Monthly Archives: May 2014

Basing Decisions on Rank-Order Framing

Posted on by

Neil Stewart, Stian Reimers, Adam J. L. Harris write,

people behave as if the subjective value of an amount (or probability or or delay) is determined, at least in part, by its rank position in the set of values currently in a person’s head. So, for example, $10 has a higher subjective value in the set $2, $5, $8, and $15 because it ranks 2nd, but has a lower subjective value in the set $2, $15, $19, and $25 because it ranks 4th

Pointer from Robin Hanson. As usual, I wonder how well this works in a world where people learn from their past behavior. But this does provide a general theory of a lot of behavioral economics findings concerning biased decisions with respect to risk and time.

The Political Economy of Big Banks

Posted on by

David Cay Johnston reviews All the Presidents’ Bankers, by Nomi Prins. He concludes,

But the banks are only big, not strong. Indeed, the “stress tests” to determine if the banks can withstand another financial shock are designed to test only for minor upsets, rigging the game in favor of the Big Six, which all engage in unsound practices, especially trading in derivatives. They remain big because of bad laws and enablers like Geithner and because politicians desperate for campaign donations listen to the pleas of bank owners more than those of customers. So the bankers live in grand style, lavished with subsidies that cost us more than food stamps for the poor. In return for this largesse, the bankers savage our modest savings.

Pointer from Mark Thoma. To me, Johnston’s rhetoric seems over the top, and if all Prin has to offer is rhetoric and conspiracy-mongering, then I see no need to read her book. Nonetheless, if you ask me about the political economy of big banks in this country, I would say that I believe that their profits come from rent-seeking in general and from the too-big-to-fail subsidy in particular. I think that breaking up the big financial institutions would provide a net public benefit.

However, I would caution you that Fragile by Design, by Calomiris and Haber, offers nearly the opposite perspective. For them, it is America’s historical hostility toward large banks, and the consequent fragmentation of banking, that is the original cause of fragility here. I think Prin would have a hard time arguing, as she apparently attempts to do, that concentrated banking has been a feature of the U.S. for over a century, when banking across state lines was all but impossible up until around 30 years ago. The other point in favor of Calomiris and Haber is the stability of Canadian banks, where the big six have a much higher market share than the big six in the U.S.

Question in the Comments

Posted on by

On this post.

“Perhaps the [record company] who makes a risky bet on a raw [artist], and who take the time and effort to train her, should be entitled to a small portion of her lifetime earnings as she moves on to more lucrative employment. That would create a powerful incentive for [record companies] to devote real resources to building the skills of their [artists].”

How’d that work out?

1. It worked out better for the record companies when they had a monopoly on the means of distribution. The Internet tends to undermine that monopoly.

2. Regardless of technology, the supply of people who want to be in the entertainment business seems to be highly elastic. And the nature of demand for entertainment (people want to like stuff in part because other people like it) tends to produce winners-take-most outcomes. So a lot of artists will make low incomes, and a few will get lucky.

3. I think that artists cultivate an image of being unusual and self-made. So they will not shout it from the rooftops that their skills reflect real resources invested by major corporations. But my guess is that if the Beatles had been so determined to think of themselves as original that they had never taken any suggestions from their producer, they would have been just been the WannaBeatles.

Daniel Kahan Discovers Expressive Voting

Posted on by

He said,

Look: What an ordinary individual believes about the “facts” on climate change has no impact on the climate.

What he or she does as a consumer, as a voter, or as a participant in public debate is just too inconsequential to have an impact.

No mistake she makes about the science on climate change, then, is going to affect the risk posed by global warming for him or her or for anyone else that person cares about.

But if he or she takes the “wrong” position in relation to his or her cultural group, the result could be devastating for her, given what climate change now signifies about one’s membership in and loyalty to opposing cultural groups.

Kahan advises climate worriers to try to engage in public discussion in ways that are less “culturally assaultive.” This assumes that climate worriers care more about climate policy than about asserting their moral and intellectual superiority over conservatives. The most charitable I can be is to say that I am willing to wait and see whether that is the case.

The FOMC and its Target

Posted on by

Van R. Hoisington and Lacy H. Hunt write,

The Federal Open Market Committee (FOMC) has continuously been overly optimistic regarding its expectations for economic growth in the United States since the last recession ended in 2009. If their annual forecasts had been realized over the past four years, then at the end of 2013 the U.S. economy should have been approximately $1 trillion, or 6%, larger.

They go on to say that the Fed has over-estimated the “wealth effect” by which higher asset prices lead to more consumption.

If the wealth effect was as powerful as the FOMC believes, consumer spending should have turned in a stellar performance last year. In 2013 equities and housing posted strong gains. On a yearly average basis, the real S&P 500 stock market index increase was 17.7%, and the real Case Shiller Home Price Index increase was 9.1%. The combined gain of these wealth proxies was 26.8%, the eighth largest in the 84 years of data. The real per capital PCE gain of just 1.2% ranked 58th of 84. The difference between the two was the fifth largest in the 84 cases. Such a huge discrepancy in relative performance in 2013, occurring as it did in the fourth year of an economic expansion, raises serious doubts about the efficacy of the wealth effect

Let me try to put on a Scott Sumner hat and speak for him. If he reads this, he can correct me.

1. If the Fed under-forecasts nominal GDP (NGDP) in one quarter, than it ought to try raise its target for NGDP in subsequent quarters. That is, it should engage in level targeting, not simply stick to a growth-rate target after a forecast miss.

2. The Fed should use market forecasts rather than rely on a model to forecast. Ideally, we would have NGDP futures contracts. But in their absence, other nominal market variables, such as the spread between non-indexed and indexed bonds, can be helpful.

3. Wealth effect, shmealth effect. Who cares what particular component of the Fed model caused it to underpredict NGDP? Given (1) and (2), there is no good excuse for the Fed missing its targets by such a large cumulative amount.

4. The period 2008-2014 is the mirror image of 1969-1979. In the 1970s’, the Fed consistently under-predicted NGDP, with the result that monetary policy was too loose. In the recent episode, the Fed consistently over-predicted NGDP, with the result that monetary policy was too tight.

Remember that when I take off my Scott Sumner hat, I reject macroeconomics altogether in favor of PSST.

Brad DeLong is Uncharitable to Piketty’s Critics

Posted on by

This is an example of the sort of writing that I think serves only to isolate the left-wing blogosphere. Brad starts out innocently enough:

Piketty’s argument is detailed and complicated. But five points seem particularly salient:

1. A society’s wealth relative to its annual income will grow (or shrink) to a level equal to its net savings rate divided by its growth rate.

2. Time and chance inevitably lead to the concentration of wealth in the hands of a relatively small group: call them “the rich.”

…

Pointer from Mark Thoma. Read the whole thing. He then proceeds to heap scorn on Piketty’s critics. He does not cite any criticism of the second point, which is really the heart of the criticism that I have made. I think that many others have criticized point (2), also, but let me just speak for myself.

To reiterate my criticisms:

1. The distinction between capital income and labor income that underlies the forecast for wealth concentration is unrealistic. Most of “labor” income is a return to capital: human capital, social capital, institutional capital, and so on. Much of “capital” income is a return to risk. Brad himself has pointed out that the rate of return on private capital includes a huge risk premium.

2. Several critics (although I believe I was the first) have pointed out that if you believe r is greater than g, then social security is a giant rip-off and should be privatized immediately. Instead, in one of the most disingenuous arguments in the book, Piketty dismisses privatizing social security because of the high risk embedded in capital income. What is disingenuous is that this risk in private investment undermines Piketty’s main thesis.

3. I think it is pretty difficult to reconcile the risk component of investment with a model in which inherited wealth comes to dominate. Instead, given the relatively low rate of return on risk-free assets, my line is that the inheritors shall be meek.

The Capital Asset Pricing Model notwithstanding, it is idiosyncratic risk that makes you rich. People like Bill Gates and Mark Zuckerberg take large idiosyncratic risks that pay off. For wealth to become concentrated into an oligarchy, their heirs will have to invest in ways that outperform future idiosyncratic risk-takers. That strikes me as implausible.

Finally, I have to quote this from DeLong:

To be sure, everyone disagrees with 10-20% of Piketty’s argument, and everyone is unsure about perhaps another 10-20%. But, in both cases, everyone has a different 10-20%. In other words, there is majority agreement that each piece of the book is roughly correct, which means that there is near-consensus that the overall argument of the book is, broadly, right.

If I understand this paragraph, what Brad is saying is that unless a majority of Piketty’s reviewers harp on a particular fault, then there are no faults in the book. That is certainly a charitable approach to assessing someone’s work.

I think that taking the most charitable approach to people with whom you agree and taking the least charitable approach to those with whom you disagree is a path that leads to intellectual isolation.

Rothbard and Krugman

Posted on by

Jason Brennan trolls,

Yes, libertarians, Paul Krugman is a better economist than Murray Rothbard.

My comments.

1. I agree with Brennan that Krugman’s scholarly work is more important than Rothbard’s.

2. On matters of economic analysis, I have serious disagreements with both. Krugman on the liquidity trap. Rothbard on banking.

3. I think that a point of similarity is that both Rothbard and Krugman attract devoted fanatical followers who are unable to appraise their hero objectively and instead are sentimentally loyal. I am not sure, but I think that may be what Tyler Cowen means when he uses the phrase “mood affiliation.”

4. I think that at his worst (and he is often at his worst), Krugman reaches intellectual lows in terms of straw-man arguments and asymmetric insight (the claim that you understand your adversary’s motives better than the adversary understands himself) that I suspect are lower than Rothbard’s intellectual lows. Perhaps I am being charitable to Rothbard, because I have almost no first-hand acquaintance with his work.

Krugman explains his approach here.

Politics and policy are overwhelmingly dominated by what I call the Very Serious People — people who insist that deficits are our most pressing problem, that high unemployment must be a matter of inadequate skills, that low marginal tax rates on the rich are essential for growth. Behind the conventional wisdom of the VSPs lies a vast mass of power and prejudice.

Pointer from Tyler Cowen. Read the whole thing. I see this as pretty much standard Krugman. He takes the least charitable view of those who disagree with him, and he makes that the core of his argument. I think that this approach mostly inflicts damage, not so much on his enemies as on his friends. I think it brings down both their cognitive ability and their emotional intelligence.