Matt Nolan

Quote 23: Daniel Little on Popper and meta-social theories

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Excellent quote (ht Economist’s View):

Popper’s critique of historicism, then, can be rephrased as a compelling critique of the model of the natural sciences as a meta-theory for the social and historical sciences. History and society are not law-governed systems for which we might eventually hope to find exact and comprehensive theories. Instead, they are the heterogeneous, plastic, and contingent compound of actions, structures, causal mechanisms, and conjunctures that elude systematization and prediction. And this conclusion brings us back to the centrality of agent-centered explanations of historical outcomes.

Agreed with this 100%.  Fundamentally, the usefulness associated with the study of economics comes from its framing and discussion of tendencies – not from the precise value of its predictions.

An understanding of individual actions and incentives allows us to describe what has happen and inform policy – but it does not give us a crystal ball with which to see the future, or figure out exactly what will maximise social happiness.

That is why we economists never seem to agree with each other.  But when we do agree, it is probably a good idea to listen, as there must be a rare combination of compelling factors driving such an unlikely event 😀

Note:  To clarify what I think the quote says that I’m agreeing with.  I believe it says that we can’t come up with some holistic model of society that will spit out nice predictions – we can only try to understand society through the behaviour of individuals given observed actions.  This sounds like methodological individualism to me …

Matt Nolan

Bailouts, moral hazard, and the money supply

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Over at Anti-Dismal Paul Walker says:

The bailouts were not a good idea, just think of the moral hazard problem this has created, while there may have been more justification for the Fed acting to prevent the money supply from falling.

These are all important issues.  If the “bailout” (I use the term loosely, as buying profitable equity shares and making loans that get paid back are not what we normally view as a bailout) created a moral hazard problem we are just delaying an inevitable contraction – and supporting inefficient firms.  Furthermore, if there is another way for the Fed to control the money supply without a bailout it is likely that would be a preferable action.

However, the fact is that a bank run (which is what we were trying to prevent with the “bailout”) reduces the money supply – even if the Fed leaves the money stock unchanged.  As a result, we can’t really treat the two issues separately.  Remember, the Fed doesn’t control the money supply directly, the money supply is formed through the financial system.  As a result, I don’t think that the Fed could “maintain the money supply” in the face of a massive bank run.

In regards to the 1930’s this point is illustrated by Bruce Bartlett (ht Marginal Revolution):

There’s no way the Fed could have expanded the money supply in the early 1930s without bailing out the banks. How do you think the money supply declined in the first place? It’s because banks failed and their deposits disappeared. To keep those deposits from disappearing in an era before deposit insurance would have required keeping bankrupt banks afloat.

If we had experienced a bank run, we would have suffered a similar decline in the money supply – even with the Fed pumping money out into the money stock.  Now if prices cleared perfectly this wouldn’t matter, the drop in “velocity” would be met by a drop in the price level.  But prices don’t move immediately, implying that the drop in the money supply as a result of the bank run would have had an impact on real output (*).

Now, I completely admit that Moral Hazard is a relevant issue.  But is a the cost of letting large financial institutions know that, in a 1 in 100 year collapse in the global economy, they will be prevented from going bankrupt immediately greater than the benefit of avoiding a sharp and self-propogating decline in economic activity?  For the bailouts to be a good idea we merely need to say:

  1. the costs exceeded the benefits,
  2. this was the best scheme that was able to be approved at the time.

I think both these factors hold – although I completely understand when people feel differently, given that there is a trade-off.

Matt Nolan

The 24% price pick

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There were supposed to be a number of important points made today as I can finally cover the house price pick.  Here is a list of what I was supposed to cover:

  • The first house price increase (to June 2010) merely takes us back to where we were in December 2007 in nominal terms.
  • Real house prices don’t re-reach their peak for another year after the nominal level returns.
  • However, house prices remain 30% overvalued – structural factors imply that this is an “equilibrium”, although not a very nice one.
  • Ultimately, in the long-run, we agree with Bernard Hickey and Gareth Morgan that prices need to go back to “fair value”.  Our argument is only over the transition path.  There is a difference between saying that they economy needs to rebalance (true) and assuming it just magically will – we don’t think it will in the short-term.

Driving growth is:

  • Loosening credit conditions,
  • Low interest rates,
  • Limited supply on the basis of a weak build rate
  • Limited supply on the basis that people don’t really want to sell (unemployment stays moderate, interest rates low, lack of forced sales).
Matt Nolan

GST on rent

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In an excellent article from Brian Fallow, the idea that GST could be applied to rent is brought up.

I agree with this 100%.  By not taxing rent we are distorting incentives regarding the investment in housing – after all, rent is a form of consumption and should be captured by a tax on consumption.  (Note:  I haven’t been clear enough that the “revenue neutrality of the tax” is very important – this only makes sense if we are cutting more distortionary taxes as a result (eg income taxes).)

However, I would go a step further.  We should be taxing the rental equivalent of ALL properties with GST – as the rental equivalent (when you own a house) is consumption.  Now remember this doesn’t just impact on renters, it depends on the incidence of tax.  As a result, it will lead to lower net of tax returns to property investors – net returns that are more closely related to the relevant net returns among other asset classes!!

Part of the reason that New Zealand has overinvested in housing is because of favourable tax treatment.  A clean up of GST in regards to the housing market, combined with a revenue neutral increase in GST rates, would have a big impact on the housing market.

Update:  Kiwiblog comments here.  Not PC comments here.  Rates Blog comment section here.

Matt Nolan

Breakfast tomorrow: Defending the 24% increase in house prices

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I will be on Breakfast tomorrow (at 6.50am) defending Infometrics pick of a 24% increase in house prices over the next three years.

Although the last pick was a little off, house prices still only feel a little bit more than we stated (falling 10% vs our 5% – although if you look at median house prices the decline was only 5.4% :P) and this was really the result of a collapse in credit markets – something that had not fully eventuated at the time.  Once the credit crisis stepped up following Lehman Brothers we moved into the 10% fall camp.

Anyway, feel free to complain about things I say here – until I get a post up discussing what I went over.

The Hand

Bank runs and TARP

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This is a Hand post, but it is actually just the normal authors of the blog.  We all had the same idea at the same time 😀

Over at Anti-Dismal, Paul Walker reaches the conclusion that

The moral of the story, markets can deal with asymmetric information

In the case of bad and good banks.  He states that banks are able to signal whether they are strong or not, and so government intervention is unnecessary.

However, this doesn’t seem to weigh up properly with the vast amount of literature that points out that bank runs are a concern resulting from asymmetric information (and multiple equilibrium – for economists this is because withdrawal decisions are strategic complements) and that a small amount of government intervention can help prevent said negative outcomes (here and here are seminal pieces).

Now there is a way that we can put both points of view together. Lets look at how the market is overcoming the asymmetric information problem:

At least one major US bank is advertising the fact that it refused TARP funds.

So the market was only able deal with asymmetric information in this case because the government created a mechanism that allowed banks to credibly signal (the TARP program).  It is ONLY because the government created this mechanism that the individual banks could signal their “strength” credibly, thereby preventing an inefficient bank run equilibrium.

So I would change the moral of the story slightly to

markets can deal with asymmetric information, when the institutions are in place that allow them to credibly signal quality – an issue government can sometimes help with