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Showing posts from July, 2009

Panic! No wait...don't panic

Robert Peston writes an entertaining, slightly scary, story about BT's pension liabilities.
But is this anything to worry about? Not really. He makes a few points that sound striking, but under closer examination are utterly unsurprising.
...in an economic sense, BT's current and future pensioners own this totemic business. True, but any business is "owned" both by its creditors and its shareholders. The creditors always have to be paid off first before the shareholders have clear title to the company's assets. And in most large, old companies, pensioners are among the biggest creditors. Look at General Motors, which has just handed over a majority stake in itself to its pensioners (via their union, the UAW).
To put this £8bn chasm in its pension-scheme into an appropriate context, the entire market value of the company is less than £10bn.Also true, but meaningless. The pension deficit - like any other debt that BT has - is already factored into its market value.
If y…

Buzz about behavioural finance

Lots of behavioural finance conversations going on on the blogs today and yesterday.Chris Dillow of Stumbling and Mumbing replies to my proposal for governments to take into account cognitive bias while regulating.Simon Johnson of Baseline Scenario responds to a debate between Richard Thaler and Richard Posner about financial regulation.Alex Tabarrok from Marginal Revolution highlights the difficulty of fighting asset bubbles, even if you have overcome the challenge of identifying them.Kenneth Arrow (via Conor Clarke of The Atlantic) argues that behavioural economics doesn't predict anything.Update: A friend points out this letter in the FT from John Maule calling for behavioural approaches to be used more in regulation and investment decisions.I'd love to have time to engage in depth with all of these debates, but let me start with a couple of key points.

Commenters on both Chris's and Simon's posts use a familiar argument to dissent from the idea of behavioural regula…

Twenty years of economics

Robert Peston's article today isn't a bad summary of the last twenty years of economic theory.

Information asymmetry is the term for markets that don't work because proper information is not available to both parties - e.g. the broadband speed example that Robert gives.

Adverse selection is a related problem which causes credit to be mispriced. It works like this: companies know more about their business prospects than banks, thus banks will charge a premium on loans to account for the risk they run. This premium puts off creditworthy businesses, whose owners will prefer to invest their own money or raise it in the markets. This leaves only businesses which are middling or downright bad risks still willing to borrow. As the best businesses have left the market, this affects the average risk profile for the banks, who put the rates up again... discouraging the borderline cases and leaving only the really bad risks. Rates then go up again, and... you can see where this leads. …

The economics zeitgeist, 26 July 2009

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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.

De-averaging and behavioural economics

From the Bloggers Circle:
John Copps of New Philanthropy Capital is applying lessons from the record industry to charitable donations. Just as record companies are creating a wider range of distinct products, in an effort combat illegal copying and generate more revenue from devoted fans, charities should be doing the same to maximise their donations.
An anonymous commenter points out that this is just price discrimination - and many industries have been doing it for decades. True enough, but there are lessons to learn from this.
Price discrimination is less visible in either commodity or high-growth markets.
If you sell commodities, it's harder to use price discrimination - although you will still see it on a smaller scale. The petrol market is fairly competitive, without many proprietary products, and thus there is far less diversity of price than in, say, the retail market for coffee. But because it is high-volume and the margins are small, 5p per litre of extra revenue for "p…

The economics zeitgeist, 19 July 2009

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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.

This week's posting is a few days late but the data is still based on the period from Sunday 12th to Sunday 19th.
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.

SuperFreakonomics update

When Stephen Dubner announced a contest to guess the number of Google hits there would be for "SuperFreakonomics" on November 3, my thought process went something like this:There are about 11,000 results now.There are 1.3 million for "Freakonomics".As the SuperFreakonomics launch comes closer, it will be discussed more and more.But it is unlikely to get close to the total for Freakonomics - partly because many SuperFreakonomics pages will also have the word Freakonomics in them; partly because it's a sequel; partly because Freakonomics is a cultural phenomenon, surely beyond the original expectations, and the chances of Levitt and Dubner hitting two home runs in a row are low (nothing personal, guys, just stats).So somewhere in the 50,000-300,000 range is probably about right.I have no accurate way to predict where it will fall within that rangeBut - just like The Price is Right - success in this contest does not correlate precisely with accuracy; instead, it d…

The Onion scoops a major development in monetary policy

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And to continue the topic of my last posting... The Onion really is America's Finest News Source. Though I suspect they may not be aware of the full import of their relevation:



Maybe the WSJ will be reporting the same thing soon.
From this video, around 2:30. The rest of the clip is also quite funny.

Is the Bank of England targeting nominal GDP?

How interesting. The Bank of England, whose notional target is a 2% inflation rate (CPI), is now looking at cash GDP in deciding its quantitative easing policy.

That's according to Stephanie Flanders, who has an intelligent writeup of the Bank's considerations in deciding whether to print another £25 billion to purchase government and corporate bonds.

Scott Sumner will surely be pleased to hear it: he has been advocating for a while that central banks should target nominal GDP. What's more, they are looking not at the rate of change, but at:
...the Bank's expected path for cash GDP in the next year or two...implying that the target is an absolute level, so if there's a shortfall this year they may even try to make it up next year.

Now there's some way to go from using NGDP as one of the considerations in guiding this month's policy, to setting a formal rising path at 5% a year, trading a futures index and giving up inflation targets altogether. But this is an i…

More on financial transparency

From a conversation with Richard Thinks yesterday: Thanks for the link today...looking back through the emails I notice we had another conversation about transparency a few months ago. I think the idea of publishing standardised information about financial products is one of the strongest part of Osborne's proposals - but the way it's sold as enabling "price comparison websites" is a bit misleading.
One of the oddities about the price comparison market (and I wrote, with a colleague, the first version of confused.com so I have a bit of inside knowledge) is that they make their profits precisely because the providers do not offer their products in a standardised way. Instead, everyone (deliberately) distinguishes their products in many different dimensions so that they cannot be directly compared. Ever tried to figure out which mobile phone deal is the cheapest? This is why those sites are so popular.
If everyone did publish their terms and conditions in a common machine…

Monetary versus fiscal policy

The debate between proponents of monetary and fiscal policy remains surprisingly interesting all these months later.
Not so much at Robert Peston's blog, unfortunately, where the question is more or less ignored; instead it is reduced to a question - without an answer - about how expensive it will be for the government to finance its debt.
But have a look at some of the comments on this Worthwhile Canadian Initiative posting. Adam P in particular makes an intriguing point: Moreover, this really goes to a distinction that people are often not careful about (I was trying to make this point in the discussion of your 'why fiscal policy won't work competition'). We need to decide on what we mean for fiscal stimulus to "work". There are two distinct questions:
1) Can fiscal policy increase output in a liquidity trapped economy? Clearly yes. 2) Can fiscal policy end the recession, break the trap? Only by increasing expected inflation which could also be done by monetary …

Andrew Lo's adaptive markets and the Slow EMH

Andrew Lo, writing in the FT, says:...human behaviour is hardly rational, but is driven by "animal spirits" that generate market bubbles and busts, and regulation is essential for reining in misbehaviour. Regular readers won't be surprised to see me agreeing with this, and indeed I have a proposal for how that regulation could work.
However I am suspicious about any theory which does not make testable predictions, and I fear that Lo's "adaptive markets hypothesis" may fall into this category. This "Adaptive Markets Hypothesis" (AMH) - essentially an evolutionary biologist's view of market dynamics - is at odds with economic orthodoxy, which has been heavily influenced by mathematics and physics...The formality of mathematics and physics, in which mainstream economics is routinely dressed, can give outsiders a false sense of precision....fixed rules that ignore changing environments will almost always have unintended consequences...The only way to…

The right way to regulate financial services

Robert Peston reports the Conservatives' new proposal for financial regulation. I'm not a fan of the title: "Proposal for sound banking" sounds like a "proposal for secure borders" or "proposal for safe streets after 11pm": the choice of language prejudices the solution.
But to be fair, every policy document has to be marketed to the voters. So I will try not to make assumptions about the content. Note that I haven't read the document, as it has not been published yet. But the Tories' embargoes are less strict than the government's [I still have an unpublished draft blog posting from two months ago based on Peston's accidental release, seven hours early, of the Treasury Select Committee's report on the banking sector], so he has been able to outline most of the key details of the document in advance of its release.
A simple summary: Macro-prudential regulation transferred from the FSA to the Bank of England, creating a new Financi…

Some thoughts provoked by a few blogs

Some of these articles have been lingering in my spare browser tabs for weeks, so it's time to link to them and explore a few thoughts that they have stimulated.
Chris Dillow asks if economics is like Feynman's onion. It's a good analogy. People, much more than physical particles, are complex. This isn't to say we can't build models of how they behave: we can and should. And while there are lotsofpeople decrying the state of economics (having been given permission to do so again this week by The Economist), those who think model-building is a bankrupt approach are wrong.
Model-building is the essential activity of economics and perhaps its greatest contribution to the social sciences. Indeed this is why it is to similar with physics: the best physicists know, as Feynman did, that they are not looking for an ultimate answer and even if they found one, they wouldn't know it. All we can ever seek is a model that describes the world well, and keep testing it to make …

A simple solution for labour market flexibility

OK, this solution is simple only to the extent that it's also simplistic.
But it might just make a contribution.
Arnold Kling asks (via Mark Thoma) "Why is the Recovery of Modern Labor Markets So Slow?" Part of the answer - I emphasise it's only a part - is the reluctance of people to accept low paying jobs while they still feel there's a chance to get a better paid opportunity. This means that people burn through their savings, reducing their own economic welfare as well as society-wide GDP, when they may end up having no choice but to take the same low-end job that was available to them when they were first laid off.
Why do people act this way? Undoubtedly part of the cause is a cognitive issue: the hit to pride and self-esteem from accepting a lower-paid and lower-skilled job. But another aspect highlighted by Thoma is that they want to spend their time looking for a better job instead of working at a worse one.
Now how much time do people really spend looking for…

Incoming links and arriving packages

Tyler Cowen's book has finally arrived and I'm devouring it. Full review later.My bubble detection proposal was mentioned by Scott Sumner on TheMoneyIllusion this week, and there's also an interesting discussion of it on Baseline Scenario today.The Walker Review was published today, in interim form. You can read the report here and our submission to the process here. Some of the points on the moral hazard of limited liability, and the externalities imposed by the financial sector, echo our comments. Some of our other suggestions, for example that banks should use standardised product definitions to enable transparency of their asset mix and better decision-making by their creditors, have not been taken up but we may make another submission during the consultation period.As part of its "where economics went wrong" feature this week, The Economist has an interesting analysis of the efficient markets hypothesis and some departures from it, including the implications…

George Loewenstein on behavioural economics

I'm reading George Loewenstein's book Exotic Preferences at the moment (still waiting for Tyler Cowen's to arrive) and enjoying it greatly. It's a collection mainly of journal papers and speeches authored by Loewenstein, but not too technical and an interested lay reader should find most of it very accessible.
So far the most important message is this. Traditional microeconomics derives from preferences based on consumption utility; which is certainly an important component of total utility, but by no means all of it. Philosophy, psychology and behavioural experiments all indicate that people gain much, maybe most, of their motivation from things other than consumption.
The first article is about mountaineering and the - definitely exotic - preferences of top mountaineers and polar explorers, who push themselves way beyond the limits of action that could plausibly be rationalised by consumption utility. Loewenstein gives four key examples of non-consumption utility: self…

Gold(man) jewellery

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I slightly misread the headline of this article yesterday.
It certainly struck me as a good question, though a baffling one. Just how should we interpret Goldman Sachs' Unexpectedly Large Earrings...


1. Stimulus 2. Restructuring 3. Growth

Adam Posen's submission to the Treasury Select Committee - in advance of his appointment to the Bank of England's MPC - are reported by Stephanie Flanders today. Some interesting thoughts.

The first is that:
The bottom line, he says is that economists just don't understand deflation very well:

"I think these facts call for some degree of humility. The Bank of England is right to be engaged in quantitative easing to address our current problem. But I think we should stay away from very mechanistic monetarism that, 'Oh, boy, they've printed a lot of money so at some point that has to turn into inflation.' Or, 'If we do this specific amount of quantitative easing, so it will lead to this result.'

Looking at Japan, it is clear that their quantitative easing measures had the right sign, in the sense of being stimulative, but did not have a predictable or even large short-term result, let alone cause high inflation."
An intriguing comment and one that wi…

The economics of Arsenal

Robert Peston highlights a nice, rather knotty, little economics problem for Arsenal Football Club.
This conundrum highlights a number of areas of economic theory: Generalised agency problem. The interests of the different stakeholders in the club all, potentially, conflict with each other. The fans want maximum money spent on good players so they have a chance of winning something for the first time in years. The management of the club want (I guess) stability and a profitable business, which probably means accepting a lower probability of sporting success. The different shareholders want different outcomes: Usmanov may want an equity issue because, with more cash available than the other shareholders, it would probably allow him to increase his stake. Other shareholders want to preserve their stake relative to him, so they are less keen on the increase in investment. The players and manager presumably want to be successful on the pitch, well-paid and - in Wenger's case - to have h…

The economics zeitgeist, 12 July 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. The millionth Wordle is likely to be published this week, though as we approach it the rate of generation of new Wordles seems to diminish.

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.

SuperFreakonomics contest

Today I wasted 45 minutes on a contest to win a £9.99 book.
Not rational at all - except for what I learned from the experience, and the satisfaction of feeling cleverer than 651 other contestants.
Background information on the contest is here. In short, you need to guess how many Google hits there will be for SuperFreakonomics on November 3rd, two weeks after the eponymous book is published. This is the sequel to Freakonomics, so it should be popular. But how popular?
Now this kind of contest has some interesting idiosyncrasies. Like guessing the price in The Price Is Right, or like guessing the weight of a nun - or whatever it is they do in travelling carnivals - your best strategy is not to try to accurately work out the weight. Instead, you should look at what other people have guessed and pick your number to maximise the chance that you'll be just a tiny bit closer than them. You might also recognise this strategy from the "beach vendor problem".
In the simplest case, i…

Women of Iceland, my sympathies

According to this article, you wouldn't want to be a woman in Iceland right now:
Iceland, unlike many of the other nations that went mad for credit, has lots of things going for it: an average age of 37, a highly educated work force, a nearly positive birthrate...Ouch.

An open letter to Tyler Cowen (or his publishers)

Dear Tyler
I'm very much looking forward to reading Create Your Own Economy and even more encouraged by your offer on the blog today.
And yet I have a dilemma. It seems that it won't be published in the UK until September (not in fact, as per amazon.co.uk, last February). I can order it now from Amazon US, but the estimated delivery time is 18-32 business days - which might take me nearly up to the UK publication date anyway. Unless I pay more for priority courier service than the price of the book. And that option - even if it still generates positive consumer surplus - just doesn't feel right.
On the other hand, I can buy the CD version which is available in the UK and get it delivered next week. Or I can get an audio version online - but that isn't downloadable until Tuesday 14th.
And anyway, either of the audio editions will take longer to consume than the hardcover version. I am pretty sure I can read faster than Patrick Lawlor can speak. Not as long, admittedly, as w…

Europe swamped by 0.007% increase in population

The BBC reports that:Nearly 37,000 immigrants landed on Italian shores last year, an increase of about 75% on the year before. This increase means that last year's invasion - making up 0.004% of the EU's population - has leapt to an overwhelming 0.007%.
Clearly this army of economic refugees must be stopped. Otherwise Europe's carefully designed demographic timebomb will be accidentally defused. Instead of declining by 9.4% in the next 25 years, Europe's population will fall by only 9.2%. If they're not careful, European countries may actually be able to pay some of their pension commitments.
The question the BBC has to ask itself is not: what should we do about this incoming flood of one immigrant for every 13,480 Europeans? It's not even: why are you publishing ridiculous stories like this? After all, the BBC covers plentyofridiculousstories.
The question that matters is: why do you bring attention to the laughable opinions of Nick Griffin? Just let the guy shout…

Bubble-detection technology

Pointing out a speech by William C. Dudley, president of the New York Fed, Simon Johnson says: Dudley says that the Fed can pop or prevent asset bubbles from developing. This would represent a major change in the nature of American (and G7) central banking. It’s a huge statement - throwing the Greenspan years out of the door, without ceremony.
It’s also an attractive idea. But how will the Fed actually implement? Senior Fed officials in 2007 and 2008 were quite clear that there is no technology that would allow them to "sniff" bubbles accurately - and this was in the face of a housing bubble that, in retrospect, Dudley says was obvious. But is that true?
If we define a bubble as "overvaluation of assets relative to their future returns" then to spot one, we would need to compare asset prices with future returns. But although asset prices are measurable, future returns are not - and this is why people generally think that bubbles are unspottable. We wouldn't wan…

The economics zeitgeist, 5 July 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. The millionth Wordle is coming up in about a week, so look out for that.

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.

Signalling, rationality and blunt levers

What trouble it causes in life when you can't just act directly on your preferences but need to signal indirectly.
Chief example at the moment: tomorrow's vote at Marks and Spencer. The shareholders don't really want to get rid of Stuart Rose - he's done a good job - but they do want to tell the M&S directors to stop messing around with corporate governance. So there's a proposal to get him to step down as chairman (not chief executive); but if it passes, or gets significant votes, it's likely to be interpreted as a vote of no confidence in Rose himself.
What else? A debate over on Worthwhile Canadian Initiative about the bluntness of the interest rate tool as a way of controlling inflation. If inflation is low anyway, for other reasons, but interest rates are kept low to boost economic activity, price pressures can leak over into asset prices - causing a house price bubble for example. A tool, when not designed directly to address the problem it is meant to …

"Ant mega-colony takes over world"

Best article title I've seen since Super Cally Go Ballistic, Celtic are Atrocious and Diana fund pays out to Gypsies and Asylum Seekers in the Express.

Bad mathematics and dodgy economics

Robert Peston today attempts to demonstrate that bank executives have ripped off bank shareholders over the last twenty years or so since deregulation of the City.
However he does so with some classic statistical tricks. See which ones you can spot in the article if you wish, before I carry on...
(note that these tricks are actually courtesy of Andrew Haldane, a director of the Bank of England - Robert just communicates them to us)
from 1900 to 1985, the financial sector produced an average annual return of around 2% a year, relative to other stocks and shares...But in the subsequent 20 years, from 1986 to 2006, returns went through the roof: the average annual return soared to more than 16% OK so far (though that "relative to other stocks and shares" is a bit tricky, because it's aready quite a meaningful excess return - banks haven't always been as safe as Robert and Andrew suggest).
But now what's happened?
The collapse of banks' share prices in the past two yea…