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Alex Tabarrok argues that we can’t even stop asset bubbles when we know they exist
Bubbles [in the laboratory experiments] occur even as uncertainty about the fundamental value diminishes (JSTOR). We also know that once a bubble starts it’s difficult to stop. Circuit breakers and brokerage fees (transaction taxes), for example, don’t do much to stop bubbles (see King, Smith, Williams, and Van Boening 1993, not online.) Investor education doesn’t help (for example telling participants about previous bubbles doesn’t help). Even increasing interest rates doesn’t do much to stop a bubble already in progress and may increase volatility on net.
The fundamental problem, I believe, is convincing investors that they don’t know where the turning point will be. You can’t say that “you won’t make money in bubbles” because that isn’t true. Its also not true that you can’t sell out before the bubble bursts completely. Bubbles burst quickly but typically not so quickly that someone can’t get out at the first sign of danger.
The problem is that when it first starts you don’t know how much higher a bubble is going to go. Are you getting in at the beginning (unlikely), the middle or the top. If you’re getting in near the top then you will loose even if you sell before the bubble hits bottom. You’ll loose because you don’t have much upside to cushion your downside losses.
Its hard to convince people of this because they play “if only I had” games with themselves. They knew it was bubble, they should have gotten in, they say. They saw the burst, they would have gotten out, they think. What they don’t realize is that they didn’t know at the time how much upside there was between when they saw the bubble and when they saw the burst. Without that knowledge you can’t make the scheme work.
Today’s ADP report showed a loss of 371K jobs roughly in line with other economic indicators. Together with the New Claims data it suggests that the BLS payroll report on Friday will show a loss of around 365K jobs.
The historical ADP data tracks BLS pretty well but this after substantial revisions to both series.
ADP only counts private sector jobs and has historically been about 15K jobs lower than the BLS, but also about 10% less volatile. Take together this would imply that BLS should clock in at 396K.
However, there are a few reasons to think that might not be quite right. First, government employment is likely to be less volatile than trend given the stimulus package’s attempt to stabilize state and local employment.
Also, the New Claims for Unemployment Insurance data predict a somewhat lower BLS Payroll number.
To get this I averaged the new claims for employment insurance from the last four weeks of each month to get a monthly average for new claims. I plotted this monthly average against the payroll data.
I used a second degree polynomial because of the same floor problem that existed with the unemployment rate. New Claims just don’t go below 200K even if the economy is smoking.
This rough and ready method predicts a loss of just under 340K on the BLS payroll series. Taking these two methods together gives me around 365K as a very rough forecast.
As a note the the scatter data suggests that to get no change in employment you need 388K new claims for unemployment insurance, roughly equal to Brad Delong’s eyeball estimate.
Matt Yglesias notes that the business community might have finally caught on to the idea that advertising doesn’t really work – at least the way they though it did.
One possibility that’s disturbing for people who work in the media but probably worthy of being taken more seriously is that the reason ad rates for web ads are so low is that advertising is actually much less effective than people have historically thought, and the greater measurability associated with web advertising is just revealing that fact.
When I went through grad school this was the conventional wisdom. Advertising is mainly about conveying information. People are not really swayed.
When asked why there was a massive media industry predicated on advertising most people just shrugged and said, “Well, information on the nuances of various breakfast cereals must be really important.”
The real answer is probably that markets can stay irrational long enough for generations of media giants to stay solvent.
I am not sure what to make of either Ross Douthat’s column arguing that blue state economies don’t perform well or Economix’s response to it. It is pretty well established that richer states are more Democratic leaning.
There are two major outliers. One is DC in the upper right and the other is Wyoming in the bottom center. However, the overall pattern is that one increase in Democratic voting corresponds to roughly $1,000 a year increase GDP.
There is the impulse to exclude DC because it is not a state or because it is just one city. My sense is that in general more points and more variation should be included regardless of pure definitions or equilibrium characteristics. For example, perhaps urbanism is the mechanism through which income and democratic voting are linked and hence DC is an important data point.
However, DC doesn’t control its own policies as much other states so if we think the causation runs from democratic voting to income, DC should be excluded.
DC was more democratic than you would expect given its income and so excluding increases the income associated with each change in PVI. Now one PVI is about $1,250 of income. However, the explanatory power is cut in half.
Some people might also want to exclude Wyoming because of its outlier status and heavy federal ownership.
Wyoming was less democratic than one would expect for a state with its income and excluding it returns us to $1,000 per PVI and restores a little explanatory power.
So the outliers don’t seem to matter much. The basic patter is that wealth and democratic voting go together.
The question is “why?”
Contra Jonah Goldberg, Matt Yglesias argues that the possibility of an asteroid strike has no bearing our concern about global warming.
Personally, I’m sympathetic to the view that public policy should be more concerned than it currently is about asteroid strikes. But this is also a total non-sequitur. Failing to pass the Waxman-Markey bill or negotiate a good deal at Copenhagen doesn’t put us any closer to safeguarding ourselves against asteroids. Nor would enhanced monitoring of potential collisions require us to build new coal-fired power points. The two issues simply have nothing to do with each other.
This is not quite right. Whether asteroids or other existential threats should have a major impact on how we deal with global warming is debatable, but they are definitely related for two reasons.
First, and I in no way want to condone the style or tone of Jonah’s presentation, but there is a logical strain behind it. The underlying assumption is that the public and the scientific community have limited attention for existential threats and that too much of this attention is directed to climate change.
There are other bad things that could happen: asteroid strikes, pandemics, nuclear terrorism. We shouldn’t expend a disproportionate amount of national attention on any single one. In short, unless you believe the reservoir of public concern is infinite you can’t think that the public should be more concerned about asteroids but that asteroids have no impact on how much we should be concerned about everything else.
Further, the argument might go, we should be weary of over hyping nuclear terrorism because it fits with the basic world-view of the right. There is a natural tendency for nationalism to fuel this fear and so there is a strong chance it will receive too much attention.
Similarly, we should be weary of climate change because it fits the world view of the left. There might also be a tendency to give too much attention to the dangers of industrialization and consumer culture.
Now, I tend to think this argument may be overplayed on both sides. Though, yes there are people concerned about nuclear terrorism and climate change for all the wrong reasons, it is nonetheless the case that they are significantly larger threats than average. Its not so bad that they get a lot of attention.
Second, each additional threat lowers the optimal amount of resources spent on addressing all other threats. In practice the reason people are motivated about terrorism or climate change is because the two concepts are frightening. They are a source of worry and doing something calms worry.
However, from an analytical point of view the reason we should do something about these threats is because we care about the future. However, the greater the probability that the future will be destroyed anyway, the less important action is on any one threat.
That is, if we knew that preventing Iran from developing a nuclear weapon or reducing carbon would mean a prosperous future for our grandchildren then we should invest an enormous amount resources into assuring that it happens. However, if there is a non-trivial chance that our grandchildren will live in disaster anyway, we should hedge. After all, there is a chance they we could suffer the consequences of action and they still gain no benefits from that action.
Now, I think the chances are pretty large that our grandchildren will in fact in enjoy a prosperous future and thus the effect of additional disasters on our calculus is not that great. However, it is not zero.
Free Exchange and Noam Scheiber both comment David Gregory’s interview with Larry Summers
David Gregory did not acquit himself well in his Sunday interview with Larry Summers, in which the host repeatedly suggested that since the unemployment rate was higher than predicted the stimulus had necessarily failed and should be repealed because of deficit concerns. This is wrong on two levels. First, as Mr Scheiber notes, Mr Gregory fails to understand that improvement off a lower than anticipated baseline might still generate a worse unemployment rate than forecast. And second, this is not the time to be focused on closing the deficit, and the stimulus is fairly insignificant so far as long-run budget problems are concerned.
Gregory was simply unwilling or unable to see that the point of the stimulus was to boost employment relative to where it would have been without the stimulus.
The common retort to this has been “didn’t the Administration tell us that the world was going to come to an end, how could it have been worse than that.”
The answer is that the Administration was mixing problems and mixing solutions.
The first problem was that the American financial system was on the verge of collapse and would probably have taken the global financial system and the global economy with it. This was the end of the world scenario. If that had happened its hard to imagine that a $787 Billion stimulus package was really going to matter.
Indeed, a combination of actions including TARP, Federal Reserve backstopping and massive credit easing prevented a global meltdown. This left us with the second problem – a large but ultimately manageable fall in consumer spending.
This is what the stimulus was about. The stimulus was never going to fix the end of the world. It was going to make the world more tolerable provided that some other program saved it. Now, its hard to make these points clear in sound bites which is why I maintain they never should have printed this chart:
A 2002 paper by Bowles and Gintis casts serious doubt on whether income similarities between parents and children can be explained by IQ. Based on the data they offer, however, there doesn’t seem to be much doubt that in modern America the income of children will be very similar to the income of their parents.
The question of course is why? Is it genes or is it environment?
It turns out that the answer depends in large part of how you define genes vs. the environment.
For example, suppose that Amy was born very beautiful. Because Amy was beautiful the teacher always called on her on her school. She always got the job if she made it to the interview. Her boss gave her the assignments she wanted. Amy wound up making a lot of money.
Did Amy succeed because of genes or because of her environment? In one sense it was her environment. She faced a different set of opportunities than did most people. Her choices yielded different results than most people. Under the most uncharitable of interpretations Amy’s success was the result of blatant discrimination. A preference for the pretty.
However, the genesis of that discrimination was in Amy’s genes. Her genetic differences induced an environmental difference.
This is important, because if we assume that the difference between fraternal twins and identical twins is all genetic, then 71% of intergenerational success is genetic. If instead we think of identical twins a sharing a more similar environment because they are identical then perhaps as little as 36% of intergenerational success is genetic.
For practical purposes I think the 71% figure makes more sense. The environmental differences between identical and fraternal twins are not the types of things we can easily tweak with policy or parental awareness. Telling people not to favor the handsome, or the tall or the gregarious is not likely to be very effective.
From a policy perspective I think this helps to soothe our economics concerns about heavily progressive taxes. Whether or not you think high taxes on the rich are fair, chances are taxes will not alter their genetics. If genetics are strong determinates of economic success then it is likely that high taxes won’t make as much of an economic difference.
HT: Delong
Via Brad Delong, Marty Feldstein critiques Dean Baker’s and Mark Weisbrot’s stance on equities.
[Baker and Weisbrot’s] basic point is that "the 6.5-7.0 percent real returns assumed by advocates of investing in the stock market are inconsistent with the 1.5 percentage growth rate for the economy and profits assumed by the Social Security Trustees" (News from Preamble, February 22, 1999).
As a matter of basic economics, this is simply wrong. There is no necessary relation between an economy’s growth rate and the rate of return earned on capital in general and equity capital in particular.
I have not read Baker or Weisbrot on this issue. However, the point I’ve tried to make is that in the long run profits cannot grow faster than the rate of growth of the overall economy.
This implies that if there is any upper bound on the P/E ratio then stock prices also cannot grow faster than the economy for long. Now, price increases are not the only return to equity. There are dividends.
Indeed, assuming that the P/E ratio is bound and that the stock market is a representative sample of American business, the rate of return of equities will be essentially the growth rate of the economy plus the dividend yield.
In fact the stock market is almost certainly not a representative sample of business in the long run. In the long run, many businesses that will dominate American industry have not even been created yet, so they cannot be listed in a stock index.
Thus the long run return on the equity market is somewhat lower than the growth rate plus the dividend yield.
All of that having been said, the question is, is 6.5 – 7.0 percent an implausibly high return? I think so.
Right now the dividend yield on the S&P 500 is just under 3%. The long run growth rate of the economy is somewhere around 2.5%. Thus the long run return on equities should be something short of 5.5%.
In the past dividend yields were higher and the economy was growing faster. Both of these effects could be attributed to demographics. With a fewer workers entering the workforce, there is less labor supply. With more workers looking towards retirement there is more capital supply. This drives down the growth rate for the economy and the dividend yield.
