Matt Nolan

Quote of the Day: Barry Ritholtz on the outlook

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Via Justin Wolfers on twitter comes this excellent quote – an answer to “what is your outlook on the markets and the economy”:

I think it is of much greater value to be able to put the current situation into broader context, via a variety of variables and factors, than make guesses about the future.

This is very true.  I’d add a little something though.  Any “forecast” we provide is really just an interpretation of evidence of where we’ve been, and where we are now.  If someone is going to give you advice about risks and challenges they should really spend more time trying to explain what is happening and the context it is within.

“Where we are now” is actually a much harder question than most people recognise, it is even harder than “where have we been” which is also incredibly difficult.  We have to have a pretty compelling, and pretty transparent, case for being able to answer those questions before we can say much about “where might we be going”.

Often when I say this to people they say “what a waste of time, I can tell you where/show you some math that says we are going”.  I’m sorry, but whenever I hear people talk this way – without a proper appreciation of where we’ve been and history – I do not expect to get much out of what they say.  I haven’t been disappointed yet!

Mathematical and statistical analysis are key, definitely, but only with a respect for historical context – which is the information mathematical and statistical models rely on in the first place.  Our apriori knowledge is not clairvoyant enough to conjure up structural breaks, or give us an objective model of reality without appeal to sense data 😉

Matt Nolan

Good marginal revolution posts for today

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Ahh I see two Tyler Cowen posts up in the past 24 hours that I have to list down for future reference:

  1. On the jump in bond rates as the Fed suggested a tapering in QE was in sight.
  2. On the differences of views between the economics community and economics blogs.

I would note a couple of things.

The term structure of interest rates are always confusing – and hard to interpret without reference to other variables at the same time.  The drop in asset and commodity prices at the same time as the drop in bond prices indicates “tighter monetary policy” (I prefer avoiding the bubble line – as the word is a bit loaded, and a ‘bubble’ based on cheap credit is different than a ‘bubble’ based on out of whack expectations … in fact I wouldn’t even use the term in the first case) – the real question of interest for me is “what were expectations of Fed tapering prior to the announcement”?  This seems like a strange reaction for an announcement that in many ways should have been expected!  [Add this from Money Illusion, and all the links within – the simultaneous events in the US and China make this a messy thing to read indeed]

And in terms of blogs, Cowen is right that economists are generally less overconfident and moralistic in their research than they are on blogs.  Economics research is neat to read, and is unlikely to get you hot under the collar in the same way blogs do 😉 .  Now this is the difference between writing as an economic researcher, and writing as an individual, so it should really be expected 😉

Matt Nolan

BS from the BIS?

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I see that the Bank for International Settlements has released their latest annual report.  I have not read it, but will place it here to peek at later.

However, if this (great) post from Ryan Avent is to be believed, it sounds like I will not like this report very much.  I’d also note that this report led Lars Christensen to pop this post back up on Twitter (it reminds me of Lords of Finance – the BIS took quite a hammering in that book).

Towards the end of Ryan’s post he quotes this from the report:

Although central banks in many advanced economies may have no choice but to keep monetary policy relatively accommodative for now, they should use every opportunity to raise the pressure for deleveraging, balance sheet repair and structural adjustment by other means.

This is absolutely and totally shocking – I’m having to convince myself it is somehow out of context to prevent an accidental blog rage 😉 .  I was going to write something, but then I realised Ryan said it better than I ever could:

No. They should not. Central banks—small, elite, technocratic groups given as much independence from political pressure as is institutionally possible—should absolutely not use every opportunity to raise the pressure for structural adjustment. Central bankers have been given a phenomenal amount of economic power: relatively untrammeled control over the unit of exchange and, by extension, over the demand side of the economy. Use of that phenomenal power to influence control over other aspects of the economy—including budget decisions, labour-market regulations, and the benefit structure of old-age pensions—is wildly outside the purview of the central bank and sure to prove corrosive to the independence of the central bank and the democratic process.

Part of the parcel of reasons why I’ve been defending central banks against politicians over here suggesting they should do EVERYTHING is because it is wildly inappropriate (lately here and here).  Not only is it outside their mandate, but as I noted on this bubble post, it violates democracy pushing decision making towards a technocratic elite who “know best”.

The point of an independent central bank IS NOT so that technocrats can do fancy things without needing a democratic mandate … it is actually just the way democratically elected governments tie their own hands with regards to monetary policy, just monetary policy.

All these other “structural” policies in the broad economy, they should be determined by our democratically elected government.

If technocrats/economists are not able to “persuade the public” about risks, this is not a reason to use public office to “force” the public to accept this – it is instead a call to try to make your argument more compelling, and to learn to accept that sometime society may not agree!  I’m not a political scientist, but a situation where unelected technocrats punish us if we don’t do what they think is right doesn’t sound like the right way forward …

And here is something I would note.  By trying to force technocrats to impose these structural policy, taxes, costs, and adjustments a democratically elected government would be merely trying to hide the fault for (provide misinformation about) introducing unpopular policies – in itself, a move that seems undemocratic.

Update:  Lars Christensen discusses these ideas with regard to accountability and the “number of targets“.  I completely agree – this combined with the benefit to communication is why I am a fan of clear concise and separate targets for different authorities.  The idea of “why” we give independence and the level of accountability are things we should be discussing – and an area which the Greens have opened up for debate.  After NZAE I intend to start blogging some of the literature discussing this and trade-offs 🙂 … I see NZIER decided to kick that off in any case!

Update 2:  Brennan McDonald raises his concerns about Basel.  I have sympathy for this view – these actions in the name of “financial stability” do have an allocative impact, an issue that is important to try and understand.

Update 3:   Economist’s View points out a bunch of posts – good posts – also frustrated at the BIS report.  I am not sure whether I should read this report anymore 😉 – jks, read everything especially when it disagrees with your priors!

Update 4:  James sent me an Economist article disagreeing with the RA one here.  It stated:

Countries that misallocated resources to the sectors that boomed before the crisis, such as construction and finance, are being held back from the necessary adjustments by rigidities in labour and product markets. Supply-side reforms are needed to break down these barriers but loose monetary policy reduces the pressure to force through these painful changes.

I decided to pop in a response in my email to James:

I’ll link to that, but this is one of the reasons why I still favour flexible inflation targeting – if it is true that the government has munted the supply side, expected inflationary pressures will rise before we hit our prior trend, and a demand focused central bank will start lifting interest rates.  It is still demand management, and the governments choice to f the supply side was theirs.  Furthermore, it is the government, and societies, choice to cut potential output … not technocrats.

Matt Nolan

Neat reddit post on Philosophy

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Via Philosophy Bro on twitter I spotted this reddit entry on professionals, and then more broadly on philosophy.  It is a neat read.

I especially enjoyed the bit right at the end:

For most philosophy students, I can tell how well they’re doing in gaining the right skills by how worried much they understand compatibilism about freedom of the will. When they are no longer worried about determinism being compatible with free will, they tend to also be good at philosophizing. For whatever reason, “How I learned to stop worrying and love the determinism” tends to be a pretty good marker.

I am not a philosopher.  I am not very good at philosophy.  I get hung up on the free will vs determinism issue (usually when talking about neuroeconomics here and here).  So this sound like a legit rule 🙂

In terms of understanding action, I am not sure the distinction is actually terribly important – in both cases, people will be following what appear to be deterministic rules.  But how we interpret those rules, and policy actions around them, has a moral element which we may value in different ways depending on whether we view the mind, and in turn how we view action as due to free will or determinism.  I think that sort of stuff sounds pretty interesting and cool, even though it is over my head 🙂

jamesz

Self analysis through exhaustive data gathering

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When tech companies were torturing their interviewees with questions like ‘why are manholes round?’ there was much fawning over the way they got people to think on their feet. Now Google’s HR boss says that those questions were all a waste of time:

brainteasers are a complete waste of time. How many golf balls can you fit into an airplane? How many gas stations in Manhattan? A complete waste of time. They don’t predict anything. They serve primarily to make the interviewer feel smart.

Instead, what works well are structured behavioral interviews, where you have a consistent rubric for how you assess people, rather than having each interviewer just make stuff up.

Legions of HR professionals will probably roll their eyes and nod with smug satisfaction as Google figures out what they knew already. But what I find really impressive about this interview is the way it emphasises Google’s quest to improve itself. It tried numerous interviewing techniques, tracked the successful candidates, and then analysed the data to figure out what worked. Most of all, it isn’t afraid to acknowledge that the techniques for which it became notorious were wrong!

Matt Nolan

Interpreting a (monetary) quantity – we need a cause

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Over at Not PC I noticed that Peter is putting some of the “blame for the housing bubble” at the feet of the RBNZ.  His view shares similarities to the discussion I’ve been having – and will continue to have – with Lowell Manning (here, here, here).

Essentially, the view is that the Bank is allowing M3 to grow too quickly and this is showing up in excessive house prices.  By having “too much” fiat currency the central bank is devaluing the currency, and that is coming through the price of land/housing.  Now don’t get me wrong, look at monetary aggregates – they provide useful information.  Furthermore, I believe these guys deserve a response, and next month I’ll try to craft something a bit better than this.  But let me note down some points as an accidental “Reserve Bank apologist”.

This story provided does have a compelling narrative, it has a start, and end, a villian, a potential heroine, all the good elements of a believable story.  But for me, there are a few key things missing:

  1. The central bank doesn’t set the “quantity of money”, it sets the “price”.  In reality it doesn’t even do that – the interest rate is set by forces in the economy.  Instead, the central bank targets the rate of growth in the “general price level” – and it has stuck to that.   They are going to devalue fiat currency at a predictable and steady rate – and that is just what has happened.
  2. Where is individual choice in this model?  M3 growth is too high, and as a result people blindly borrow the floating $$$ to buy houses … knowing that the future real value will fall and burn them?  This sounds funny.  Instead, with individuals choosing to buy property M3 growth doesn’t seem like the cause here – so much as it is the SYMPTOM!
  3. Say that the RBNZ has been soft, why is it the relative price of housing … not general inflation … that is rising.   We may say “land is durable, and the price is high because of expected future inflation” – but then the question would be why we don’t see this across all asset classes in NZ, and more importantly why survey measures do not show these “inflation expectations”.
  4. Furthermore, if this has been a long last bubble (due to the persistent high growth in M3) why have the “relative prices” of other goods never caught up – if this has been one big long bubble due to “monetary policy” at some point we need to be getting that high inflation.  Monetary policy doesn’t keep relative prices out of whack forever.

This is the thing for me – it is a relative price of housing issue.  The money supply is “endogenous” and so, since “demand for housing” has risen, so has borrowing and M3 growth.  With no generalised inflation going on, the RBNZ isn’t printing money to cause a housing bubble – it is allowing the money supply to rise given the housing bubble, in order to not excessively constrain the rest of the economy.

Note the Bank will be concerned about a “housing bubble” if it is leading to “excessive consumption and/or investment” which creates inflationary pressures – in that case they will act with monetary policy.  They will be worried about issues of “financial stability” due to high gross debt levels, highly leveraged groups, or a concentration of debts in an asset class – in that case they will act with macroprudential policy.

Outside of this, this issue has nothing to do with the Bank.  In fact, outside of this this issue of a “bubble due to irrational expectations” is virtually IRRELEVANT for society as a whole – if people are determined to pay over the odds for something to other people, then that is just a straight transfer of goods and services.  If we really have an “irrational bubble” why are we so keen to punish the rest of the economy in a weak (and likely to fail) attempt to stop people making their own dumb mistakes – as we will be inappropriately lifting interest rates and making other forms of investment more expensive to “deal with” the fact that some people have strange ideas about the potential for house price appreciation in the future 😉 [And let’s not start talking about foreigners – as this is just a transfer FROM overseas TO NZ].

As an Austrian economist I am sure that Peter is also concerned about a misallocation of capital.  However, in this context this would require “overbuilding” … if there is a “housing bubble” we will “overinvest in building houses” (remember trading houses between each other isn’t “investment” in this sense, it is a transfer).  Is this what we are seeing?  And if it was, are the welfare costs really that large … especially relative to the practical status-quo, since no-one truly knows how to pop bubbles outside of kidnapping people or taking their savings off them!