Category Archives: Quotes

Quote of the day: On bank subsidies

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Via this excellent review by John Cochrane, I decided to read “the banker’s new clothes“.  I’m only a small way in, but it already seem like a pretty good book, written for a non-technical type of audience.  Excellent.

My view has been that there is potentially some type of externality from bank’s actions (systemic risk stemming from asymmetric information and potentially linkages), and that there has been a implicit subsidy to  deal with this – and so the clearest solution would be to treat the lender of last resort function as enforced insurance … and make banks pay an insurance premium (*,*).

The book is taking a very similarish line, although it is focusing on capital ratios.  Essentially, banks become highly leveraged because debt is lower risk than capital funding when they go to borrow (as bondholders will get bailed out, but equity holders won’t) – so they appear to be pushing towards (as Cochrane is) much higher minimum capital ratios.  I would note that this is where the NZ Reserve Bank has been pushing regulation since prior to the crisis (to prove this I was looking for a paper I saw from 1999 … and ran into this bulletin from 1996!), and a number of measures have been introduced or are close.  By default I prefer price to quantity mechanisms, but I’m leaving myself open to be persuaded by the book.

In any case, the quote.  Here:

Subsidizing banks to borrow excessively and take on so much risk that the entire banking system is threatened is like subsidizing and encouraging companies to pollute when they have clean alternatives

On thing missing in the quote is the cost – we haven’t pinned down the true relative price for clean vs non-clean.  But adding a subsidy in the face of an externality is peverse, and is a good motivator for looking at the issue.

Harford on economic forecasts

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Writing in the FT he says:

I think forecasting in a complex world is a poor test of expertise because luck is the overwhelming success factor. … The wonderful thing about a forecast is that both the forecaster and his audience feel that something profound has been expressed. And nobody will remember the forecast anyway.

I’m not sure that’s wholly true: forecasters seem to spend a lot of time disavowing their predictions and claiming that the narrative is the important thing. Of course, they still publish headline figures and institutions such as the Bank of England, who only publish a range, get regularly criticised for being too vague. Even if you don’t believe Harford’s explanation, those facts need to be reconciled somehow.

Madison on public choice

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If men were angels, no government would be necessary. If angels were to govern men, neither external nor internal controls on government would be necessary. In framing a government which is to be administered by men over men, the great difficulty lies in this: you must first enable the government to control the governed; and in the next place oblige it to control itself. A dependence on the people is, no doubt, the primary control on the government; but experience has taught mankind the necessity of auxiliary precautions.

- James Madison (1788)

The dangers of writing widely

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Pankaj Mishra is “…the author of “Temptations of the West: How to be Modern in India, Pakistan, Tibet and Beyond,” “The Romantics: A Novel” and “An End to Suffering: The Buddha in the World.”" He doesn’t know anything about economics or economic history and yet writes about it on Bloomberg as though he is an expert. When speaking to an expert audience that is dangerous, and perhaps a little foolish.

Rothbard memorably wrote that

…it is no crime to be ignorant of economics, which is, after all, a specialized discipline and one that most people consider to be a ‘dismal science.’ But it is totally irresponsible to have a loud and vociferous opinion on economic subjects while remaining in this state of ignorance.

You could easily substitute any discipline for ‘economics’ and it would be as true. Why is it that people with so little expertise are so willing to pass judgment?

For economics it may be the familiarity with the subject matter since everybody lives it every day. While an ignorance of Abelian rings is obvious to us, the gaps in our knowledge of optimal taxation are less so. The everyday language of economics and its subject matter seem familiar enough that people feel they have an intuitive understanding of the subject. While it is fantastic to have such engagement with the discipline, it often seems to lead to overconfidence in untrained commentators. For instance, Mr Mishra might have been hesitant to voice an opinion on the Bourbaki project, yet he felt no such qualms about commenting on the reasons for economic growth.

It may also be that the same lack of kjnowledge precludes people from understanding the limits of their knowledge. Bertrand Russell boldly claimed that “…those who feel certainty are stupid, and those with any imagination and understanding are filled with doubt and indecision.” However, modern research by Dunning and Kruger suggests that the effect has more to do with knowledge than intelligence. Their experiments show that those who are ignorant in a subject vastly overestimate their own skills. Yet, with only a little bit of tutoring, they gain a far better understanding of their level of understanding.

The lesson I take from all this is that poor writing about economics is a consequence of too little economic education. As economists we all have a role to play in helping people to understand the basics of our discipline. Every time we turn up our nose at a casual discussion about economics among non-experts we are promoting the spread of misinformation by our omission. Rather than just pointing and laughing at people who are plainly wrong we should be there to help.

There’s no new criticism

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Mark Blaug in 1997:

Modern economics is sick. Economics has increasingly become an intellectual game played for its own sake and not for its practical consequences for understanding the economic world. Economists have converted the subject into a sort of social mathematics in which analytical rigour is everything and practical relevance is nothing. To pick up a copy of The American Economic Review or The Economic Journal these days is to wonder whether one has landed on a strange planet in which tedium is the deliberate objective of professional publication. Economics was once condemned as “the dismal science” but the dismal science of yesterday was a lot less dismal than the soporific scholasticism of today