Friday, 31 December 2010

Things to do in Denver when you're Greg

Sorry, I couldn't resist the title. If you'd like to meet Greg Mankiw in person, just head over to the ASSA (Allied Social Science Associations) meeting next week and sign up for his discussion on economic policy.

More to the point, the American Economics Association conference is also taking place at the same time. You can get an interesting insight into the concerns and priorities of the discipline by running some keyword searches on the preliminary programme, which is available here.

Some topics of interest to me:

  • cognitive: appears 12 times, though mostly related to cognitive and noncognitive skills, particularly with relevance to the labour market. There is one mention of cognitive biases and one of cognitive economics - which highlights a study called CogEcon of which I wasn't aware. Again though, it appears to mainly focus on a cognitive skills measure for Americans over 50, rather than a more general exploration of how cognition affects economic behaviour and modelling.
  • behavio(u)ral: appears 16 times. The most interesting-looking talk seems to be "Inflation targeting from the perspective of behavioral economics". No abstract available for that one, but I'll see if I can get any information from the authors. There's also an amusing-looking session on "Selling Economics to the Foundations" which includes a talk "Eric Wanner and The Economics of Behavioral Economics". My main conclusion from this is that if nothing else, the discipline of behavioural economics needs to be renamed so that it can be spelled consistently by researchers in all (English-speaking) countries.
  • psychology/psychological): 6

  • monetary: 83
  • fiscal: 32

  • banking: 27
  • industry: 36

  • unemployment: 14
  • employment: 72

  • Keynes: 6
  • Hayek: 0
  • Friedman: 6 (although all six are presenters who just happen to be called Friedman - none refer to Milton)

  • macro: 43
  • micro: 31
  • econometric: 63
You are welcome to make whatever inference you like from the above; and no doubt you can do your own searches to prove whatever point you'd like to make.

I suspect, though, that the highlight for most blog readers will be this little gem:

Jan 07, 2011 10:15 am, Sheraton, Governor's Square 15 
American Economic Association
What's Wrong (and Right) with Economics? Implications of the Financial Crisis (A1) (Panel Discussion)
Panel ModeratorJOHN QUIGGIN (University of Queensland, Australia)
BRAD DELONG (University of California-Berkeley) Lessons for Keynesians
TYLER COWEN (George Mason University) Lessons for Libertarians
SCOTT SUMNER (Bentley University) A defense of the Efficent Markets Hypothesis
JAMES K. GALBRAITH (University of Texas-Austin) Mainstream economics after the crisis

Unfortunately I can't make it to this year's conference due to a client project and some personal commitments, so I hope this session will be filmed or recorded. Are any readers planning to go?

Update: Anyone who is in Denver is recommended to spend an hour or two at the humo(u)r session, where Jodi Beggs (@jodiecongirl, Economists Do It With Models) and Greg Mankiw are both speaking, along with Yoram Bauman, the Standup Economist.

Wednesday, 29 December 2010

Links: Cities, inequality and the ghost of Keynes

Some recent interesting articles:

A Physicist Turns the City Into an Equation is a description of an ambitious project by Luis Bettencourt and Geoffrey West at the Santa Fe Institute to develop mathematical models of the behaviour of cities (and earlier, of the physiology of living organisms). They claim to have found some strong correlations in both cases. For instance, a city that doubles in size increases its productivity and economic activity per capita by 15%. And animals that grow larger become more efficient users of energy. However, it's not clear whether they have a real model which explains these phenomena, or just some statistical correlations.

Paul Mason went to the LSE and conducted a whimsical interview with the ghost of John Maynard Keynes. As fits someone who changes his mind with the facts, he has grown out of Keynesianism and is seeking a new model which can handle fiat currencies and global finance. An excellent challenge.

Another challenge comes from Tyler Cowen, in The Inequality That Matters. He deals first with (what he considers to be) popular myths about inequality, and concludes that outside of the top 1% of the population, inequality has not increased at all. And even within that 1%, the issue is not inequality itself - Cowen's life is much more similar to that of Bill Gates than would have been the life of an equivalent 1900 college professor to that of Rockefeller. The issue here is the intrinsic tendency of smart people in finance to take risks. As he says:
The first factor driving high returns is sometimes called by practitioners “going short on volatility.”...There’s a second reason why the financial sector abets income inequality: the “moving first” issue...We have to find a way to prevent or limit major banks from repeatedly going short on volatility at social expense. No one has figured out how to do that yet.
Well, there can't be much that's more calculated to provoke a blogger than an assertion like that. So I'll just suggest that the anti-correlation proposal which I and others have made might be a step in this direction. I need to write this up in more detail - but it's a way to encourage banks to take risks which are uncorrelated with other risks - and therefore less likely to go wrong all at once.

Tuesday, 28 December 2010

Banks and moral hazard: not all risks are bad

Some interesting research on banks, public guarantees and risk-taking (via the Alea blog). The researchers use a natural experiment on German banks (some of whom lost the state guarantee on their deposits due to a court ruling in 2001).

The research finds that these banks reduced the riskiness of their lending after the change (compared with a control group of other banks who didn't have a guarantee in the first place). This is what you would expect from conventional theory.

But I wonder whether their conclusion is correct:
"The results suggest that public guarantees may be associated with substantial moral hazard effects."
An alternative view: perhaps banks without guarantees take less risk than is socially optimal, and public guarantees partly correct for this effect. There are several reasons why this might be the case:

  1. Information asymmetry - the "market for lemons" argument. Businesses (and consumers) borrowing money have much more information about their own situation than does a bank. Thus there is an incentive for non-creditworthy borrowers to borrow more than they should, and banks may respond to this incentive by imposing restrictive conditions on all borrowers.
  2. Herding of lenders. Partly as a result of point 1, banks are likely to identify groups of similar borrowers, with similar situations that are more easily measurable and comparable with other banks. Thus people in some types of job can borrow much more easily; businesses in specific, established sectors find it easier to borrow than those in new ones; and banks in 2005-2007 became much more likely to invest in mortgage-backed securities than other types of securitised asset. Thus, certain kinds of lending are overprovided by the market and others are underprovided, because of a higher estimated level of risk.
  3. Lending has positive externalities. Lending to consumers provides profits to makers of consumer goods, which are not captured by the consumer (and therefore cannot be priced by the bank). More importantly, lending to businesses enables innovation in the marketplace, new product development and increased consumer surplus - much of which cannot be captured by the businesses in increased profits. Economic theory indicates that goods with positive externalities will be underproduced - and thus, we can see that banks will under-lend.
So, state guarantees, while they may create moral hazard in some cases, can also be an important force to enable lending to people and businesses which couldn't otherwise get it.

This issue pervades all policy responses to the financial crisis. It's important not just to cut the total amount of lending or "total risk" (as if there were such a thing). What we really want to do is to stop those risks which are specifically problematic. These come in four main categories:

  1. risks associated with moral hazard (where I get the benefit but you pay for the losses)
  2. as a special case of moral hazard, those which are driven by agency problems (the employees have the upside but the shareholders - or taxpayers - have the downside)
  3. those risks which arose from misunderstanding of how probabilities in complex systems really work (such as the fat tails of loss distributions)
  4. and those which arise from, or are amplified by, bad coordination across the system (for instance, banks overinvesting in mortgage backed securities because of network effects)

But while doing this, we must consider how we can better distinguish between different risks, to make sure we don't stop people from taking risks which are socially useful, as an unwanted side-effect of preventing the bad ones.

Sunday, 26 December 2010

The economics zeitgeist, 26 December 2010

This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the 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.

Sunday, 19 December 2010

The economics zeitgeist, 19 December 2010

This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the 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.

Saturday, 18 December 2010

The psychology of bank bonuses

The FSA is expected over the next few days to publish published yesterday its new rules on bank bonuses, broadly in line with the guidelines announced by CEBS, the pan-European committee of regulators. It's likely that, fFrom 1 January, banks will only be allowed to pay a third 40% of bonuses in cash, with the rest paid as deferred claims of one kind or another - debt, preference shares or equity - which can be drawn down over three to five years.

This is meant to reduce the incentive for bankers to take risks: with a high proportion of their wealth tied up in the company they work for, they will want to ensure its survival. However, there are two questions it leaves open, as I just managed to squeeze in on Radio 5 this afternoon before they decided the 6 o'clock news was more important.

The first question is: do banks - and bankers - actually know whether their actions are risky? It certainly didn't seem that way in 2008. Investments in property that they thought were incredibly safe turned out to be a disaster. The problem leading to the current crisis was not the mismatch of incentives or the principal-agent problem which the new regulations are meant to solve - but a lack of awareness of risk. And more importantly, a lack of awareness of the correlation of risk across the whole banking sector.

Admittedly, people who work within a bank are probably better placed than most others to see the risks to that bank's capital. And by making company-wide risks more salient and more important, the regulations will help by encouraging people to spot the problems that might happen. But two specific interventions might make it more effective.

First, a transparency principle. Within a bank (if not outside it) the bank's detailed positions on all assets and debts should be publicised. Interested insiders would have a strong incentive to spot risks and flag them up, even if the people taking the risks missed them - wilfully or otherwise.

Second, the ability to identify correlations between different institutions. A market solution is probably the best way to do this: sell correlation-related instruments such as swaps between the assets of different banks, or combined put/call options with a spread. Banks whose assets are tightly correlated would have a low price for such swaps; two uncorrelated banks would have a high price (positive or negative) for the swaps, and a non-zero price for the option. Monitoring the market prices of these instruments would provide information to the regulator on potential systemic risks. And allowing, even encouraging, insider trading in these specific instruments, would lead to information being released quickly. Critically, banks whose assets are more highly correlated (to each other, or to the market average) should hold higher capital reserves. This will encourage banks to find new kinds of assets which are more systemic-failure-proof. As a beneficial side-effect, it will create more diversification of investment - good for the economy in general.

The second question is this: can rational incentives explain bankers' behaviour anyway? There is plenty of psychological research into decision-making under uncertainty, attitudes to risk and so on - much of which shows that people do not respond in the expected way to incentives. Instead, framing of risks (e.g. as gain versus loss), the combination of different risks into a single decision (e.g. the Allais paradox) and apportionment of risks into corner cases (very high or very low probabilities) are all known to change people's perceptions and their actions under conditions of risk.

There's a general assumption that experienced financial traders are likely to be less biased than average investors, and that's probably true. But it's very unlikely that traders can be completely rational and objective, especially when dealing with novel situations or making very quick decisions. There's a well-known piece of research showing that traders take more risks on days when they have higher testosterone levels. That evidence isn't conclusive, but it is a heroic assumption to imagine that a trader can eliminate all biases other humans are subject to. These effects need to be understood in order to know what kind of regulation is appropriate.

Despite all that, the FSA's move is a good one - and follows an interesting principle, that of trying to put some parts of regulation back into the hands of people who work in the institutions. Regulating from outside - the US approach - is always likely to leave loopholes. Aligning the interests of bank employees, investors and society has a real chance of working.

Thursday, 16 December 2010

Behavioural law and economics symposium

A very strong article here (by Claire Hill, law professor at University of Minnesota) focusing on two principles: how people see the world, and how they value things. Perhaps I like the article because these two points align closely with my model of beliefs and values. The article is one of a number of contributions to Truth on the Market's behavioural economics symposium, but most of the others are entirely different in character to Hill's. The symposium is dominated by strong skepticism about behavioural economics and particularly its application by governments.

It's interesting to see the strong feelings that this subject arouses. Among the various contributors there's a mix between resistance to regulation in general, dislike of the assumption of irrationality, insistence that regulators are just as irrational as citizens, and the assertion that people know their own preferences better than any well-meaning nanny-state regulator possibly could.

Richard Thaler has written a response and he's a good person to do it, as the subject matter is not mainstream economics but law and regulation. This is a common application of behavioural economics and is very much in Thaler's "Nudge" domain. I am mostly happy to leave them to it, because I prefer to explore economic behaviour, consumer choices and markets rather than regulation. But it's still interesting to read the debate.

To my surprise, Thaler's response actually goes deeper into markets, consumer and company behaviour than most of the symposium contributions themselves. It's a very well-argued article and I'd strongly recommend it. It demonstrates something I'd started to forget (or take for granted): there's a reason Thaler is so famous, which is because he knows what he's talking about and how to make a really good case for it.

Tuesday, 14 December 2010

Microfoundations of Macro: One Direction

[Apologies to X-Factor fans: this article is about "one direction" towards a new model of macroeconomics, not about the band. But do feel free to stick around and join in the discussion.]

If you read nothing but Rajiv Sethi's and Interfluidity's blogs, and developed all the consequences of what they said, you'd get a spectacular career in economic research out of it.

Fortunately, Mark Thoma reads them - as well as hundreds of others - and has a good commentary on a recent post of Rajiv's. I won't quote the whole thing, but here is the key message. Without the assumption of a representative agent - the idea that everyone in the economy behaves identically - current macroeconomic models can't work. But this assumption misses some of the key dynamics in the economy - the fact that some people borrow and others save; the fact that different people have different beliefs and preferences - which are fundamental to both why and how economic activity occurs. We need a way to introduce heterogeneous agents into macroeconomics.

On top of this, we can see that in the real world, people have mutually inconsistent expectations - and therefore at least one of them must be wrong. Thus, we have to abandon the idea of rational expectations with its assumption that people's expectations always adjust to match the most probable future outcome of the world.

Duncan Foley's essay, on which Rajiv's article is based, identifies the problem very clearly.
In my view, the rational expectations assumption which Lucas and Sargent put forward to "close" the Keynesian model, was only a disguised form of the assumption of the existence of complete futures and contingencies markets.
Rajiv's summary is also excellent:
To my mind the most appealing feature of the Foley-Sidrauski approach to microfoundations is that it allows for the possibility that individuals make mutually inconsistent plans based on heterogeneous beliefs about the future. This is what the rational expectations hypothesis rules out. Auxillary assumptions such as sticky prices must then be imposed in order to make the models more consonant with empirical observation.
Foley talks about two approaches to resolve this problem. The first of these, rewriting Keynesian macro to be compatible with general equilibrium, is an interesting engineering problem. And the model he describes sounds like an effective one - distinguishing between stocks and flows, and using the Hicksian concept of temporary equilibrium to explain the evolving dynamics of the system over time. But my intuition is that it will result not in a real solution - merely a better patchwork than the one we have now.

Instead my preference is for the other solution, which Foley describes as "to fiddle with general equilibrium theory in the hope of introducing money into it in a convincing and unified way". In fact, I think even that fiddling is at too high a level. We need to go to a deeper micro model, and here is my sense of what the model - and the mathematics - might look like.

The standard micro model is built from two basic concepts: preferences and expectations. As Foley says, the expectations question is assumed away either by inventing rational expectations, which are guaranteed consistent with reality, or by allowing complete markets in futures and options on all goods. Then we are left with preferences, and are forced to make lots of strange assumptions about preferences in order to explain the inefficiency we observe in the real economy. Some of those assumptions may be correct; others (strongly sticky prices) hint at the truth but are hard to justify in the way the models use them.

Instead, imagine the basic micromodel is recast in terms of two new concepts. The first is a more fundamental, slow-to-change kind of preference which we will call a value. The second is a belief about the world: either a belief that a good will satisfy one of your values, or a belief about the present or future exchange value of a good. Beliefs are tightly defined and do not include just any old assertion about the world: these beliefs are clear relations between agents, goods and values.

Agents and goods remain in the model as before. An agent ends up possessing a bundle of values and beliefs and an endowment of goods. So how does this help?

First, we have an explicit model of beliefs. This means that expectations can be addressed directly within the model, instead of making assumptions about their consistency or accuracy. A successful model is likely to examine the transmission of beliefs between agents. The belief concept is also general enough to capture a number of other phenomena - for instance attitudes to laws, saving or taxes - which in conventional models have to be tacked on as assumptions. We can discuss analytically the consistency of beliefs, because our model actually defines the referent of a belief and the statement that an agent makes about it.

As a side-effect of this, money is analysable in terms of the beliefs of agents about the future exchange value of certain goods (for example, dollar bills).

Second, we have the potential for a realistic model of behaviour. Behavioural experiments show that values and beliefs both influence behaviour, in some predictable (though not conventionally "rational") ways. Of course there are many different ways to model individual decision-making. But a simple model of choice arising from values, mediated by beliefs, under constraints on attention, accuracy and myopia provides a parsimonious and expressive description of reality. By implementing a realistic theory of decision-making into the model, we will have a closer match to the real world than current theories.

Third, the model has the potential to be simple enough to be tractable. Agent-based models, even those which are relatively realistic with respect to actual human behaviour, are too full of ad hoc assumptions and tweaks to permit analytic solution. A model which is simpler at its base (containing only three key entities) is more likely to allow for solutions in mathematics rather than simulations. These kind of solutions provide much greater generality and predictive power than computational ones.

What the actual mathematics of this theory will look like is not yet obvious. But it seems likely that there will be a greater role for discrete mathematics and fewer of the assumptions of differentiability, convexity and the like which typically constrain preference functions in economic models. Discrete mathematics has its own challenges, and in some cases new mathematical techniques may have to be developed to handle these models.

Of course there is a lot of work to do before we will even know whether a model like this makes sense, let alone whether it can explain all the observations that the standard models don't. But my strong sense is that this is a useful direction in which to travel.

Update: having re-read some of the comments on Rajiv's post I feel it would be useful to add a couple of points:

  1. The "model" I described above is perhaps more accurately a framework for a class of models. It is likely that, if this framework proves to be fruitful, various models would be developed to explore different assumptions about learning, herding of beliefs, the nature of privileged agents with high influence over the beliefs of others, the structure of institutions, and many other extensions.
  2. Foley's work includes some interesting research on mathematical approaches borrowed from physics - notably the idea of a statistical equilibrium. This is a technique that I have long believed would be valuable in macroeconomics. But one of the main attractions of the approach is that it enables you to ignore microfoundations in favour of purely statistical descriptions of large-scale objects (an economy, or a box of gas). If we have a successfully microfounded theory, much of the rationale for a statistical thermodynamics-inspired method goes away. Still, it is worth exploring.

Sunday, 12 December 2010

The economics zeitgeist, 12 December 2010

This week's word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the email box on the right and you'll get a message every week with the new cloud.

This week, some interesting news: for the first time ever, tax is at the top of the rankings. This is especially notable as it outranks both of the common words "one" and "new" which invariably show up there. This has never happened before, with only "free" and "oil" reaching position 2 in November 2009 and June 2010 respectively.

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.

Saturday, 11 December 2010

Some cognitive/behavioural/neuro links

  1. Me, very briefly, on BBC Radio 4's Moneybox ( My bit is around 16:20, but do listen to the whole report by Ruth Alexander from 13:10 or so. The subject: the psychology of pound shops...
  2. I hadn't seen the Neurokuz blog before - Marginal Revolution links to a summary of an experiment on extrinsic versus intrinsic rewards. I'm rarely convinced that there's much to learn from neuroeconomic experiments, but this does show that by focusing purely on the single dimension of reward (presumably dopamine?) we can make cognitive or mind-level distinctions between people who outwardly behave the same.
  3. What does the price of a pint say about a pub?

Wednesday, 8 December 2010

Does capitalism "create" demand?

You may have heard this one before. At the end of an interesting BBC programme this evening (The Foods That Make Billions) a commentator suggested that the problem with modern capitalism is that it sustains itself by creating desires in consumers, instead of simply satisfying desires they already have.

Is this true, and if so is it a bad thing?

Certainly our preferences are not simple, static attributes, waiting in the back of our heads to be satisfied by the products we buy. Preferences - insofar as they even exist - are formed dynamically, influenced by biology, cognition, the environment and the social groups we are in. Would it be surprising if they were also influenced by people who sell products?

To understand if that's a good thing, let's think through some of the things that happen in a consumer's mind. Not the rational consumer which generates stable continuous utility from consumption, but a real consumer with the cognitive patterns we see in actual people. The key insight here is the idea of hedonic adaptation.

Typically, enjoyment comes from satisfying a preference that was not previously satisfied. Think of the feeling you have when you've been hungry and you eat something, or you're tired and you get to go to bed. Or if you've had a headache and it goes away...what joy.

In comparison, it's very hard to maintain any level of continuous enjoyment from a preference that is satisfied permanently. If you are never hungry, you won't enjoy food so much. And if you never had the headache, you don't take any delight in your lack of pain.

In this relatively wealthy world where our basic material needs (in the rich countries at least) are pretty much fulfilled, there's little enjoyment to be had from satisfying those fundamental preferences. So it could be argued that consumers are actually better off having an unfulfilled desire artificially created, giving them a feeling of joy when it is ultimately satisfied. Not only does the consumer gain utility from satisfying the preference itself, but the process of working towards it and the sense of achievement from gaining their goal can add to that. It may be that the secret to achieving the most enjoyable life is to repeatedly depart from a basic state of neutral comfort by discovering a new unfulfilled desire, satisfy it to return to your comfortable state, and then after a pause, set out to find another new desire.

In fact, if new, volatile preferences are going to be constructed on the fly, it may be better to have it done by someone who has an interest in making sure the consumers can actually satisfy their constructed desires. Companies benefit from creating a want and giving consumers the means to fulfil it; consumers do too. This cooperative dance of imagination, communication, influence and commerce could be the best possible world for us all to live in.

I'm not necessary fully convinced by this argument. I set it out to illustrate that it might be in a consumer's interest to be manipulated by advertisers and salespeople. Presumably there are times when this goes too far and the consumer's interests are damaged. But in principle, there's nothing wrong with a system in which companies artificially create desires in their customers. It is in the best tradition of commerce and perhaps there's a good reason that consumers, and voters, have gone along with it for all this time.

Tuesday, 7 December 2010

Why do new ideas fail?

Paul Krugman in "Bourbon Economics" (and his commenter Peter von zur Muehlen) complain that we've had new ideas for decades in macroeconomics, but they don't take hold.
By 1988, it was already obvious that equilibrium business cycle theory had failed. Shiller had already circulated his devastating demonstration that asset prices were much too volatile to be explained by fundamentals...nothing happened. Real business cycle theory continued to prosper, developing an increasing stranglehold over the professional journals. Behavioral finance stayed on the margins. The equilibrium guys had learned nothing and forgotten nothing...
Our problem, in short, isn’t lack of nifty new ideas; it’s the refusal of too many economists to face up to the fact that some of their preferred theories don’t work
I sympathise - as an adherent and practitioner of behavioural finance, I could hardly not. But it's too easy to blame this on the establishment for not listening. And really, if Krugman and Shiller aren't part of the economic establishment, who is?

von Muehlen, in the comments, points out that the alternative theories aren't really very good either:
Everything you say is correct---sadly. But this criticism holds equally for all extant competing macroeconomic theories.
...Caballero notes:
"What does concern me about my discipline, however, is that...the dynamic stochastic general equilibrium approach — has...begun to confuse the precision it has achieved about its own world with the precision that it has about the real one."
This indictment affects all of macroeconomics. Yours, mine, theirs.
Those, including me, who want to promote new theories, have to face up to this: it's our responsibility to persuade people our ideas are true. If we have failed so far, then don't sit bitterly on the sidelines, bitching about how the adults won't listen to us. Engage with them, understand the debate in its own terms and participate in it...and if we do it right, and if our theories are true, we'll move the battle to our own territory eventually.

In the case of behavioural finance, I believe this means developing whole-economy models - like the Arrow-Debreu equilibrium model, like the DSGE macro models - which incorporate insights from behavioural and cognitive research. Even a simpler model would do: if we can start with the undisputed results of cognitive experiments and derive clear rules about how a single market will behave, that would be a great step forward.

David Laibson is doing a bit of this; some people like Roger Farmer, though a little more in the rational camp, are doing work that we could learn from too. There's no point complaining - let's improve our proofs and persuade people that way instead.

Sunday, 5 December 2010

The economics zeitgeist, 5 December 2010

This week's (inadvertently Declaration of Independence themed) word cloud from the economics blogs. I generate a new one every Sunday, so please subscribe using RSS or the 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.

Thursday, 2 December 2010

Nudging for health

The BBC covers the potential for behaviour change projects to improve public health. The article mixes up a few different kinds of interventions, though:
  1. Classic nudge-style policies: changing defaults, trying to influence social norms.
  2. Incentive-based policies: shopping vouchers for dieters.
  3. Full-blown regulation: banning branded cigarette packages.
The oddest thing about this confusion is the last sentence of the article:
The mandatory wearing of seat belts and the introduction of the ban on smoking in public places are two examples where legislation fundamentally altered, and some would say restricted, the choices of individuals.
Some would say???

The last couple of months seem to have seen a surge in mainstream interest in behavioural economics, which is good news - but also quite a few misunderstandings about what it is.

Some people understand it better, though - for example the OFT, which has carried out some behavioural experiments and released an interesting report today about the psychological effect of price advertising. More on that tomorrow.