Knowing and Making

So, let's say I claim that all swans are white. Prove it, you insist. Well, say I, here's a white swan - here's another one - and here's another. Therefore it's quite likely that the rest of them are white too. You probably wouldn't consider that to be much of a proof. Quite rightly, you'd insist on the scientific standard. Make clear what a counterexample would look like (a black swan) and show that a reasonably comprehensive effort to find black swans has failed. Second best might be a detailed biological analysis of swan DNA and physiology to convince you that they simply don't have the capability to produce black pigment - but even that is not very reliable. After all, by definition I am only analysing the white ones. So why in economics do we accept the equivalent of white swans as "evidence" for macroeconomic theories? If a Keynesian wants me to believe her theory about government borrowing resolving the paradox of thrift, she should tell

There are lots of reasons why finance is different from normal markets, but I am particularly interested in why it is difficult to model economically. It's not fundamentally because "finance markets deal with money, which is essential to all other markets". On this basis, energy markets would have the same problems, as no other markets can operate without energy; equally, computer hardware or telephones. Instead, it's because finance has a special characteristic in information-theoretic terms: it creates contracts which operate on other contracts, which in turn operate on the first contract again. This is what George Soros calls reflexivity - but I will use another term: self-referential . Self-referential systems behave very differently to "normal" systems. Douglas Hofstadter has made a whole career out of analysing them. In his famous book Gödel, Escher, Bach he compares the self-referential patterns in Escher's art and Bach's music to Gödel'

This week's word cloud from the economics blogs. I generate a new cloud every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud. The words moving up and down the chart are listed here . I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too. I use 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.

I had a very interesting conversation yesterday with the head of a branding agency who shares our vision of developing a scientific foundation for the practice of marketing. My view (and that of Rory Sutherland of the IPA and Ogilvy) is that behavioural economics can provide this foundation. But as a discipline, behavioural economics is not yet mature. It has a hole at its centre which needs filled before we can genuinely say that there is a science of marketing. Filling this hole is the goal of my research and this article outlines how it can be done. The key step in the development of behavioural economics is to close the gap in our understanding between neuromarketing and phenomenological descriptions of behaviour. The practice and underlying science of marketing can be represented as a multi-layered set of disciplines, from highest to lowest level: The craft and folk wisdom of sales and marketing Experimental phenomena from behavioural economics ??? Neuromarketing and the applicati

The idea of businesses using social media for marketing has bubbled up to the BBC , which I guess means it is now mainstream. The article talks about some relatively low-key applications: market research, networking with potential suppliers and local promotions. Not sure about this quote: Companies that have jumped on the Twitter and Facebook bandwagon are reporting a surge in customers while others struggle. But of course social networking - just like traditional networking - is a good channel for businesses to talk to customers, create relationships and get introduced to new prospects via their existing clients - always a good way to build a quick reservoir of trust. The question for the economy as a whole - and especially for larger companies - is whether and how social marketing can be used for a mass market. One of the commercial benefits of large companies - and equivalently, the economic benefits of a liquid market - is that they reduce the transaction costs associated with smal

Greg Mankiw apparently thinks insider trading is a good idea...at least, he links approvingly to this defence of it by Donald Boudreaux in the Wall Street Journal [ An analysis of Greg Mankiw's clever "link deniability" strategy is coming in another posting ]. An intriguing notion. It is broadly based on the idea that information is going to be hidden by companies anyway, so we may as well hope that insiders accidentally give it away by buying and selling stock. Doesn't that seem rather defeatist? If public companies aren't providing the right information to investors, so the investors can't make accurate decisions, shouldn't we find a mechanism to make them do so? Insider trading, because it enriches executives at the expense (at least in the short term) of other investors, destroys the trust which is a key variable in how well capital markets work. There is always an agency problem inherent in one person managing an asset on behalf of another. Trust is

I'd like to write a full article on each of today's links, but I may never get around to it. In the meantime, you may have your own conclusions to draw: Tim Haab has a good defence of economics as a mathematical discipline. While the particular maths we have to use will evolve, as we incorporate more psychology, theory of organisations and financial institutions into the orthodoxy, economics will and should still use lots of mathematics - because that's the only way we can build and apply successful models. In this review of Create Your Own Economy , Henry Farrell starts to build an argument that the internal mental orderings which add value to our own lives, can also add value to other people's. My own review (not out yet) touches on the converse idea - can ready-made (or at least part-cooked) mental orderings be provided to us as a service? A mini-Easterlin paradox from Stephanie Flanders : as a country, are we more interested in comparative measures of GDP (against

One of the problems we face in economics is that our theoretical solutions do not always work in the real world, because the key assumptions of liquid markets, no transaction costs etc often do not hold. In these cases, we have to spend time working out second-best solutions. But even the second-best may still hold surprises. Here's an example. Does it make sense for Bill Gates go to the trouble of disposing of his own litter? Let's say Bill drinks a can of Coke. As Andy Warhol said (h/t Russell Howard ): ...the President drinks Coke, Liz Taylor drinks Coke, and just think, you can drink Coke too. A Coke is a Coke and no amount of money can get you a better Coke than the one the bum on the corner is drinking. So Bill drinks Coke just like the rest of us. He finishes it and needs to get rid of the can somehow. But, as it happens, he's spending the afternoon in Sixty Acre Park near Redmond, and the nearest trashcan is half a mile away (amusingly, the description starts with

From Freakonomics ... Economists estimate that the costs of reducing carbon emissions are likely to be upwards of $1 trillion per year....These cost estimates are obviously highly speculative, but the true cost of reducing carbon emissions is likely to be within two orders of magnitude of this number. Only two orders of magnitude? In other words, the costs will be somewhere between $10 billion and $100 trillion per year. That is, the same as the difference between a hundred and a million dollars; or dividing the cost out between everyone on the planet, choose between a $1.50 newspaper or a $15,000 car; or if the developed world pays for it all, you can either spend $10 on a glass of wine or give up your entire $100,000 annual salary. So: to prevent global warming by reducing carbon emissions, every human being will either have to work for an extra 15 minutes once a year, or give up their entire income FOREVER . Well, I'm glad we've got the scale of the issue clear...time

Rory Sutherland of the IPA is leading a push for behavioural economics in the advertising business. This video is an excellent summary of how ad agencies should turn " human understanding into business value for clients ". Here is his TED video about intangible goods , which has plenty in common with the best bits of Tyler Cowen - he even mentions Tyler and Marginal Revolution in the talk. And here is the event on Wednesday that I missed - thanks (but no thanks!) to Mark Earls for mentioning it after the fact. I guess I should have checked his blog before Wednesday too... I agree entirely with the message that behavioural economics is a critically important discipline for marketers to master. It has the potential to finally bring science and rigour to the practice of marketing, which has for many years been a craft - a well-practised craft, but still one with no basis in testable, predictive theory.

Roger Farmer likes unorthodox monetary policy. At the turn of the year he proposed that central banks should buy and sell equities , targeting a stock price index as a method of controlling asset prices. My own version of this proposal was slightly different . Now he's suggesting that they use quantitative easing as a monetary tool , independently of interest rates. The idea is that even once central banks have started to raise interest rates to control inflation, they should separately adjust their balance sheet, changing the composition of the stock of savings in the economy, to combat unemployment. If QE is a useful tool now to help raise economic output, why shouldn't it be useful later, when inflation is taking off? Now admittedly I'm not a trained monetary economist, but I have a bad feeling about this idea. Aren't interest rate targets and QE both different manifestations of the central bank's ability to control the money supply? Crudely speaking: if money is

This week's word cloud from the economics blogs. I generate a new cloud every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud. This week's moves up and down the chart are listed here . I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too. I use 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.

David Karp comments on the Hamilton city government's policy for swine flu vaccines ( also here ): I think part of the problem trying to figure out how to allocate vaccines is figuring out what our policy goal is. Is it to cut down on externalities? Giving preference for emergency workers and child care workers makes sense in that regard, because most people in society benefit from these people being healthy enough to work during a pandemic. Is it about fairness? If so, is it really fair that some people are considered more worthy of a vaccine than other people simply because of their age, how they caught the flu, or the type of work they do? Is it about using the vaccine available to cure as many people as possible? In that case, the fifth criteria -- giving the vaccine to those most likely to survive a particular strain -- seems like the best to use. Or should the criteria be economic efficiency: those who have the highest maximum willingness to pay for the vaccine get it? Actua

Copyblogger last week told me to cross-dress my blog - to write an article from the point of view of the opposite sex, or someone of a different age. So I have been wondering "What would missmarketcrash write?" And it became clear that the ideal article would blend a cynical attitude to the financial markets with a comment about the latest fashion accessories. Fortunately, the perfect news story showed up in yesterday's paper. The Philips Rationalizer consists of an Emobracelet, worn on the wrist, and an Emobowl which displays your emotional responses to warn you if you are getting too irrational and need to step away from the terminal for a while. It's recommended for use by stockmarket traders who may be susceptible to asset price bubbles. Mainly targeting the home day-trader market, but who's to say professional traders wouldn't benefit from it too ? While that research claims to show that higher testosterone results in higher trading profits, I suspect

Sometimes I think you should stop reading my blog and just read Steve Randy Waldman's Interfluidity instead. His last two articles, like nearly everything else he writes, are full of brilliant insights. In " Information is stimulus ", he answers Paul Krugman's (and my) question about asymmetry clearly and convincingly, making a thoroughly true case for certainty as a source of economic strength. In " Vanilla afterthoughts ", he neatly clarifies the argument for vanilla financial products while providing an entirely new insight into its public choice consequences. I have noticed several times that he seems to be thinking more or less what I want to think, but is about three steps further ahead. Maybe that's because he used to be a Java programmer before taking up economics. Whereas I...used to be a Java programmer before taking up economics. Hoping to see Steve writing a bit more in future, as he's been quiet this summer.

Thanks to Lucas Engelhardt for a thoughtful answer to my questions about Austrian economics. He points out a few ambiguities and flaws in my posting and explores the "something happens" phrase which I neglected. I would like to continue the debate on three main points: Why those sectors? Lucas says: When money is cheap, interest rates drop. When interest rates drop, assets that provide payoffs further in the future gain value relative to assets that provide payoffs closer to the present. Therefore, sectors that are expected to offer high returns in the far future will see resources diverted toward them. So on this argument, all investment assets rise in value compared with goods for immediate consumption. But is this what we saw in 2001-07? Lucas and I agree that there were too many resources in residential construction, but on his argument we should have seen a general excess of investment as a whole, and a reduction (relatively) in consumption. Contrary to that, most peo

This week's word cloud from the economics blogs. I generate a new cloud every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud. And this week's moves are listed here : no surprise to see "Obama" up 187 places and "Nobel" a high new entry at 147! I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too. I use 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 w

Regular readers will have seen the blog links on the right hand side which show the latest headlines from lots of economics blogs. All of them are worth reading, but once in a while something really nice shows up. This time, two beautifully juxtaposed headlines from Daniel Indiviglio at The Atlantic and Justin & Barbara's column at Time . No relation, as it turns out, to each other at all. Nor, of course, to Brian Clark's Copyblogger advice further down... Update : Talking of headlines, Paul Mason's latest one " My return to Leigh " gave me a quick double-take...

Surprising but (I think) nice news that Barack Obama has won the Nobel Peace Prize. I thought it was a joke when I first saw it, but on balance it is a good decision. Obama's inspiring message, philosophy and personal example are worth remembering, especially when obscured by fights over healthcare and climate change policy. It's a somewhat risky prize - presuming a successful presidency before it's a quarter (and probably not even an eighth) finished. But the Peace Prize committee is a strange beast - always keen to be topical, even more than is the Economics committee. Talking of which, Greg Mankiw has a sneak preview of the winner of that prize. Update : Michael Tomasky's well-judged take on how Obama should respond and the political consequences.

This week's word cloud from the economics blogs. I generate a new cloud every Sunday, so please subscribe using the RSS or email box on the right and you'll get a message every week with the new cloud. I summarise around four hundred blogs through their RSS feeds. Thanks in particular to the Palgrave Econolog who have an excellent database of economics blogs; I have also added a number of blogs that are not on their list. Contact me if you'd like to make sure yours is included too. I use 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.

Karl at Modeled Behavior responds to Richard Posner (I am surprised to hear Posner emphasising psychology - I thought he was talking about Richard Thaler at first): I am not sure exactly what Posner means by psychology. I have never been optimistic about feelings as an economics model. Perhaps people spend more when they feel better but how do we get a consistent measure of feelings and even more to the point how does policy consistently effect them. What I do think makes a difference is expectations . Expectations do fit nicely into macroeconomic models because they bear a simple relationship to real events. Macro models mostly deal with visible events such as monetary transactions. And an expectation is just an event, translated in time and perhaps given a probability weighting. But we do model things in economics that are not that simple. The most obvious example: preferences . Preferences are very complex - just think of all the factors that impacted on your choice of what dinne

Greg Ransom comments on Marginal Revolution today that we have: ...a Hayekian artificial boom and inevitable bust with a very, very slight secondary deflation, and non-market clearing price controls on entry level labor. This is a reasonable summary of the Hayekian story, for which Greg consistently argues on my three favourite libertarian/monetarist blogs: MR, TheMoneyIllusion and Worthwhile Canadian Initiative . The idea is that easy money leads to overinvestment in certain sectors, which end up consuming more resources than their stable long-term share of the economy. Housing being the key example in the 2001-07 boom, or Internet technology in the previous one. When something goes wrong, the availability of capital rapidly shrinks and there's no more money to spend on all those houses in Nevada or foosball tables in San Francisco. Lots of housebuilders or programmers are thrown out of work and need to learn a new trade. In this story, government stimulus just delays the inevit

Markets and economies generally work because people have incentives to find welfare-enhancing trades. If you can keep the profit you make from a trade and spend it on something nice, you are more likely to make the trade. The same applies to working an extra few hours, or selling your car to someone who needs it more than you do. This is why incentives are important. And it is the basis of the major objection to high taxes and redistribution - it is meant to dilute incentives and discourage people from achieving maximum economic productivity. So what if the tax is a complete surprise? If a government creates a straight one-off windfall tax, it cannot affect economic behaviour before the windfall, because it is unforeseeable. It should not, in theory, affect economic behaviour after the windfall, because it is a one-off tax and therefore there is no reason to expect it will happen again. So why don't governments finance all their operations by a series one-off windfall taxes? Beca

Robert Peston's article today is about the potential for BAE to be prosecuted over alleged bribery. The article itself is interesting but the reader comments are what staggers me. Page after page of comments passionately defend the corruption. "It's just the way things are done"..."do you really think the French and Germans don't do this?"..."it's not as if they were bribing British officials, but foreign ones, which is how you do business in these places". You need to get through 23 comments defending BAE before finding a single one condemning illegal and immoral actions that hurt millions of desperately poor third world citizens (well done to DrDelbert, PorterRockwell and a few others for having a bit of integrity). I am left wondering if this is really how the majority of Peston's readers feel...or is it, in fact, an organised campaign?