Two bob each way

John Quiggin12 Comments
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Now that everyone is rushing to bone up on the late Hyman Minsky

and at least some of us are concluding that New Keynesian macro needs to be dumped in favour of something more like behavioural economics Left for Dead psp , I thought I’d trawl through the hard disk and see what I had to say on the subject in the past. It turns out I had something of an each-way bet. Here’s something from my 2006 paper with Stephen Bell, advocating controls on financial innovation as the best approach to preventing asset price bubbles.

One obstacle to acceptance of Minsky’s work has been the lack of microeconomic foundations, that is, of a rigorous formal account of individual behavior and the markets in which individuals interact. The idea that such an account is a necessary prerequisite for a coherent macroeconomic theory became popular in the 1970s and reached its high point with new classical macroeconomics in the early 1980s. Since then, however, emphasis on microeconomic foundations has declined for several reasons. First, users of new classical models have found it necessary to make ad hoc adjustments to microeconomic assumptions in order to improve the capacity of their models to match the “stylized facts” about the macroeconomy that they seek to capture. Second, it has been shown that, in important instances, modest deviations from standard neoclassical microeconomic assumptions (rational optimization in competitive markets) can produce large changes in macroeconomic outcomes. Third, evidence arising from fields such as generalized expected utility theory and behavioral finance has cast doubt on the empirical validity of the standard assumptions of neoclassical microeconomics.

As improved models of individual behavior are developed, it seems likely that microeconomic foundations for models similar to Minsky’s will emerge. Such foundations will take account of the fundamental role of uncertainty, emphasized by writers as diverse as Keynes, [Frank] Knight, and Minsky. For the moment, it is sufficient to observe that none of the competing models of asset markets combine rigorous microeconomic foundations with empirically realistic predictions about market behavior.

So back in 2006, I hoped that New Keynesianism ( modest deviations from standard neoclassical microeconomic assumptions producing large changes in macroeconomic outcomes) would help in the process of shifting macro away from neoclassical microfoundations, along with the generalized expected utility/behavioral economics approach. I’ve now shifted to the view that NK macro is part of the problem, and that the generalized expected utility/behavioral economics understanding is the right way to go.
This reflects the fact that the second approach has helped me to understand the crisis and the first has not.

The end of the LTTE

John Quiggin9 Comments

After a long and bloody war, marked by disregard of civilian casualties (or worse) on both sides, the Sri Lankan military has finally crushed the Liberation Tigers of Tamil Eelam as a military force, killing most of its senior leaders in the process. As national minorities go, the Sri Lankan Tamils have at least as good a cause as many others to complain of oppression and discrimination. (Broadly speaking, the usual post-colonial story where the colonial rulers favored some members of a minority group, with the result that the whole group suffered in the aftermath of independence). But their resort to armed struggle and terrorism was a disaster for all concerned, and not just because it failed. The LTTE in their temporary period of victory were worse oppressors than the most chauvinist majority governments had ever been. And of course, all Sri Lankans have suffered hugely as a result of the original policies of discrimination and worse directed against the Tamils. Even before the war broke out, the large-scale emigration of many of the most able and best educated members of the community was a huge loss.

I hope (but don’t really expect) that the government will display more magnanimity in victory than it has shown in the prosecution of the war, and that, if only on grounds of enlightened self-interest, it will seek a settlement that gives genuine equal rights to all.

This piece by Muzamil Jaleel

is well worth reading. Key quote

AK-47s cannot defeat a state and when people and communities with genuine political grievances take up arms, it only provides the state with an easy way out to enforce a military solution.

Note:This post got misplaced somehow, putting it back now

Banks should be public utilities

John Quiggin64 Comments

The news that banks have dramatically increased their fee income yet again will come as no surprise to most of us. Less significant in macro terms, but far more drastic for those affected, has been the atrocious practise of selling tiny debts to loan sharks, who will then sell people’s houses from under them at sheriff’s auctions. Given that these institutions exist only by the grace of the Australian government, it’s time to give them the same kind of message that Telstra received recently.

It’s time to offer the banks an offer they can’t refuse (unless they’re feeling lucky). Either withdraw entirely from the prudential regulation system, and stand on their own credit, or accept the fact that the public, as the residual risk-bearer, is their ultimate owner, and act accordingly.

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Time to relax water restrictions

John Quiggin34 Comments

Thanks to the rain that is still falling heavily, the water stored in Brisbane’s dams has now reached 60 per cent of their capacity. That was to have been the trigger for a relaxation of the (very stringent) water restrictions now in place, but the Water Commission has now decided* that regardless of how much water there is, the restrictions will remain until December.

This strikes me as a very foolish decision. The restrictions are socially very costly, and the risks associated with their removal very small. The construction of the water grid and the existence of a recycling plant (to be used if supplies fall below 40 per cent), combined with a sustained reduction in use, mean that the risk of a sharp decline in availability is small, and the restrictions could always be reimposed if necessary.

On the other hand, there is a significant risk that the water we are saving will end up being released to flow out to sea. The only dam in the system with any significant capacity remaining is Wivenhoe, which was built for flood control. Once it reaches 70 per cent capacity or thereabouts (that would correspond to about 80 per cent for the system as a whole) the operators will have to open the gates. More rain like we are seeing now, combined with an early and heavy wet season, would see this level reached by December or even earlier.

I’m not sure if this decision is related to the restructuring of the water industry, which has been modelled on the approach used for electricity. The electricity reforms have scarcely been an unqualified success and water is a very different commodity, so I’m dubious about the merits of this idea, which looks like a stalking horse for privatisation. Or maybe (though again I can’t see the rationale) the restrictions are being maintained to ensure that the Traveston Dam project isn’t derailed. The only other explanation for the decision is hair-shirt bloody-mindedness, which is plausible enough I suppose. I can’t really connect these dots.

*Elizabeth Nosworthy, identified with the promised relaxation, has been given the boot as Water Commisssioner.

Benefits of blogging, part 2

John Quiggin20 Comments

Although I’m among the least tightly focused economists in the academic world, I’ve published almost nothing on macroeconomics – even the few things I have done have not taken a standard macro perspective. So, in the absence of blogging, I think it’s safe to say my name would never have appeared in a Berkeley Graduate Core Macro exam.

Of course, there’s a Gerschenkron-style ‘advantages of backwardness’ story here. Having learned old-style Keynesian macro, and seen it come to grief with the inflationary outburst of the early 1970s, I kept waiting for a macro research program that would both explain the Keynesian Golden Age* I grew up in and show how to restore it in a more sustainable way. None of the contenders of the past thirty years (monetarist, new classical, real business cycle, New Keynesian, central bank eclectic) seemed very promising to me, so I left the field alone.

Now, with no intellectual capital invested, it’s easy for me to pronounce the efforts of the last three decades to be largely misdirected. The harder task will be to identify and get active in the new research program that should succeed it. The work of Akerlof and Shiller is obviously a good place to start.

* Not golden for everyone, of course. Full employment really meant full employment for men, many (not all) poor countries missed out altogether, and environmental costs were often disregarded. But it was precisely during the last years of the Golden Age (the 1960s) that these issues came to the top of the agenda. In my more utopian moments, I dare to hope that, with economic liberalism behind us, we can make big progress on these and other issues.

Spot day

John Quiggin27 Comments
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My introduction to futures markets came in a 1960s TV show called Dobie Gillis, most notable for the ‘beatnik’ character of Maynard G. Krebs, played by Bob Denver, later the eponymous Gilligan of Gilligan’s Island*. In one episode, Dobie’s high school class was assigned to do a fantasy investment exercise, and Dobie along with a cute & smart fellow student chose the egg futures markets. The smart student’s moves always paid off, and Dobie decided to copy them all in real life, building up a huge profit. Finally, the smart student announced she was selling, but Dobie intoxicated with success, decided to keep playing. This went on for a few days of rising prices, but finally when Dobie announced he had held on yet again, the fellow student said, with some horror, “But, Dobie, today is spot day”. The final scene was of the back room of Dobie’s dad’s store, filled to the rafters with the eggs on which Dobie had been forced to take physical delivery.**

Today’s Fin, with a piece by Andrew Leigh*** praising betting markets on events like unemployment rates and so on, brought this episode to mind. It struck me that the case for weak-form market efficiency (the market price incorporates all publicly available information) is much better in a market with a spot date in the near future, as is typical of real betting markets. If you are betting on a race to be run this afternoon at 3, there’s not much point in trying to track movements in the market: you’re better off backing whichever horse is offering the best odds relative to your best estimate of winning probability. More generally, markets with a spot date in the near future ought to be relatively immune to bubbles.

While I’m on the topic, I thought I would repost a piece I wrote before the 2007 elections which, I think, puts a bit of a dent in claims that betting markets really represent the superior wisdom of crowds: in this case, the polls were right long before the pundits and the punters came in last. Of course, one data point doesn’t constitute proof, but supporters of betting markets have made strong claims on the basis of fairly limited data.

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Education and the budget

John Quiggin65 Comments

No group in the community greeted the election of the Rudd government with more enthusiasm and more relief than the higher education and research sector. The Howard government had treated the sector to a decade of ideologically motivated cutbacks combined with a tribal history which reflected, in large measure, the defeats and slights its members had endured as student politicians in the 1970s and 1980s. The number of places for domestic students was effectively frozen for most of the Howard era, reflecting both a desire to pressure the universities into offering full-fee places and a belief that Australia did not really need a more educated workforce.
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