Category: Economics – General

A bit more on the economics of happiness

John Quiggin32 Comments

I was discussing the economics of happiness with my son, and in particular the Easterlin paradox. Within a given country, people with higher incomes are more likely to report being happy. However, in international comparisons, the average reported level of happiness does not vary much with national income per person, at least for countries with income sufficient to meet basic needs. The same is true over time – average happiness levels don’t change much even as incomes rise.

This is often taken to mean that it’s relative rather than absolute income that determines happiness, so an increase in everyone’s income won’t make anyone happier. Hence, we shouldn’t worry so much about increasing income, but should focus more on factors likely to contribute to happiness. The point that struck me was that, given Easterlin’s data, the paradox is almost certain to apply whatever potential source of happiness we consider, in one form or another.

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Free-market responses to the crisis?

John Quiggin43 Comments

I’m working on questions of a new financial architecture in the wake of the financial crisis and the various bailouts, and I’m interested in whether there is a well-worked out free market alternative to the policies we’ve seen so far.

To be clear, I’m not interested, at this point, in arguments about whether free markets are to blame for the crisis. I’m also not interested in criticism of the bailout unless it’s presented as part of a reasonably detailed argument that doing nothing, or doing something different, would produce a better outcome. Finally, I’m not interested in responses based on fringe economic theories, for example, anything based on gold or the ideas of Ron Paul[1]. That is, I’m interested in work by mainstream economists putting forward a more free-market alternative to the policy of partial nationalisation adopted so far.

fn1. I’ll post on this later, but in this thread, I will terminate with prejudice anything of this kind, and similarly for meta-comments that Paul is not really a fringe figure or that someones right to free speech is being censored here.

Plea for help

John Quiggin11 Comments

You guessed it, it’s a bleg(gh!). To improved the performance of this site, I need to move the blog from its current shared hosting to a different accelerated server. This involves various bits of SQL database magic that are beyond my skills. If someone can help, I’ll be happy to reward them with a post on a topic of their choosing or (if professional skills are needed) with a reasonable monetary return for their time.

The Sandlot rip

Bad models or bad modellers

John Quiggin19 Comments

The idea that bad mathematical models used to evaluate investments are at least partially to blame for the financial crisis has plenty of appeal, and perhaps some validity, but it doesn’t justify a lot of the anti-intellectual responses we are seeing. That includes this NY Times headline In Modeling Risk, the Human Factor Was Left Out Laserblast movie download . What becomes clear from the story is that a model that left human factors out would have worked quite well. The elements of the required model are
(i) in the long run, house prices move in line with employment, incomes and migration patterns
(ii) if prices move more than 20 per cent out of line with long run value they will in due course fall at least 20 per cent
(iii) when this happens, large classes of financial assets will go into default either directly or because they are derived from assets that will default in the event of a 20 per decline in house prices

It was the attempt to second-guess human behavioral responses to a period of rising prices, so as to reproduce the behavior of housing markets in the bubble period, that led many to disaster. A more naive version of the same error is to assume that particular observed behavior (say, not defaulting on home loans) will be sustained even when the conditions that made that behavior sensible no longer apply.

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A tough road ahead

John Quiggin26 Comments

Over the fold, is my piece from today’s Fin on the task facing Obama. The original version started “Following his convincing election victory, Barack Obama can look forward to taking office under the most challenging conditions facing any incoming president since Franklin Roosevelt’s inauguration in 1933,”, but another columnist came in with an almost identical lead, so I changed mine. But the great thing about a blog is that you can choose which version you like best (or dislike least). The original opening paras are at the end of the post.

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Treasury on the cost of saving the planet

John Quiggin57 Comments

I’ve been too busy to do more than read the summary of the Treasury’s estimates of the cost of an measures to reduce greenhouse gas emissions, most importantly an emissions trading scheme. Of course, there have been quite a few exercises of this kind, but what’s striking about this one is that it looks at a much wider (and more realistic, if we want to save the planet) range of options, going all the way to a 90 per cent reduction in emissions relative to 2000 levels, achieved by 2050. This is a contract and converge scenario where all countries accept a common emissions entitlement per person.

Treasury estimates that, under this scenario, GNP per person in Australia will average $78 000 in 2050 compared to $50 000 at present. By contrast in the reference scenario which has an 88 per cent increase in emissions, 2050 GNP is estimated at $83 000, or about 6 per cent higher (I don’t think this takes account of costs avoided through climate mitigation).

When I get a bit of time, I’ll report more on the details and assumptions. But the quibbles coming from predictable rentseekers, and their tame consultants, look like just that, quibbles.

Treasury’s estimates are, not surprisingly, quite consistent with the arguments I’ve made for a long time on this blog. That’s because any competent economist doing the analysis must come up with estimates of a comparable order of magnitude. If you want to make the case that saving the planet requires reducing living standards, or even a big reduction in the rate of growth of living standards, you need either to invent a whole new economics or wave your hands vigorously enough to conceal the fact that you don’t have any economic analysis to support you.

What does it all mean?

John Quiggin21 Comments

There’s been a bit of discussion about what Alan Greenspan really conceded in his recent testimony. Although Greenspan was less opaque than usual, I won’t try to second-guess him any further, and will instead ask again what the crisis means for the way we think about economics and the economy. There are two big economic ideas that look substantially less appealing in the light of the current crisis.

The first is the macroeconomic hypothesis, often called the Great Moderation which combines the empirical observation that the frequency and severity of recessions declined greatly from 1990 to the recent past with the explanation that “the deregulation of financial markets over the Anglo-Saxon world in the 1980s had a damping effect on the fluctuations of the business cycle”.

The second is the microeconomic idea, central to much of modern finance theory called the Efficient Markets Hypothesis. In its most relevant form, the EMH states that prices observed in asset markets (for stocks, bonds, foreign exchange and so on), reflect all known information, and provide the best possible estimate of the value of earnings that assets will generate.

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Greenspan concedes

John Quiggin82 Comments

There’s been a fair bit of debate about what, if anything, the current crisis means for economic policy and political philosophy more generally. A lot of this has been hung up on issues of terminology, which I will do my best to avoid here and in future.

Coming to substance, quite a few people have argued that the crisis doesn’t really signify very much, and that, once it is resolved, things will return to pretty much the way they were a couple of years ago. I disagree.

This concession of error by Alan Greenspan is, I think, pretty strong evidence against the view that the crisis is not so significant, in policy or ideological terms.
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Steve Keen on debt

John Quiggin51 Comments

There’s been a lot of discussion recently about Steve Keen‘s work on debt, presented (among other places) in this paper for the Centre for Policy Development last year. I made some comments at the time, as follows:

I’m generally in sympathy with the arguments presented here. However, having made similar arguments for a long time and having been continually surprised by the durability of the asset price boom/bubble let me offer a couple of counterarguments/cautions:

(1) The increase in house prices can be partially explained (on the supply side) by the increase in the size/quality of the average/median house and, particularly in the last decade, by increases in the cost of labour and materials

(2) On the demand side, given the above and the fixity of land, some increase in prices would be expected as a result of population growth and income growth. If you suppose that housing is a superior good, this would imply that the value of houses should grow faster than GDP, and probably that debt would also rise relative to GDP.

(3) Looking at the big picture of the rise in debt, it has gone on for so long (40+ years) that it must cast some doubt on arguments based on the claim that bubbles always burst. I still think the arguments are valid, but the objection can’t just be dismissed

(4) A fuller version of the optimistic story would say that credit markets have become steadily more efficient with the result that households are able to manage much larger volumes of debt. A plausible version of this story might include the concession that the debt growth of the past decade has outrun the capacity of households and markets to manage it, implying the need for a painful correction as is now happening in the US, but also allowing for a continued upward trend in, or stabilisation of, debt/income ratios.

On balance, having thought through all this, I still think the story in Steve Keen’s piece is the right one. But it’s important to confront the opposing argument in its strongest possible form.

Obviously, the opposing arguments I wanted Keen to respond to look a lot weaker now. Whatever qualifications I might still want to make, Keen got the basic points right, and those who are criticising him now should concede this.