jamesz

Experience may not improve judgement

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We’ve all met hardened cynics in our professional lives. Those people who think the worst of those they meet at every turn because they’ve been burned so many times. They give nobody the benefit of the doubt and look down on new staff for their hopelessly naivety and gullibility. The question posed by a group of researchers in the latest EJ is whether judges are similarly afflicted by experience.

They take a panel of UK Competition Commission decisions from 1970–2003 and evaluate the effect of the chairman’s experience on the probability of an adverse finding. Using a panel of that size allows them to control for various effects such as the chairman’s age.

Using a unique data set of companies investigated under UK competition law, we find very strong experience effects for chairmen of investigation panels, estimated from the increase in experience of individual chairman. Probit and IV probit regressions indicate that replacing an inexperienced chairman with one of average experience increases the probability of a ‘guilty’ outcome by approximately 30% and, after chairing around 30 cases, a chairman is predicted to find almost every case guilty.

jamesz

Housing fuelled consumption boom?

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In the EJ:

There is strong evidence that house prices and consumption are synchronised. There is, however, disagreement over the causes of this link. This study examines if there is a wealth effect of house prices on consumption. Using a household-level panel data set with information about house ownership, income, wealth and demographics for a large sample of the Danish population in the period 1987–96, we model the dependence of the growth rate of total household expenditure with unanticipated innovations to house prices. Controlling for factors related to competing explanations, we find little evidence of a housing wealth effect.

Matt Nolan

Careful where we lay the blame

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Brian Fallow writing in his normal clear and intelligent manner has come out discussing the government budget.  As he says, a slump is not the time for “austerity” in terms of cutting back the size of government, and we should allow temporary deficits to help ease the blow – the point of automatic stabilisers is that they help out those that are struggling the most during a protracted slowdown.  Furthermore, I agree that the low level of long-term government bond rates does imply that government should be shifting investment forward now – something they seemed willing to do in 2009 but have moved away from since.

But, I have to slightly take issue with this:

Especially so since the Reserve Bank yesterday voiced concern at signs that the improvement in household saving rates may be stalling and that household debt is rising from a level already high relative to incomes.

The Government also argues that by running a tight fiscal policy it allows the bank to keep monetary policy looser than it otherwise could – lowering pressure on interest rates and the dollar.

However, as the bank reminded us yesterday, that silver lining comes with an increasingly ominous cloud in the form of rampant house price inflation, most notably in Auckland.

With the dollar as high as it is, the bank is reluctant to raise interest rates.

With the supply side of the housing market, especially in Auckland, unlikely to relieve the pressure on prices for years, and with gruesome examples in the Northern Hemisphere of what happens to an economy when a housing bubble bursts, at some point the bank is going to have to crush the demand side by raising interest rates.

If that coincides with fiscal contraction from a debt-obsessed Government, the effects could be unpleasant.

I don’t like where this logic is starting to go.  The RBNZ is responsible for “aggregate demand” in the economy.  If this is too low, then the RBNZ has set monetary conditions too tight, it is their fault.  Sure they may say it is not, some may say I am being unfair saying this … but if there is anything history has shown us, whenever we try to say “this time is different” with regards to a demand shortfall we usually end up coming back to blaming the central bank.

Relatively high debt levels and high house prices are not a monetary policy or demand issue.  They are an issue of financial stability, an issue of economic structure.  Yes, they create risks and can have negative welfare consequences.  Yes, competition, fiscal, and financial stability policy needs to account for them.  But monetary policy needs to take fiscal, competition, and financial stability policy AS GIVEN and then focus on “demand” from there.

Not dealing with demand because of concerns about these issues isn’t prudent, it is policy failure.  Blatant policy failure.  If you don’t believe me, ask someone who is both smarter and more articulate than me such as Nick Rowe.

Now, if the government remains on course and the RBNZ tightens monetary conditions to “fight the housing market” while it expects inflation to be low and unemployment high, they are explicitly violating their mandate and best practice of a central bank.  It is as simple as that.  I’m happy saying this out loud because they would not do that, they know these things, and will continue attempting to set monetary policy at the right level to deal with demand issues (as represented by their forecasts for inflation and unemployment over the next two years).  But given that the RBNZ does this appropriately, the government deficit does not matter outside of its impact on the composition of the economy.

If we want to criticise government policy during the recession, do it in terms of investment (it would have been a good time to move a bit more investment forward), and social policy related things.

Note:  If we believe that the response to interest rate changes will be very small, that in some sense investment demand is very “inelastic” then we can make a claim for government investment – we just need to be very clear on that AND we need to ask why in that case we still have a positive cash rate.  Remember, government investment here also works by driving up the “natural” interest rate … so through the same logic it will lead to a higher real exchange rate and higher government borrowing … unless the “cumulative impact” of rising demand pushing activity towards potential outweighs that.  And if we are using that “cumulative impact” argument for government spending then it also holds for a cut in domestic interest rates, just with a lower real exchange rate and compositionally more private sector activity.  So protip:  we can’t complain the exchange rate is too high and that government spending is too low at the same time!

Update:  Also after today’s unemployment and employment numbers I think people should be willing to rethink whether they think there is a “demand” issue in NZ going forward … 😉

jamesz

Who can we really believe?

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In a great interview, Dani Rodrik asks why

You get trade theorists who have built their entire careers on “anomalous” results who are at the same time the greatest defenders of free trade. …the minds of analytically sophisticated [economists] turn into mush when they are forced to take seriously the policy implications of their own models.

This is something that we all encounter constantly: people who ‘should know better’ advocating a policy that seems poorly designed. Why might it happen? It is common to resort to explanations that involve mendacity and duplicity, but they are as unsatisfying as they are implausible. It is highly unlikely that everybody we disagree with lies, while we ourselves are paragons of virtue and transparency. In fact, Rodrik identifies the most convincing explanation later in his essay: “There are powerful forces having to do with the sociology of the profession and the socialization process that tend to push economists to think alike.” Exactly, and none of us are immune to it.

Psychologists have demonstrated that logic tends to be used only as a post-hoc rationalisation of our intuitive response to ideas. When economists respond to a new policy idea they will tend to draw on their toolbox of ideas to defend whatever intuitive response they have to it. Those intuitions are greatly influenced by our social identity, which develops to align the intuitions of social groups. As Rodrik points out, the prevailing view of economists at the time that free trade and unfettered markets are a good thing was far more influential than the, more ambiguous, implications of current research. Of course, economists had a vast stock of reasons why governments might fail and could mount a very convincing justification for their free market intuitions. It takes other experts with different intuitions to cut through that fog as they justify their own beliefs.

What does this mean for the way we listen to experts and interpret their opinions? As Tyler Cowen says, “Evaluate literatures not individual papers.” Individuals are incredibly unreliable for the reasons outlined above. The aggregated view of a range of people with different intuitions is much likelier to represent the truth. No individual is an oracle and following the teachings of a few people is likely to lead us astray. That is why economists tend to be sceptical of ‘surgical policy interventions’ and far more trusting of markets than most people. Of course, in saying that I’m probably exhibiting my groupish bias in favour of market solutions!

Matt Nolan

Which side is arrogant? (Thoughts on framing and debate)

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Via Bernard Hickey on Rates Blog I see the following:

All you need to do is deregulate, privatise and target stable inflation and everything will work.

Broadly, they still believe that. I listen every day to this group think in Wellington. Treasury, the Reserve Bank and the cabinet have not changed that mindset.

The Global Financial Crisis has exposed that as both arrogant and wrong. New Zealand can kid itself that our relative economic stability and apparent prosperity (relative to everyone else) is the exception that proved rule.

Let’s put to the side that this is not what policy makers in New Zealand have done – we have had active competition policy, and we do have significant income transfers to support parts of society.

I have a more fundamental qualm with this – the idea that it is arrogant to presuppose that the knowledge of policy makers is limited and that intervention should be based on a clear idea of “what is wrong” … rather than presupposing that non-policy makers are idiots.

To me, I find the other way of looking at it arrogant – and yes, this does imply that I think that Stiglitz’s views on the ability to micromanage the economy are in themselves a touch arrogant.

Let us think about this a bit more.  What is more “arrogant” – forcing people who want to trade with each other not to because we are concerned about it, or not doing so?  What is more arrogant, accepting that our knowledge is limited and trying to work with society to ensure that as a society we can protect ourselves from unexpected things (the mainstream way of viewing things), or assuming that our knowledge of what is going on in a broad economy is great and trying to micomanage industries, credit markets, and the transactions people are allowed to choose.

In all honesty, I am sick to death of the mystical presumption that “free markets” have done horrible things to us and we need to do something about it.  Government as a share of national expenditure is larger than it used to be.  Transfers through the tax and benefit system are larger than they were 20 years ago.  Competition law and regulation is a lot clearer and much more active than it used to be.

Rant over – now to make an actual point!

Now do not get me wrong – in reality I actually don’t think Stiglitz, or Hickey (who wrote the above comment), are being arrogant.  I was trying to illustrate a point, I mean no offence 🙂

My point here was that how we frame this question makes the different sides look incredibly different!  I don’t think it is fair to call any side arrogant, in truth we just have different beliefs regarding the ability and knowledge of technocrats to guide the economy.  Stiglitz and Hickey both place more faith in the hands of policy makers to make choices for individuals that are better than the choices that individuals would make – either because of direct mistakes by individuals, or factors that stem from the interrelationship of individuals.

The economic model allows us to clearly paint the picture of these issues – and debate our value judgments.  Just like Rodrik says in this awesome piece.

So how about we stop treating the “other side” as ideological idiots, and actually ask “why” our views are different and whether the assumptions involved are appropriate or inappropriate.  I am afriad that I often see Bernard Hickey giving the Treasury and RBNZ people too little credit for their views in these pieces – the solutions are not as simple as a single newspaper article, or academic paper, will suggest!  Furthermore, there are always trade-offs – unlike politicians someone with integrity (such as an economist) will look at costs of choices as well as benefits.  And yes, that final statement was an example of stunning arrogance by me – but I’m not going back on it 😉

Matt Nolan

Treading the thin red line

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I see that, due to concerns about systemic risk for the financial stemming from the housing market, the Reserve Bank of New Zealand has decided to increase capital requirements for high loan-value mortgages.  Fine, I think this can be fit inside our concept about why you want to deal with these types of issues, as we’ve noted here.

But it is a balancing act, and there are some comments I’m inherently uncomfortable with.  Namely the context of these two statements:

credit is now increasing faster than the rate of income growth (figure 2.1), after declining as a ratio to income over the past four years. …
While credit is growing more slowly than in most of the decade before the financial crisis, that growth is stretching household debt-to-income ratios, which are already elevated (figure 2.2). Rising house prices, combined with a greater willingness on the part of banks to lend against low deposits, suggests that many new borrowers will be acquiring homes with higher debt levels relative to both income and assets. Low  mortgage rates are helping to keep household debt burdens manageable in the short term, but the increase in underlying indebtedness leaves households vulnerable to a reduction in incomes or a rise in interest rates.
Factually true, indeed.  But how do we unpack this?
It doesn’t matter that people are highly indebted … unless this stems from a process that involves the increasing level of debt, and the distribution of the debt burden, in such a way that it creates an externality.  Where this risk is in turn thrust onto other people.  The very idea of systemic risk.
This is well and good, I have no doubt the RBNZ took policy actions with this in mind.  But I would another two points when we think about credit growth:
  1. We should compare credit growth to average expected income growth – not current income growth.  You borrow in the basis of future income, so the comparison they laid down was a bit dodge.  4% credit growth is lower than this.
  2. New Zealand is rebuilding its (arguably) second biggest city.  It will have to accumulate a higher level of debt (especially relative to current income) to do this.  We are going to have higher current account deficits etc as a result – the idea is that this investment in a new city will create a rate of return that covers it.  If we believe the rebuild leaves some areas streched this is still not a concern – it is just when those sectors in turn threaten to undermine the financial system.  Given this, the increase in investment, activity, employment, and debt are all pretty slow – this type of counterfactual is an important element to keep in mind.

We DON’T care about financial stability because we are worried about asset prices, or bubbles.  If people want to piss their money against the wall gambling on a bubble, no policy maker should try to help them.  It is if their actions have an impact on the broader economy – if we think that financial markets are underpricing risk due to systemic risk issues for example – that we care.  Bubbles and debt don’t magically stop people working and producing in of themselves, and we have to be careful that we interpret the data with the perceived externality in mind, rather than solely being focused a moral distaste for bubbles and debt … which is policy irrelevant.