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July 7, 2009

Economist's View - 5 new articles

"Economists on Trial"

This is part of an interview of heterodox economist Michael Perelman:

Michael Perelman, on Market Myths, Past and Present, by Seth Sandronsky: ...[Seth] Sandronsky The Depression of the 1930's changed the public policy views of some in the economics profession. In brief, what were the main changes, and how do they connect with the post-bubble economy of mid-2009?

Perelman The Great Depression severely tarnished economists' reputations. For example, The Economist published an article on 17 June 1933, entitled "Economists on Trial," which described a "mock-trial - not entirely mockery -" of "the economists." The trial was staged at the London School of Economics, with Robert Boothby, M.P., representing "the state of the popular mind." He accused the economists with "conspiring to spread mental fog," charging that they "were unintelligible; that they had in general proved wrong; and that in any case they all disagreed." The economists - Sir William Beveridge, Sir Arthur Salter, Professor T. E. Gregory, and Hubert Henderson - were all highly respected in the field. They answered Boothby's charges without wholly refuting them. The article concluded, "There was never a time when the advice of an expert was so often asked and so seldom followed as the present." According to the magazine, the problem was that the authorities did not listen to the economists.

At the same time, during the New Deal economists played a very prominent role. For the most part, they had not previously been among the doctrinaire defenders of laissez-faire. But keep in mind that, until the post-World War II era, the economics profession was much more diverse. A good number of progressive economists had been purged from academia, but some progressives remained. The more elite a university was, the less diversity it had. Yet, even in elite universities there was a modicum of diversity.

Although the discipline of economics became radically more conservative after World War II, during the 1970's economists who were active during the Depression tended to give me a much more sympathetic hearing, even if they had drifted considerably to the right.

Today, the makeup of the economics profession has changed dramatically. The economists who experienced the Great Depression are gone. On virtually any campus, the economics department will be among the most conservative. Dissenting views are rarely tolerated, except in liberal arts colleges. Catholic colleges also tend to be less fearful of unorthodox views.

However, the government's stimulus plans - under both Bush and Obama - have been so inept that a good number of very conservative economists have been highly critical in ways that do not entirely differ from my own.

Perhaps what is most surprising is how little influence economists have had in the policy realm. Virtually no Congressional hearings have called upon economists, whether they are conventional or radical. How much influence economists - other than Larry Summers - have had behind closed doors is an open question. ...

What Caused the Housing Bubble?

Ed Glaeser says that if people were as smart as he is, they would have realized housing price increases were unsustainable and there wouldn't have been a housing bubble:

In Housing, Even Hindsight Isn't 20-20, by Edward L. Glaeser: ...[Is] the housing market ... starting to hit bottom? ... One major point of economics is that predicting asset prices is extremely hard... Moreover, the last seven years should make everyone wary about predicting housing price changes. ...

The housing price volatility of the last six years has been so extreme that it confounds conventional economic explanations. Over a four-year period — from February 2002 to February 2006 — the Case-Shiller index increased ... about 50 percent in constant dollars.

Certainly, those price increases cannot be explained by increases in average income. Income growth was quite modest from 2002 to 2006. Nor can the boom be explained by a dearth of new housing supply. Construction rose dramatically during the boom...

A number of pundits place the blame for the bubble on ... Alan Greenspan. They argue that loose monetary policy caused housing prices to rise. While lower interest rates are correlated with higher prices, the relationship is far too weak to explain the price explosion that America experienced. ... To get a 50 percent real increase in housing prices, real interest rates would have had to decline by more than ...10 percentage points..., which is not what happened. ... Real rates actually rose slightly between 2002 and 2006.

While low interest rates, on their own, cannot make sense of the bubble, perhaps the increased availability of credit to subprime borrowers has more explanatory power. ... Yet the correlation between housing price growth and subprime lending across markets is as likely to indicate that lenders took more risks in booming markets as that those risks caused markets to boom. ...

The most plausible explanations of the bubble require levels of irrationality that are difficult for economists either to accept or explain.

For many years, the creators of the housing index, Chip Case and Robert Shiller, have argued that housing bubbles were fueled by irrationally optimistic beliefs about future housing price appreciation. More recently, Monika Piazzesi and Martin Schneider have documented the rise in optimistic beliefs about housing price appreciation over the recent boom. Using some elegant algebra, they suggest that overly optimistic beliefs could cause a boom even if those beliefs were held by only a small share of the population.

It is hard to argue with this view. The only way that anyone could justify spending bubble-level prices in Las Vegas was by having the incorrect belief that those prices would increase.

I once thought that the Las Vegas housing market was so straightforward (vast amounts of land, no significant regulation) that no one could be deluded into thinking that prices could long diverge from construction costs, but I was wrong. I underestimated the human capacity to think rosy thoughts about the value of a house.

Yet even if ridiculously rosy beliefs are a major part of bubbles, we cannot say that we understand those bubbles until we understand the sources of such beliefs. Economists like to link beliefs to reality, but these views weren't grounded in sound statistics. The housing boom was a great wildfire that spread from market to market, but it is hard to make sense of its flames. ...

I don't think people believed that housing prices would never, ever go down, what they thought is that housing prices would go up in real terms, on average, over time - that housing was a good long-run investment. They knew there would be variation around that trend, but they expected the variation to be relatively mild, they didn't expect the severe variation in prices and associated problems that actually occurred.

But as Shiller argues, the belief that real housing prices rise over time is false, the evidence suggests that real housing prices are relatively flat over the long-run. Because people expected prices to rise on average when they should have expected them to remain flat, the correction - the variation in prices - was far larger than anticipated and many homeowners weren't able to simply ride out the short-run variation like they thought they would be able to do.

But this still leaves a question unanswered. Why did people have this false belief about the long-run trajectory of prices? Shiller explains that this happened because people believed that both land and building materials were becoming relatively more scarce over time, a belief he says is false, but that just pushes the "but why did they believe that" question back one step from housing prices to the prices of land and raw materials.

So let me take a quick stab at an explanation (I'm not pushing this, it's just a quick thought). People are told (or were at that time) that stock markets are a great long-run investment. If you have the time to ride out the short-run fluctuations you can earn 8% per year. Just dump your money in an index fund that duplicates the market portfolio, and forget about it until many, many years later and you will do fine. Risk adjusted real returns on assets ought to equalize across markets through arbitrage, so shouldn't housing yield a real return similar to stocks (adjusting for risk)? Shouldn't there be a real return on housing just like in stock and other asset markets, and if so, doesn't that mean real prices will rise on average over time? This still requires beliefs about long-run prices at odds with (Shiller's) evidence though.

One more note. I may be wrong to assert that people thought that housing prices would rise forever. If you know that there is a bubble in an asset market, but you believe you can sell fast enough once the market hits a turning point to still make a profit, or at least not lose much in any case, then you may be willing to make an investment that tries to exploit the short-term surge in prices. But while I think that may apply to stock markets, or other markets where assets can be sold quickly (the belief that is, the reality is quite different when everybody tries to sell at once), I'm not sure this applies to housing where sales can be notoriously slow. But it's still possible that people would know there is a bubble in housing prices, but still be willing to make an investment because they believe that housing prices would fall so slowly that, if necessary, they could sell their house before taking a loss. It just doesn't seem to me that this explanation works as well in housing as it does in stock markets.

France is "Remarkably Effective at Deploying Funds Quickly"

The "cheese-eating surrender monkeys" say that when it comes to stimulus programs, "The country that is behind is the U.S., not France.":

France, Unlike U.S., Is Deep Into Stimulus Projects, by Nelson D. Schwartz, NY Times: French workers normally take off much of the summer, but this month,... throngs of tourists will be jostling alongside stonemasons, restoration experts and other artisans paid by the French government's $37 billion economic stimulus program.

Their job? Maintain in pristine condition the 800-year-old palace of more than 1,500 rooms where Napoleon bid adieu before being exiled to Elba and where Marie Antoinette enjoyed a gilded boudoir.

Besides Fontainebleau, about 50 French chateaus are to receive a facelift, including the palace of Versailles. Also receiving funds are some 75 cathedrals like Notre Dame in Paris. A museum devoted to Lalique glass is being created in Strasbourg, while Marseilles is to be the home of a new 10 million euro center for Mediterranean culture.

All told, Paris has set aside 100 million euros in stimulus funds earmarked for what the French like to call their cultural patrimony. It is a French twist on how to overcome the global downturn, spending borrowed money avidly to beautify the nation even as it also races ahead of the United States in more classic Keynesian ways: fixing potholes, upgrading railroads and pursuing other "shovel ready" projects.

"America is six months behind; it has wasted a lot of time," said Patrick Devedjian, the minister in charge of the French relance, or stimulus. By the time Washington gets around to doling out most of its money, Mr. Devedjian sniffed, "the crisis could be over." ...

As it turns out, France's more centralized, state-directed economy ... is proving remarkably effective at deploying funds quickly and efficiently in bad times. ...

It is easier to find money for castles and cathedrals, of course, in a country that believes "art is equal to other investments, not secondary," as Mr. Devedjian puts it. But the largess is driven as well by President Sarkozy's support for more spending to combat the recession, even if it means borrowing more and running up big deficits.

That contrasts sharply with the commitment by the German chancellor, Angela Merkel, to hold down stimulus spending and move as quickly as possible to curb her government's budget deficit.

So what about the criticism that Europe is not being as aggressive as the United States in combating the global slowdown, with only tepid stimulus packages? That's not the way the French see it.

"You lost time with changing a president and no decisions were made in the last three months of 2008," Mr. Devedjian jibed. "Nothing happened in January 2009, and in February, there was just a speech."

"The country that is behind is the U.S.," he said, "not France."

While the scale, $37 billion versus close to $800 billion, is a bit different and probably ought to be accounted for in the comparison, there does seem to be a difference not just in the speed of deployment, but also in the focus of the policy. It will be interesting to see how that difference, which seems to place somewhat more emphasis on boosting employment and aggregate demand immediately than on long-run growth in France as compared to the U.S., translates into a differential response to the fiscal policy boosts in the two countries.

"U.S. Revives Section 2 of the Antitrust Act"

Since I've argued that the enforcement of antitrust law hasn't been strict enough many times in the past -- "the idea that markets 'self-police'" anti-competitive behavior always seemed much more of a hope than a reality in my view of the evidence -- to me this is good news (but it's not good news to everyone). It's not just the textbook economic effects of monopoly power that are worrisome, it's also the ability of large and powerful firms to tilt regulation and legislation in their favor:

Sherman Stirs: U.S. Revives Section 2 of the Antitrust Act, by Ashby Jones. WSJ: For nearly 120 years, the Sherman Antitrust Act has been the main vehicle through which the government and private parties have regulated the so-called anticompetitive behavior of corporate America.

The act's two main sections target vastly different types of behavior, though each may result in both civil liability and criminal punishment.

Section 1 largely addresses situations involving anticompetitive behavior of two or more entities working in concert. Cases involving price-fixing and market-division arrangements are typically brought under Section 1.

Section 2 cases typically involve the behavior of one firm, acting alone. Section 2 cases generally require a private party or the government -- either the Department of Justice or the Federal Trade Commission -- to show that a firm with a significant market share has done something anticompetitive in order to increase or maintain its monopoly. Monopolies, without evidence of anticompetitve behavior, aren't necessarily illegal.

While Section 1 cases are fairly common, the bulk of the headline-grabbing antitrust cases have been under Section 2... John D. Rockefeller's Standard Oil Co. ... AT&T... Microsoft ...

Enforcement of Section 2 went largely dormant under President George W. Bush. Toward the end of his second term, the administration issued a report which codified its views on Section 2. It took the position that the marketplace, not government regulators or courts, provides the ideal check on anticompetitive business practices.

In May, Christine Varney, President Barack Obama's pick to run the Justice Department's antitrust division, repudiated the Bush administration report, squarely placing some blame for the country's economic problems on the Bush administration's laissez-faire regulatory policies.

"Americans have seen firms given room to run with the idea that markets 'self-police' and that enforcement authorities should wait for the markets to 'self-correct,' " Ms. Varney said at the time. "Ineffective government regulation, ill-considered deregulatory measures and inadequate antitrust oversight contributed to the current conditions ... we cannot sit on the sidelines any longer."

Antitrust experts weren't surprised by Monday's news that with an initial review of conduct by large U.S. telecom companies [such as AT&T and Verizon], the Justice Department had started dusting off Section 2. ..

links for 2009-07-07

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