Knowing and Making

I presented this paper today at the conference of the Cass Behavioural Finance Working Group . In summary, it replaces the concept of "news" or "information" in the Efficient Markets Hypothesis with a model of beliefs , reflecting the idea that nobody in a market has objective, indisputable knowledge  about anything, only beliefs of different levels of confidence. Slides here ; will tell you more later.

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.

This article is from October, but germane to my discussion of fiscal salesmanship. Cass Sunstein: Wall Street's Lemmings : Why policymakers need to understand psychology as much as economics to solve the financial crisis. A couple of comments below the article point out that psychology is not the only  cause of the financial crisis, but Sunstein is not claiming that. Undoubtedly it makes a big contribution and turning it around (he uses the example of Roosevelt, maybe the best fiscal salesman ever) is within the powers of politicians - Barack Obama of course being the one most capable of it, for many reasons.

I read Paul Krugman's latest NYTimes column (via Economist's View ) and it got me wondering. Why does crowding out not happen? In other words, why does an increase in long-term public debt not result in a reduction in long-term business investment? There's a school of thought which argues that there is money which would otherwise go into productive private investment, but instead is diverted into lending to government (which is likely to lead to less productive spending). Due to less money being available, this pushes up the price of borrowing for businesses and means some otherwise-viable investments will not happen. Krugman gives part of the answer - that a (successful) stimulus encourages economic growth which in turn makes business investment more, not less, likely. But there's another reason. This is that business investment is not  happening anyway. There is not a large pool of money going into long-term business investment now. Why? Because investors weight shor...

We need certainty about the future in order to do anything. It’s a basic requirement of the action-feedback cycle that intelligent beings use to achieve their goals. On the simplest level, if I want to pick up an apple to eat, I need to know that when I tense my arm muscles, my hand will move in such a way, and when I grip it and pick it up, it will weigh (more or less) how much I expect, so that I need to apply just this much pressure to bring it to my mouth. I need to know that it will be this hard to bite and that it will give me some energy and assuage my hunger. If I am missing any of this information it’s highly unlikely I’ll be able, or even want to try, to pick up and eat the apple. In a more sophisticated decision I need the same predictability. I have to know that when I hire this person, they’ll show up at work, and when I sign this contract, the customer will pay the money on time, and when I build this car, someone will buy it. If we have certainty, it lets us see clearly ...

If the leveraged financial structures supporting the operations of the world economy are unravelling, what will happen? In the short term, it's dangerous. Today, according to the FT , banks are refusing to lend to each other. Soon that will start to have knock-on effects for exporters, and soon after that for domestic business too. They can't borrow money because their banks' risk models require the loan to be laid off to other parties who will no longer play. So companies won't be able to get export finance, and won't be able to take on domestic projects that require financing either. Why is that? If the money is out there but the banks won't lend to each other, people who need it are going to have to start finding new financial suppliers. Let's say that bank A has a strength in lending foreign exchange to manufacturers, and usually finances this by swaps with banks B and C in the forex markets. The money is spent by the manufacturers and comes back into th...