Category Archives: The dismal science

Guest Post: Predicting the Improbable– Evidence from Playing the Lottery

By Claus Bjørn Jørgensen , Sigrid Suetens, and Jean-Robert Tyran. Cross posted from VoxEU.

Japan’s trio of tsunami, earthquake, and nuclear disaster has left the world stunned. As this column points out, even the experts were shocked. But while these events were highly unlikely, they were still possible. This column uses evidence from the Danish lottery to show that people tend to adjust their expectations of future events based on only small pockets of recent experience, often at their cost.

S&P Negative Watch for US Flagged Financial Sector as Major Risk

Yes, I know I dissed the S&P report as fundamentally wrongheaded, but as we will discuss shortly, it contained some interesting commentary on the US financial sector that has gotten perilously little notice.

But I’d first like to address the way the media and some blogosphere commentators have hopelessly muddied the issues on the downgrade scaremongering. One is the “we depend on foreigners to fund our budget deficit” hogwash. As Michael Pettis pointed out, the idea that the US is funding its federal deficit from foreigners is a widespread misconstruction.

Guest Post: Too Much Finance?

Yves here. I managed to miss this post last week, but since it did not get the notice it deserved, I thought I’d feature it.

One of the recent disturbing indicators of the triumph of the doomsday machine known as modern finance is Timothy Geithner’s vision that banks will continue to grow via increased penetration of emerging economies. From a recent interview by Noam Scheiber in The New Republic:

He told me he subscribes to the view that the world is on the cusp of a major “financial deepening”: As developing economies in the most populous countries mature, they will demand more and increasingly sophisticated financial services, the same way they demand cars for their growing middle classes and information technology for their corporations. If that’s true, then we should want U.S. banks positioned to compete abroad.

“I don’t have any enthusiasm for … trying to shrink the relative importance of the financial system in our economy as a test of reform, because we have to think about the fact that we operate in the broader world,” he said. “It’s the same thing for Microsoft or anything else. We want U.S. firms to benefit from that.” He continued: “Now financial firms are different because of the risk, but you can contain that through regulation.”

As anyone one with an operating brain cell realizes, “can contain” is not the same as “have contained” or “have a snowball’s chance in hell of containing”. Simon Johnson was also not happy with the Geithner vision of US financial firms occupying even bigger swathes of the world economy.

This post is important because it tackles a very basic question: when does the financial sector become so large as to be unproductive? And the answer is at levels of GDP that the US passed shortly after 1980.

Initial Award of Frederic Mishkin Iceland Prize for Intellectual Integrity: Calomiris, Higgins, and Mason Paper on Mortgage Settlement

It seems more than a bit peculiar that, per American Banker, financial services industry participants have paid for three academics to issue a lengthy paper attacking a leaked draft settlement between state attorneys general and mortgage servicers. We have pointed out in multiple posts that the state AGs bargaining position is weak due to the lack of investigations. If the banks don’t like the terms, they can tell the AGs to see them in court.

But far more interesting is how embarrassingly bad this paper, “The Economics of the Proposed Mortgage Servicer Settlement,” by Charles Calomiris, Eric Higgins, and Joe Mason, is, yet how the economics discipline continues to tolerate special-interest-group- favoring PR masquerading as research.

In real academic disciplines, investigators and professors who serve big corporate funders have their output viewed with appropriate skepticism, and if they do so often enough, their reputation takes a permanent hit. Scientists who went into the employ of tobacco companies could anticipate they’d never leave that backwater. Even the great unwashed public knows that drug company funded research isn’t what it is cracked up to be.

But in the never-never realm of reality denial within the Beltway, as long as you can get a PhD or better to grace the latest offering from the Ministry of Truth, it gives useful cover to Congresscritters or other message amplifiers who will spout whatever big donor nonsense they are being asked to endorse this week.

Satyajit Das: Voodoo Economics Redux

n the film Ferris Bueller’s Day Off, an economics teacher, played by Ben Stein, launches into an improvised soliloquy: “… Anyone know what this is? Class? Anyone? Anyone? Anyone seen this before? The Laffer Curve. Anyone know what this says? It says that at this point on the revenue curve, you will get exactly the same amount of revenue as at this point. This is very controversial. Does anyone know what Vice President Bush called this in 1980? Anyone? Something-d-o-o economics. “Voodoo” economics.”

In the late twentieth century, US President Ronald Reagan discovered voodoo economics. In framing policy responses to the global financial crisis, central bankers and governments have increasingly embraced more exotic forms of voodoo.

Amar Bhidé on the Role of Human Judgment

Rob Johnson of INET interviews Amar Bhide, an old McKinsey colleague and author of the book A Call for Judgment. From the introduction to this video:

The Professor of International Business at the Fletcher School of Law and Diplomacy criticizes the tendency in many quarters to rely on mathematical models to inform investment decisions. It’s that overreliance on models that tend to generalize and simplify that helped drive the world into the global financial crash of 2008 and the ensuing Great Recession. Bhidé makes a strong case that human actors need to immerse in the details of individual cases and weigh many different factors to come up with tailored decisions that more closely apply to the complexities of the real world. Bhide also argues that regulators need to take a similarly human-centered approach.

Stiglitz Tells Us the Redistribution Fairy is Dead, but She Still Lives in Economists’ Fantasies

Vanity Fair has published a short article by Joseph Stiglitz on how the top 1% aren’t merely taking way more than their fair share, but how they are increasingly organizing the world to make that into a self-perpetuating system. After debunking the idea that the new economic order is a function of merit, as opposed to socialism for the rich and rent extraction, he turns to its destructive features, including:

….perhaps most important, a modern economy requires “collective action”—it needs government to invest in infrastructure, education, and technology. The United States and the world have benefited greatly from government-sponsored research that led to the Internet, to advances in public health, and so on. But America has long suffered from an under-investment in infrastructure (look at the condition of our highways and bridges, our railroads and airports), in basic research, and in education at all levels. Further cutbacks in these areas lie ahead…..

OMG, Greenspan Claims Financial Rent Seeking Promotes Prosperity!

I was already mundo unhappy with an Alan Greenspan op-ed in the Financial Times, which takes issue with Dodd Frank for ultimately one and only one disingenuous and boneheaded reason: interfering with the rent seeking of the financial sector is a Bad Idea. It might lead those wonderful financial firms to go overseas! US companies and investors might not be able to get their debt fix as regularly or in an many convenient colors and flavors as they’ve become accustomed to! But the Maestro managed to outdo himself in the category of tarting up the destructive behaviors of our new financial overlords.

What about those regulators? Never never can they keep up with those clever bankers. Greenspan airbrushes out the fact that he is the single person most responsible for the need for massive catch-up. Not only due was he actively hostile to supervision (and if you breed for incompetence, you are certain to get it), but he also gave banks a green light to go hog wild in derivatives land. And on top of that, he allowed banks to develop their own risk models and metrics, which also insured the regulators would not be able to oversee effectively (there would be a completely different attitude and level of understanding if the regulators had adopted the posture that they weren’t going to approve new products unless they understood them and could also model the exposures).

And the most important omission is that the we just had a global economic near-death experience thanks to the recklessness of the financial best and brightest.

What’s the difference between government bonds and bank notes?

In a fiat money environment, the first function of the Treasury bonds is to serve as a vehicle to add or subtract reserves in the system to help the Federal Reserve hit a target Fed Funds rate. The second is to give holders of government obligations a return on their investment. After all, bank notes or bank reserves don’t pay much if anything.

Am I missing something?

Scott Fullwiler: Paul Krugman—The Conscience of a Neo-Liberal?

By Scott Fullwiler, Associate Professor of Economics at Wartburg College

The old saying that bad press is better than no press is definitely true in this case. Without the advent of the blogosphere, our work would likely never even be noticed by the likes of Paul Krugman, so the fact that he’s writing about us (here and here) this weekend at least means we’re doing better than that, even if his assessment of us is far less than glowing. At the same time, and particularly given that Krugman is so widely read, it’s imperative to at the very least set the record straight on where MMT and Krugman differ. I should note before I start that others have done very good critiques already that overlap mine in several places (see here, here, here, and here).

Krugman makes three incorrect assumptions about what MMT policy proposals actually are while also demonstrating a lack of understanding of our modern monetary system (as is generally verified by volumes of empirical research on the monetary system by both MMT’ers and non-MMTer’s). These are the following:

Assumption A: The size of the monetary base directly (or indirectly, for that matter) affects inflation if we’re not in a “liquidity trap”

Assumption B: MMT’s preferred fiscal policy approach or strategy—Abba Lerner’s functional finance—is Non-Ricardian

Assumption C: Bond markets alone set interest rates on the national debt of a sovereign currency issuer operating under flexible exchange rates

Assumptions A and C are central to the Neo-Liberal macroeconomic model. Assumption B is a common misconception about MMT and a common perception of Neo-Liberals about the nature and macroeconomic effects of fiscal policy (i.e., Neo-Liberals often believe that activist fiscal policy is Non-Ricardian).

While MMT’ers argue that all three assumptions are false, one does not need to necessarily agree. The point is that to critique MMT on the basis of assumptions that are inconsistent with MMT is to actually not critique MMT at all. It is a straw man.

Complexity and War or How Financial Firms Wreck Economies for Fun and Profit

There’s a great post up, “Human Complexity: The Strategic Game of ? and ?,” by Richard Bookstaber, former risk manager, author of the book A Demon of Our Own Design and currently an advisor to the Financial Stability Oversight Council. As insightful as it is, Bookstaber does not draw out some obvious implications, perhaps because they might not be well received by his current clients: that the current preferred profit path for the major capital markets firms is inherently destructive.

I suggest you read the post in its entirety. Bookstaber sets out to define what sort of complexity is relevant in financial markets:

The measurement of complexity in physics, engineering, and computer science falls into one of three camps: The amount of information content, the effect of non-linearity, and the connectedness of components.

Information theory takes the concept of “entropy” as a starting point…

Richard Alford: Fed Policy, Market Failures and Irony

By Richard Alford, a former economist at the New York Fed. Since then, he has worked in the financial industry as a trading floor economist and strategist on both the sell side and the buy side. “..there is always a well-known solution to every human problem — neat, plausible, and wrong.” H L Mencken One […]

The Stigmatization of the Unemployed

One thing I have never understood in America is the way that people who lose their jobs become pariahs in the job market. We’ve now had a spate of commentary on the fact that official unemployment figures are looking a tad less dreadful by dint of the fact that increasing numbers of the long term unemployed have dropped out of the job market entirely. Even the conservative Washington Post woke up last week, Rip Van Winkle like, to take note of the growing number of long-term unemployed. Bizarrely, or perhaps as a fit illustration of the spirit of the day, the article was titled: “Hidden workforce challenges domestic economic recovery.” In other words, they are Bad People because if the economy ever picks up, they might come out of the woodwork and start looking for jobs!