Winner of the New Statesman SPERI Prize in Political Economy 2016

Thursday, 12 March 2015

The power of financial markets

You might imagine that the global financial crisis had reduced the power and influence of finance and those involved in financial markets. After all, the excesses shown by participants in those markets had caused the largest recession since WWII. (Not to mention a constant stream of cases of illegality and mis-selling.) However I wondered yesterday if the opposite might be true.

This was during a debate at the Houses of Parliament, in which Jonathan Portes and I were debating austerity with Roger Bootle and Doug McWilliams. A constant refrain from our opponents was that (a) the stock of government debt was very large, (b) you needed the confidence of markets to be able to maintain this level of debt, (c) markets were fragile beasts, so best take no chances, and (d) therefore we needed austerity to reassure those markets.

I immediately thought of one of my better posts, where I suggest too many people view markets like a vengeful god, and those that are ‘close to the markets’ like high priests. (I couldn’t quite believe it when a member of the audience asked our opponents about whether they thought some proposal would ‘pass muster with the markets’.) Now Roger, who is a sensible guy, did agree that default was not really an issue for the UK, but the danger was rather inflation, if the deficit or debt became ‘too large’ and markets refused to fund it, so it had to be monetised. If it seems odd to you that the markets would start worrying about the monetisation of debt because a large recession increased deficits, but be quite unconcerned today about the central bank creating money to buy huge quantities of government debt as part of Quantitative Easing, then your mistake is to think that the markets are always rational. If they are both fragile and febrile, as our opponents and others close to the markets often suggest, it could happen.

Before the financial crisis, it was in the interests of those involved with financial markets to emphasise how rational they were. No need for regulation - these are clever people who knew what they are doing. The crisis blew that argument apart, but instead it created the idea that the markets could be dangerously irrational: irrationally exuberant at one point, and irrationally risk averse the next. It also showed how dependent on these markets the economy had become. Hence the idea of a vengeful god that could suddenly turn on you for no good reason and who therefore had to be appeased at every turn.

This kind of argument has a strong emotional appeal, particularly when the financial crisis is fresh in peoples’ minds. I suspect that attempts to show that markets are actually pretty rational most of the time will not work. Instead I’m afraid we have to focus on the high priests. A truly irrational market could do anything. The problem comes when the high priests declare that, by being close to the markets, they can discern some logic to its tantrums. And by a divine coincidence, this logic just happens to fit macro view of the world that the high priests hold.

For example, we are told that markets worry about large deficits and require austerity immediately. Never mind that there is no sign of worry, and that interest rates are falling: markets are fragile and febrile and could turn at any moment. The high priests, being close to the markets, understand that. Strangely the high priests never detect any concern that a persistent recession brought about by austerity might - through hysteresis effects - permanently damage productive potential, with potentially greater impacts on the tax base and long term solvency. I guess the high priests markets had not read that paper.

We are told that Osborne needed to give a clear demonstration to the markets that he had the political will to bring the deficit under control, which is why deficit reduction had to be front loaded. It does not seemed to have occurred to the high priests markets that, given his desire to reduce the size of the state and win the next election, front loading austerity is exactly what he wanted to do, even if he had no particular concern about the deficit. To show a clear conviction to give top priority to reducing the deficit required him to do something that was politically costly, like raising inheritance tax.

And do not forget that Ireland and Portugal were constantly told by those close to the markets that they needed to embark on acute austerity to ‘regain the trust of the markets’, when in fact what the markets were looking for all the time was for the ECB to act as a lender of last resort. I could see that from my academic ivory tower, but most of those ‘close to the markets’ did not.

The financial crisis may have told us about the power that financial markets have, and how it is important to understand how they behave. But the way to do that and to make good policy in the meanwhile is through economic science, and not to rely on the wisdom of priests. As I said in my little speech at the debate, the cost of UK austerity in 2010 and 2011 was at least 5% and probably more like 10% of GDP, numbers which neither of our opponents challenged. The gods it seems require big sacrifices nowadays. But if the only reason for making this sacrifice is that the high priests tell us that this is what the gods require, then I think the time for enlightenment is well overdue. 

60 comments:

  1. Robert Peston is one who is obviously far too close to "the markets".

    ReplyDelete
  2. Maybe I'm a bit confused here, or possibly not. But why should a switch from funding new debt through the financial markets to funding through monetisation cause inflation? Surely it would also require some other move to increase aggregate demand.

    ReplyDelete
    Replies
    1. I'm no expert, but that's probably just as well for answering this question.

      Covering debt with bonds doesn't increase the total supply of assets. In theory the amount of money chasing goods hasn't increased. This means that the borrowing doesn't increase inflation.

      Monetizing debt means the government prints money to cover the deficit. This increases the amount of money chasing goods, i.e. increased demand, which causes inflation.

      Delete
    2. Robert has this right. This is why people need to focus a whole lot more attention on borrowing-finance by govt compared to tax-financing. They both extract cash from the economy, but one also leaves wealth/assets out in the hands of the wealth who trade in such debt/assets (it is a wealth transfer upward scheme of finance). If you are trying to fill a gap in aggregate demand with govt spending, printed-new-money is better than borrowing.

      Since everyone is scared of printing, then the next best solution to raise the cash is to tax otherwise idle resources - and now you know why the already wealthy prefer the borrowing-finance approach (it avoids taxes them).

      JF

      Delete
  3. I’m thinking of having half my grey matter surgically removed and with a view to lowering my IQ to the point where I’d qualify for the job of “high priest”. I gather the pay is pretty good.

    ReplyDelete
    Replies
    1. I would say that it is not about IQ levels, but about where your desires lay. If all your desire is to hoard as much money as you can, which enlarged becomes power over other human beings, then IQ level will have not much influence.
      Well, desiring such might be because of low IQ to be honest, or to upbringing. :-)

      Delete
    2. Not to mention IQ is not as strongly correlated with rationality as one might expect [Dysrationalia].

      Delete
    3. And you can get margaritas, yeah.

      Delete
    4. Clayton Christensen of Harvard Business School uses similar religious terminology:

      "Why is financial capital flowing disproportionately to innovations that do not produce jobs? I think the roots lie in a powerful new belief system. About 40 years ago some people established what I describe as a new church. I call it the New Church of Finance.

      The members of this church are finance professors at business schools, a lot of economists and the partners in hedge funds and private equity funds. I call it a church because it has many of the characteristics of a well-catechized belief system. For those committed true believers within this “church” it is inconceivable that the catechism isn’t true."
      http://treasureislands.org/financial-ratios-and-the-new-church-of-finance/
      (I tried to post this comment earlier but it didn't seem to work; apologies if it's appeared twice.)

      Delete
  4. Not sure how far the High Priest metaphor can be pushed.

    So, just as the behaviour of the weather is uninfluenced by the predictions of forecasters, the behaviour of 'the Gods' (eg volcanos, storms) was uninfluenced by the High Pirests.

    Markets are driven by the views of those participating in them (the Priests if you like). If the consensus is that a stock is underpriced, it will rise, regardless of whether it is underpriced. In the short run at least, the consensus view of participants matters more than the reality.

    Those views may be wholly mistaken and wrong, but they will still determine market movements. The truth can only change this by becoming the view of the market participants.

    So, listening to market participants is not quite as valueless as asking High Priest whether it will rain tomorrow.

    That said, Bootle and McWilliams were feeble.

    ReplyDelete
    Replies
    1. It is misleading to think about people like Roger Bootle as representative agents in the market. They do not know why market prices change - they guess. Financial markets are huge. Talking to one or two participants in the market does not give you any special insight. In most religions the priests are not and do not become gods.

      Think about how economists analyse firms. We typically do not ask firms why they do what they do: we work out what they would do to maximise profits. Occasionally, when puzzling issues arise (like why prices are sticky), we might conduct large scale surveys - but we do not base our analysis on what one or two firms that we happened to have access to told us.

      So in listening to people like Roger, we gain no special insight about the views of market participants. I've talked to quite a few market participants in my time, and this tells me that their views are highly diverse about most things that matter for markets, but they do tend to agree on issues like taxes are too high!

      You should have said hello. As you must have realised by now, I'm no Jeremy Clarkson.

      Delete
    2. Professor, while i agree with your general point, market participants tend to run in herds, which causes irrational exuberance on the upside and huge crashes on the down-side. That does not mean that austerity works.

      Delete
    3. Rob sol's point is an extremely important one in this discussion. It always strikes me as slightly quaint when people talk about the 'views of market participants' as the main driver of market movements. Market participants don't operate according to their views: they operate according to their incentives.

      Delete
    4. Simon, you are absolutely correct! I would rather those who comment on the "views" of markets would instead report on the observable behaviour of prices, rather than focus on commentators. As a market participant myself - which gives me no advantage in insight - it was very clear that the UK was never vulnerable to a run on its debt, in contrast to sovereigns within the Eurozone. Markets - logically - discriminated consistently between countries which can print money and those that can't. Market price behaviour revealed starkly that it was never about the size of debts or deficits. For example, JGBs rallied during the Eurocrisis - despite Japan a) have a larger debt and deficit than any Eurozone economy and b) expanding it's deficit in response to Fukushima. Academics such as Paul de Grauwe subsequently spelt out what was clear to anyone watching the correlation of government bonds prices to news: countries doing QE experienced the opposite of a run - their bonds rallied in response to the growth shock caused by the Eurocrisis - and the ECB's overt declaration that it did not stand behind Euro sovereigns fostered a panic. To an observer of market prices, and global bond correlations, the UK coalition's stance never made sense (I have always assumed it was an excuse).

      I am of course not arguing that markets are "efficient", I am simply observing that there was absolutely no evidence of any "loss of confidence" in deficit country bond markets outside the Eurozone. The evidence clearly suggested the opposite. These assets were priced as safe havens, regardless of their deficit trends. In this instance, market behaviour was entirely reasonable: there is no credit risk if sovereigns are printing money to buy significant shares of their outstanding stock debt (QE), and the macroeconomic consequences of the Eurocrisis were disinflationary/deflationary longer-run interest rate expectations should fall - as has happened.

      Unfortunately, many who speak on behalf of "markets" believe - a questionable premise - often appear ignorant of what prices and correlations are in fact doing. There is much to be learnt from the behaviour of market prices, but we should be very sceptical of any self-appointed representative of their beliefs.

      Delete
    5. JD, whatever market participants were saying on television/radio, they were drving British sovereign bond prices down. As you point out, look to their actions and not pay too much attnetion to their posturing.

      Delete
  5. I've been doing similar (well, commenting on a web article) with John Fender, Professor of Macro at Birmingham. He asserts I just didn't get it (oh and that Portes and Co. are wrong) - austerity was necessary to keep interest rates low. Clearly I don't get it, but all the same, it seems a very weak argument. Where's the evidence?

    http://theconversation.com/austerity-was-necessary-in-2010-but-we-dont-need-much-more-37939

    ReplyDelete
    Replies
    1. Specifically to keep inflation below target. Why deliberately missing a target is a good thing I have no idea, but David Cameron was championing it again yesterday.

      Delete
    2. I think he's arguing interest rates (on govt debt) mostly. Either way, I'm not getting the rhyme and reason - other than asserting that markets might/will pay slavish attention to some obscure signal about the govt.'s chosen strategy for dealing with debt:gdp and go into a collective sulk, while simultaneously asserting that they'll endlessly ignore all other factors - including front and centre signals like prices and stuff. I'm no economist, but at face value this seems completely nuts.

      Otherwise, yeah I reckon you're right. Cameron and Co. are just making it up as they go - safe in the knowledge that the BBC's journalism is is too flaccid to check anything.

      Delete
    3. “It can be argued that a rapidly rising public debt is dangerous and that if a country’s public debt is excessive, its economic performance suffers. So it is necessary to stop the public debt rising inexorably and to put it on a downward path.”

      What argument is that then?
      Oh, there's a link.
      Surely not...
      *click*
      *gasp*

      Delete
    4. Twice in fact - it's linked a second time later in the piece. It's almost as if the argument for austerity hinged on a single (not very good) study.

      Delete
  6. Simon W-L
    Comment about gods demanding large sacrifices nowadays strongly remainded me about Yanis Varoufakis's Global Minotaur where he describes huge domestic and trade deficits of USA demanded large sacrifices of others (in real value). In order for USA to keep Agregat Demand of other nations that are not able to employ their people with domestic demand, they had to sacrifice their hard earned money to Wall Street. That is the set up of banking in USA.

    USA cut 27% of their imports (spending on imports) which kept global demand and employment with it, after 2008 crisis. This fall in demand is causing global recession.

    ReplyDelete
  7. Yup, markets are so weak, so they need pampering from state. They are so weak that they can destroy country if they want, they are so strong.

    ReplyDelete
  8. Yup markets are so strong that as soon as state cuts spending, markets have to fire people and reduce production.

    ReplyDelete
  9. Or alternatively, you could consider that the Coalition government's policy of Austerity was trying to deliver what the people of the country had asked them to do by voting them in. [Echoes of Stafford Cripps' original Austerity?]

    During the early part of the recession there was an enormous Keynesian boost to demand from the UK government with a fall in VAT and interest rates plummeting towards zero. In addition, there was a major reduction in income tax rates to 20% and an increase in the income tax allowance at the time of the removal of the 10 pence tax rate. And there was also an increase in investment in welfare to work policies - over and above the automatic stabilisers in dealing with JSA - which not only maintained the productive potential of workers but also increased it (labour supply during the recession).

    Given all of these changes it was actually very difficult to find groups of people who actually suffered during the recession - real wages rose across the piece, take home pay increased, and the job loss was not great. The main group to lose out were people in the immediate post war baby boom who were beginning to take out private pensions and suffered from the stock market crash. (And this groups income has, unlike some other groups, not recovered).

    Looking forward from this situation the people probably concluded that it was necessary to address the structural deficit problems that arose during the Keynesian boost they had benefited from.

    However, despite the fact that the standard rate of income tax was at its lowest level since the 1920s it seems that raising direct taxation - either on workers or businesses - would not have been acceptable - and in fact further major reductions in income and corporation tax (particularly for the lowest incomes) were introduced. Consequently, the long-standing tradition of shift the burden of taxation from direct taxes to indirect taxes and NICs was continued but it too hit obstacles (e.g. the pasty tax). Therefore, in delivering what had been promised to the people the focus increasingly fell on reducing public spending which also involved extending the time it will take.

    In the election coming up the questions to the people will again be clear - partly because of your work and also of the IFS. But one thing that may colour the result is that, unlike previous recessions, the smallest losses in terms of income, wages and take home pay has been amongst the people who started off in the worst position. Inequality has fallen at the bottom of the distribution. And as the recovery has taken hold this relative improvement for people at the bottom of the income distribution may now be turning into absolute improvements on the pre-recession period.

    But whatever the result it does seem to me that there has been a structural reduction in tax raising powers that will either require structural tax rises (probably not through direct tax rises if history is any guide) or substantial public spending cuts or some combination of the two if the people do decide that the structural deficit needs to be addressed.

    Bill Wells

    ReplyDelete
    Replies
    1. " But one thing that may colour the result is that, unlike previous recessions, the smallest losses in terms of income, wages and take home pay has been amongst the people who started off in the worst position. "

      People with nothing have the least to lose. Also, where you write "real wages rose across the piece" -- I'm not sure what you mean by "the piece" but real wages have fallen substantially since the recession:

      http://www.ons.gov.uk/ons/rel/elmr/an-examination-of-falling-real-wages/2010-to-2013/art-an-examination-of-falling-real-wages.html#tab-Recent-trends-in-real-wage-growth

      Delete
    2. "Or alternatively, you could consider that the Coalition government's policy of Austerity was trying to deliver what the people of the country had asked them to do by voting them in."

      This is highly misleading I think. First of all they did not have a majority, so saying they were doing the will of the people as a whole is wrong. Secondly, if you look at their 2010 manifesto, nowhere will you find a commitment to making drastic cuts in public spending.

      http://news.bbc.co.uk/1/hi/uk_politics/election_2010/8617433.stm

      "Economic measures include the big early issue in the election campaign - the plan to reverse the government's proposed National Insurance rise - and promises to raise the inheritance tax threshold to £1m, freeze council tax for two years and to increase NHS spending in real terms every year."

      Feel the austerity!

      Delete
  10. I came across 'City's influence over Conservatives laid bare by research into donations' at guardian.co.uk, Friday 30 September 2011, with a link to the full Bureau of Investigative Journalism's report on the topic, which showed private donations to the Tory Party in the year June 2010 to June 2011.

    The graph on the Guardian article breaks down where the money came from, which was overwhelmingly from the City.

    They really did invest heavily in Osborne Plan A, and have presumably invested just as much in Osborne's Plan B as the election nears.



    ReplyDelete
  11. It seems to that the power of financial markets is zero. The government controls interest rates, not the financial markets. It could well be that the CB needs to raise rates to contain inflation because of household savings demands. But these demands are in the non-financial sector. I.e. the financial sector is left out with no power whatsoever to constrain rates, which is why it screams so loudly that it must be listened to.

    ReplyDelete
  12. Opponents of austerity from America to Greece can and should argue that growth is the best way to bring budgets under control. As Wren-Lewis has written, the priority should be to close the output gap first. Today Dean Baker writes about the prospect of the Fed raising rates prematurely and the example of the Clinton years:

    http://fortune.com/2015/03/11/the-biggest-threat-to-the-u-s-budget-a-fed-rate-hike/

    "Since the release last week of the latest monthly U.S. jobs report, the positive numbers have many wondering if the Federal Reserve will start raising short-term interest rates as early as June.

    The central bank may offer more clues when officials meet next week. If the Fed chooses to raise rates soon, it would easily add between $1 trillion to more than $2 trillion to America’s debt over the next decade, compared to a scenario in which rates remain low."

    and

    "Although this isn’t generally recognized, the budget surplus during the Clinton years in the 1990s was largely due to low unemployment. In 1996, the CBO expected a large budget deficit for fiscal year 2000. However, by keeping interest rates low, the economy grew much faster than officials expected. The CBO had projected the unemployment rate would be 6% in 2000; instead it averaged just 4% for the year."

    Krugman could only come with France in the 20s as a country with its own currency being attacked by the vengeful bond vigilantes.

    http://krugman.blogs.nytimes.com/2012/11/23/franc-thoughts-on-bond-vigilantes/

    "What Khimm doesn’t note, however, is that the problem with bond vigilante scare tactics runs even deeper than that — because it’s actually quite hard to tell a story in which a loss of confidence in U.S. bonds hurts the real economy. Why wouldn’t it just drive down the dollar, and thereby have an expansionary effect?

    Yes, I know, Greece — but Greece doesn’t have its own currency. What’s the model under which a country that does have its own currency and borrows in that currency can experience a slump due to an attack by bond vigilantes? Or failing that, where are the historical examples?

    The closest I can come to anything resembling the danger supposedly lurking for America is the tale of France in the 1920s, which emerged from World War I burdened by large debt, and which did in fact face an attack by speculators as a result. Yet the French story does not, if you look at it closely, offer any support to the deficit scare talk we keep hearing."

    ReplyDelete
  13. The Bond market can't take on a Central Bank in its own sovereign currency; the CB is the MONOPOLY ISSUER of currency for and on behalf of its Sovereign Treasury.

    Base / overnight interest rates are always set by the Central Bank for its own currency. The CB can control any 10; 20 etc year Bond rate by threatening to buy unlimited quantities of it at a particular interest rate. For instance; if the 10 Year Bond is priced to yield 3% in the market, the CB could threaten to buy unlimited quantities if the yield is above 2.5%. The market yield will drop to 2.49%

    The Sovereign Treasury and its Central Bank, can never run out of its own currency. Can never be insolvent or forced to default in its own currency. There is no invoice in £s that it can't pay.

    The Treasury and its Central Bank never have to "borrow" their own currency. (There are very few reasons why it would ever have to borrow in a foreign currency). But; they do pretend to do it by issuing Bonds and Gilts to "match" the deficit and make it look like it is the same as a Household and fool the voters into a "austerity" mindset. A Household is a CURRENCY USER, it can't pay its taxes in anything other than £s so it has to get some by income or borrowing.

    If you are a member state of the Eurozone, then you are a currency USER not a currency ISSUER; you all use a foreign currency, the Euro, over which you have little control. You are exactly the same as a Household. Your government Treasury will spend by issuing Bonds and actually "borrowing" Euro for real in the "market". Then the Bond market has you by the short and curlies unless the ECB acts like a proper central bank to control interest rates.

    All the government's "money" is created by "spending it into existence". It first appears as RESERVES at its bank, the BoE. All government, so called, "borrowing" is bought with reserves (government "high powered" money) that already exists having been spent by the government previously. QE simply does the reverse, it swaps the bond back to the original reserves that bought it in the first place. Those reserves have to appear on the BoE balance sheet. No new financial assets have been created in the process, they just moved from one filing cabinet to another at the BoE.

    ReplyDelete
    Replies
    1. what about the exchange rate?

      Delete
    2. The exchange rate would be free floating (not pegged) and would be subject to primary supply and demand. If you are a persistent net importer, foreign countries will be holding a lot of your currency and will spend it buying mansions in Chelsea or UK Government Bonds. They may even buy factories to make the stuff they are selling you, locally, to remove the import transport costs.

      If you import a lot of stuff, the value of your currency will gradually decline to try and balance out your trade deficit. If you are a big importer from a foreign country, that country's Central Bank, will start buying up your currency to raise its price, so you can still afford to buy its exports. The Germans make a bundle from having the Euro effectively pegged at below market by Club Med states.

      If you peg your currency to another, you need a reserve of foreign currency to buy it and pull its price up; or, sell a lot more of your own currency to push it down. Eventually, like Switzerland, the stress becomes too much and you just have to sever the peg and take the hit. Like Major did with the ERM disaster.

      Delete
    3. that's may be fine if you are the UK or another developed nation, but I don't think they would be interested to buy mansions in Zimbabwe.
      Your claim that countries who issue currency ''Can never be insolvent or forced to default in its own currency'' is questionable and much depends what country we are talking about and differs per case.

      Delete
    4. At the last count, Zimbabwe was using five different currencies, mainly the US Dollar and the SA Rand. Its own currency was suspended in 2009. Have a read of 7DIF, for a detailed explanation of how it is not possible for a fiat currency issuing government to go broke in its own currency.
      moslereconomics.com/wp-content/powerpoints/7DIF.pdf

      Delete
  14. Markets are indeed fickle, but they are unfailingly sincere. Unlike market commentators.

    ReplyDelete
    Replies
    1. Nuts. These markets are made and managed by a small number of people - minuscule % of the population. ?Sincere?

      Bravo to SWL here. The remedy is clear. Allow central banks to purchase public debt issuances directly. Right now the laws of finance in the countries require the public debt issuances to be openly marketed, ceding control to this small number of makers/managers of these markets. No surprise the prices/yields follow their interests in making profits (and their interests in controlling govt decision making). You can still market the new issuances openly, but the markets will settle knowing that the positions can be purchased directly at any time by the central bank.

      JF

      Delete
  15. "But the way to do that and to make good policy in the meanwhile is through economic science"

    You do not think this is a little bit pompous. I think the profession needs to be a little less triumphalism. Try rewording as

    "There is a large enough body of falsifiable evidence in economics to safely conclude that..."


    Quite a few people who think economists have as much to blame as bankers for what happened over the decades until 2008. The policy prescript to deal with which was arguably successful in preventing a full blown crisis in the real economy was no thanks to Rational Expectations "state of the art science" but to an 80 year old book.

    I know macro-economists love their models, but a little more humility please.

    Oh, and the way to make good policy is widely and deeply informed analysis. (Even with the catastrophe of 2007 a few people have not learned that.)

    ReplyDelete
  16. Why in the 1970s did the UK have to seek assistance from the IMF?

    ReplyDelete
    Replies
    1. They needed dollars in order to maintain the value of the pound.

      Delete
    2. Why did they need to maintain the value of the pound?

      The only way "there is no way that the UK will default" can be true is if there is no need to maintain the value of the pound.

      Delete
    3. Maintaining the value of the Pound was to prevent importing inflation when a country has a negative current account with the rest of the world.

      The process means you are forming a currency union with a foreign currency; like the Eurozone countries have done. Sovereign fiat currency economies are not designed to be pegged to other currencies, it negates the whole point of having a fiat currency. You might as well go back to the Gold Standard.

      Africa 19 fixed currency countries; 14 of them using the CFA franc that is pegged to the Euro currently, acting as a currency union for these small economies. Large exporters of oil, tend to peg to the currency oil trades in, with 7 Middle East countries all pegged to the US Dollar.

      Delete
  17. In my humble opinion this post is excellent, outstanding, and brilliant.

    ReplyDelete
  18. ''And do not forget that Ireland and Portugal were constantly told by those close to the markets that they needed to embark on acute austerity to ‘regain the trust of the markets’, when in fact what the markets were looking for all the time was for the ECB to act as a lender of last resort.''

    what if debt keeps rising in next decade(s) in those countries, is it the job of the central bank to keep acting as lender of last resort, pushing yields down, or is it the job of the markets to (possibly) push yield up so those countries start controlling their debt somehow?

    ReplyDelete
  19. (disclaimer - academic/Prof. in computational decision theory): I wish people would stop using the word “irrational” when they really mean “behavior other than what I would want”. “Rational” as defined by decision theorists is dependent: (1) on your preferences, which do NOT have to be EMV, even if we could all agree on an appropriate discount rate; and (2) infinite computational resources (infinite time horizons and an infinitude of potential factors in the real world, most of which we can’t estimate, make the computational challenge…interesting).

    ReplyDelete
  20. It's victory day for macro-economists and their models. Just consult your ISLM gadget or your rational expectations model with sticky prices and everything will be fine. We can ignore history, we can ignore all knowledge we have about what actually goes on and just have faith in these...what?

    Clearly there has been a failure in the education system somewhere for things to get to this level of farce. And didn't we learn anything about the consequences of hubris from recent events?

    ReplyDelete
  21. Only read the first para:

    "After all, the excesses shown by participants in those markets had caused the largest recession since WWII. (Not to mention a constant stream of cases of illegality and mis-selling.) However I wondered yesterday if the opposite might be true."

    In case you haven't realized by now: Dear SWL, with your debt socialism approach you are a lobbyist of the financial markets.

    ReplyDelete
  22. I agree with you that the market can behave irrationaly. (and often do)

    The answer should be austerity, just depend less on the "high priests" chaos.

    ReplyDelete
  23. There is high comedy in SWL's accusing others of being high priests when he is himself the high priest of his own macroeconomic religion: He believes that fiscal stimulus can flood the economy until we have 4% or more inflation, and then it will be a mere technicality in containing or reducing it. So SWL not only giveth but the taketh away the punchbowl. I do not want to hear the screams of the unemployed when he does a Volcker on them or think of the suicidally minded government that might follow his recommendations. To ignore the rules of political experience as he does requires a sacrifice of intellect worthy of his faith. Blind faith is what it takes to think his system might work.

    ReplyDelete
    Replies
    1. Anon 15:19 - 4% inflation would not be a problem. Indeed, for the many people out there with epic mortgages, inflation is about the only way out..

      I would like to see these 'rules of political experience', other than the one where austerity leads to political extremes and instability. We got that one in the 1920s and 1930s, thanks, would like to avoid a repeat.

      Delete
    2. Andrew:

      You don't read SWL very much, do you. He wants to bring about 4% inflation through fiscal stimulus, i.e. deficit spending, in other words raising public debt to be repaid by your children. And he also discusses the problem that that might lead to overshooting inflation and that it would then be necessary to rstrain it. He thinks that would be easy. Do you?

      Delete
    3. If you've not noticed, "public debt" is never "repaid" and, if it was, we'd have the mother of all recessions.

      Delete
    4. Anon 7:57 -

      Whereas the 'Austerity' argument is that my kids should simply be unemployed, or very poorly paid. This is emotive talking-point argument.

      The UK has serious infrastructure problems, from a lack of housing to a lack of transport links to a lack of power stations - and there is plenty more. And at the same time we have considerable unemployment and underemployment. The case for a large scale set of public works is rock solid from both these angles, and certainly a lot stronger than the case for austerity-driven stagnation.

      Delete
    5. gastro george16 March 2015 at 08:39

      If so, why do we ever have to pay taxes? Let governments borrow all they want for their expenditure (and spend even more on me).

      At least SWL is aware that governments do sometimes have to pay a part of their debt.

      His weakness is to think that, at the zero lower bound, fiscal stimulus (without monetary policy) is able to raise inflation to 4 % or more, and if inflation goes too far, ther will be no great problem in containing it.

      To believe that, you have to follow St. Augustine, bishop of Hippo: Credo quia absurdum (I have to believe it since it is absurd and so cannot be proved).

      Delete
    6. @Anon 02:24

      You take the manichean view that governments could either not net spend or could/would spend as much as they like. I was taking the more nuanced view that it is entirely normal for governments to net spend. Of course this should not be excessive, but it is part of a normal healthy economy.

      Delete
    7. gastro george17 March 2015 at 02:41

      No problem about that. But what about inflation and containing it? That was my original point, which you have been avoiding.

      Delete
    8. @Anon 03:33

      I think the onus is more on you to give reasons why inflation might not be containable. Historically inflation of 3 or 4% is not that unusual, and episodes of >10% are very unusual. In an era of deflationary tendencies, why should we worry about inflation rising to 4%?

      Delete
  24. " Blind faith is what it takes to think his system might work"

    Blind faith is what we being governed with now. Some say it is all we have ever been governed with.

    ReplyDelete
  25. Well whenever I have to know something related to finance market, I ask straight forward from Dr. Aloke Ghosh. He really have vast knowledge of Finance and accounts. I must say if you have ever doubt related to accounts or finance then ask him.

    ReplyDelete
  26. Is your blog complaining about the "high priests" of the market you engaged with on the night or the market itself?

    Railing against a couple of random mouthpieces is all good fun, we all do that. Railing against the market is like President Maduro of Venezuela complaining about speculators causing shortages. The financial markets no more caused the "largest recession since WW2" than speculators caused the shortages in Venezuela.

    Markets merely reflect an underlying situation, not cause it.

    ReplyDelete
  27. "I suggest too many people view markets like a vengeful god"

    I have, half jokingly, described the market that way so many times. "She" is a vengeful God who demands to be respected or she will rain fire and brimstone down upon you.
    Interesting the perspective of those who have actively participated versus those who take no risk but merely pontificate.

    ReplyDelete

Unfortunately because of spam with embedded links (which then flag up warnings about the whole site on some browsers), I have to personally moderate all comments. As a result, your comment may not appear for some time.