

Oh, you fickle economists.

Bored with AIG already? It's fallen 129 places from number 7 to number 136 in this week's word cloud.
The theme of the week? Plan is up 75 to 17 and Geithner up 218 places to 72. Asset and assets are up 106 and 53 places respectively, with toxic up 683 places and FDIC 436. Loan is up 237, bonds up 175, paper up 43 and purchase up 168 places.
At the top of the charts, one, new and financial remain in the top three places, with market up two to 4 and government and US both down one place to 5 and 6.
Banks is up 8 places to 7, banking and bank also rise substantially (also bankruptcy); currency is up 246 places and dollar and dollars both rise a few dozen positions, though money is down six places to number 14 and bill down 135 places into the 300s, with cash also falling slightly (but green jumping 477 places).
Crisis, capital, risk and investment are all up and policy, public, federal and Washington all down.
Larger movements include sales, up 230 to 61, lo…

Dunfermline Building Society - irrational incentives?

Robert Peston reports that Dunfermline Building Society is going to be taken over by Nationwide, and asks "why Dunfermline took such risks that ultimately cost the society its independence".
Here's an article with a bit more detail about the story and what happened.
I haven't been able to find out whether management were incentivised with highly leveraged short-term bonuses, but given that this is a Scottish building society, the obvious assumption is that they were not.
So why would they take such huge risks?
The answer surely is that they did not knowingly do so; but that they felt a pressure to chase profits and closed their eyes to the risk that usually goes with high returns. The pursuit of high profits is ingrained in the behaviour of managers even without financial incentives.
This could be seen as a social pressure to keep up with the next guy; a psychological pressure to be the alpha male; or a boundedly rational economic decision based on an inaccurate estimate …

The economics zeitgeist, 29 March 2009

Image
This is a word cloud from all economics blog postings in the last week. I generate this every Sunday so please subscribe using the links on the right if you'd like to be notified each time it is published.

It has been constructed from a list of economics RSS feeds from the Palgrave Econolog and other sources, and uses Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data.
You can also see the Java version in the Wordle gallery.

If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch.
Update: Analysis of this week's trends now out.

Economic predictions from a theory of mind

Mark Thoma reports Robert Shiller's article on the psychology of the asset bubble and bust, and asks "how to implement this forecasting technique - one based upon a theory of the mind".
I have been working in this area for some time and can suggest the following as a possible framework. I don't know if Shiller has something like this in mind - I suspect not - but I do think it will be a step in the direction that he calls for. Note that this is not yet a fully developed model, but a proposal for how such a model might look.
While standard economic theory deals with a set of goods, I propose instead that there are a set of concepts in the world. We can imagine some of these as corresponding directly to traditional goods - for example the concept of a loaf of bread or an economics PhD. These concepts are mental constructs and not physical ones; they represent the relationship of a person in this model to the ideas of bread or PhDs.

Next, let us define concepts which repre…

A behavioural theory of money

If you have clicked onto this article just from reading the title, then I may disappoint you slightly. I am not (yet) going to propound a behavioural theory of money, though I think there's one coming in the future.
But I will point to a couple of results which may indicate where to get one. The first is a quote from John Moore and Nobu Kiyotaki of LSE, in the beautifully titled lecture Evil Is The Root Of All Money. "Money is the medium of exchange.

Notice that for this argument to hold together, there has to be a set of mutually-sustaining beliefs, stretching off to infinity. I was willing to hold money yesterday because I believed the dentist would accept it today. She is willing to hold money today because she believes someone else will accept it tomorrow. And so on. If there were a known end-point to history, the entire structure of beliefs would collapse back from the end." This, as they point out, is the conventional view among microeconomists about the existence of m…

Back to equilibrium?

A very reassuring sign from Barclays and the FSA (via Robert Peston) today - the FSA's evaluation that Barclays will not need to raise new capital or buy the Treasury's asset insurance (though it can voluntarily do so if it wishes).
Of course this is good news for Barclays itself and a good sign for the financial system. But it also heralds a more subtle improvement in the economic firmament: the possibility of a return to an equilibrium market in finance.
Over the last 18 months, contagion has ruled the markets. Any financial institution in danger created a concern for the viability of all others. When Lehman failed, lots of other banks (and insurers such as AIG) all suffered because they were trading with it. When there was even a sniff that Citigroup, or HBOS, or other banks might go under, everyone else suffered too.
This is not how normal markets work. If Alitalia were to collapse, Air France, British Airways and Ryanair would all benefit. If one of your local pubs closes do…

Waiting for a delayed plan

Paul Krugman this afternoon is, intentionally or not, "waiting for a delayed plan at O'Hare". Perhaps his flight is on Geithn Air? (sorry)
While waiting, he discusses Eichengreen and Temin's paper about the "gold mentality". I strongly agree that the gold standard, equated by some "not just with prosperity, but with morality, decency, civilization itself" is a dangerous thing; and it's a symptom of a wider illusion.
Those who fetishize the manufacturing sector and say a service-based economy is "hollowed-out"; those who say gold is the only real currency and fiat money is a fraud; those who think everything needs to be manufactured within the borders of their own country (but presumably don't take that to its logical conclusion, by operating a car factory, iron mine and arable farm inside their own house) - these people are suffering from a delusion about what reality consists of.
If they think that only physical objects are real an…

Search theory and business investment

I visited a networking group yesterday which brings entrepreneurs and investors together to try and matchmake them.
At the end we had a conversation about how to make the group work best. One of the persistent concerns about investment networking events is that each investor just stands there while a hundred entrepreneurs swarm over them, trying to get their money.
This is unmanageable for the investor and doesn't serve the entrepreneurs very well either. Most of them get nothing and it is so competitive that those who might get an offer, get screwed down on terms.
What's more, the facades that people (particularly entrepreneurs) erect make the search for worthwhile matches difficult. Even though investors will nearly always get to the truth before providing and money, the results of search theory mean that they will have to spend more time, and will find worse matches, than if the entrepreneurs were honest (although there may be behavioural phenomena that counter this - back to …

The Apprentice series 5: episode 1

And finally: See you all next week (you can of course stick around and read my normal blog in between). Subscribe using the links on the right if you want to be updated with new articles every day.
Serious irrationality count this week: only 2. Surprising. I will keep a closer watch next time.
10:32 I am really not going to blog the whole of Newsnight just to wait for Raef to come on. You can watch that yourself.
10:30 The highlight of the last half hour (apart from Anita's new slimline figure): a trailer for The Wire, starting next Monday. If you've never seen it, you must watch. I can recommend the Guardian organgrinder blog (home of the infamous Anna Pickard) for lots of discussion of it. But watch the show first.
10:29 A very un-economic programme, You're Fired, relying on assertion and jokes to make most of its points with no numbers and no incentives to make the right choices. I think we need to rely on the real show for the hard-edged decisions.
10:28 Anita's little …

Live blogging: The Apprentice

As regular readers know, one of the subjects of this blog is what is it to be rational: understanding how people's real behaviour departs from traditional economic notions of rationality.
And as regular viewers know, there's nowhere else you'll see the displays of irrationality that show up on The Apprentice every week (for US and other overseas readers, the British edition of the show is starting tonight).
So I'm going to give a running commentary on The Apprentice each episode, to point out where the contestants are irrational, to show where Sir Alan is, and to highlight ways in which an understanding of irrational behaviour would enhance the teams' chances of winning the tasks. And I'll try and have a bit of fun too. Nearly everyone on the programme is eminently mockable.
Come back at 9 pm and reload every few minutes to see the latest comments. Please post your own responses too or email leigh@inon.com with your input. Let me know if it's not for publicati…

Is bad news for the Treasury good for the private sector?

An intriguing post from Robert Peston raising the spectre of the Treasury failing to sell all the bonds it wanted to sell yesterday.
Is this, as he implies, plain bad news for the government because their funding is getting more expensive?
Or is it good news for private lenders - implying that investors are fed up with their "flight to quality" and are now considering private sector investments instead?
The answer is dependent on two further questions: is investors' money switching to foreign investments, UK private lending or UK equities?
are investors actually running out of money to invest - the infamous savings trap, where people in aggregate try to increase their savings but fail to do so, because the attempt to save reduces total income in the economy and available savings are reduced too?Hopefully we can find out. How could we figure it out? by looking at total UK savings this month - this is not an exact science but we should hopefully be able to see if the trends are …

Lemons followup

I promised more on the lemons discussion but Sandro Brusco has gone into more depth in this posting than I could have done in the time I had available yesterday.
There's some way to go in analysing this, but Brusco has a couple of important points:
The first is that the problem will only be solved by revealing information. He suggests doing this by requiring managers to make a personal investment in the assets, so they have an incentive to get the valuation right. As an alternative, I would consider simply publishing the detail of the assets so that third parties can look at what they consist of and make their own determination of value. Depending on the level of detail, this may raise privacy concerns for the original mortgage borrowers, so it won't be possible to publish absolutely everything. But I'm sure a lot could be released.
The second is that the banking system can't function normally until this information is revealed, so it's critical to get it done soon. T…

Lemons and toxic assets

Following up Geithner versus Darling by Robert Peston:
There are three reasons why the assets held by banks (loans to weak borrowers, packaged in whatever way) might not be worth very much:The borrowers really can't (or won't) pay them backThere is not enough liquidity so the banks can't sell themThere is a "lemon" discount based on asymmetric information[Updated] Buyers or sellers of the assets are somehow irrational. I don't analyse this option in the article below but will try to work out for a future article whether it is a major factor. I am trying not to suggest a bounded rationality explanation for everything in the world!
There is a huge argument going on about which of these is the real answer - because it has a bearing on which kind of bank rescue plan we should implement.
If the answer is number 1, then the banks have screwed up and we may not want to throw more good money after bad by buying the loans. If the answer is number 2, we should be happy to…

Links for 23 March 2009

I don't often do link lists but they seem to be quite the thing for bloggers. Here's one:
Tim Harford's article in Forbes about what credit does to our brains.
A clear and simple model showing one way to think about toxic bank assets from Mark ThomaThe US is following the UK again: the administration has a plan to improve small business access to credit, just like Alistair Darling; a guest post on Econbrowser has some interesting microeconomic analysis of the rationale.Nick Rowe is always good value: here is a discussion of how liquidity can be factored into the value of a financial (or other) asset.A very nice summary (PDF) from Tyler Cowen of different definitions of rationality used in economics (somewhat technical, so you'll need a bit of economics vocabulary, but not much mathematics)That will do for now. Given the results of this week's zeitgeist, perhaps I should include something about AIG. But I find it difficult to care.

State assets and the importance of being earnest

Robert Peston's column today got me thinking on a tangent.
If the state incurs liabilities (let's say while rescuing banks), there are a few ways it can pay them off.
One is by selling assets that it acquires along with the liabilities. For example, if it acquires a 70% stake in Royal Bank of Scotland, it can sell it into the private sector for (let's say) £20 billion. This might offset some or all of the liabilities it has covered.
Another is by increasing taxes. In one sense, this is exactly the same as selling assets: it takes money from the private sector into the public sector. The difference is in the distribution. When selling assets, the money comes from those people who choose to buy the assets. When taxing, the money can come from whoever you like.
A third is by walking away. After all, the state's liabilities are unenforceable except by the state itself. Thus the state can simply ignore its liabilities (as Argentina did a few years ago, and most developed econom…