Hot tip: bet one Aussie dollar each way.

At the one extreme we have exotic financial derivatives that no-one knows how to value as well as opaque bundles of high risk loans and low risk bonds that no-one knew how to value either. At the other extreme, we have the simplistic nonsense known as technical analysis that anyone can understand, but happens to be bollocks. No wonder the world financial system is such a ferrel beast.

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Age write Lucy Battersby has produce this gem of an article, that spruiks the sage thoughts of Paul Ash, president of the Victorian chapter of the Australian Technical Analysts Association. It is all about the much-buffeted AUD.

It turns out that the Aussie went down for a while, then up, then down, then up a little bit, then down a tiny bit. This is clearly big news. But not one to take things at face value, Ms. Battersby notes that the Aussie is

at a moment of indecision that could see it continue downwards or climb and break though resistance.

Let’s rush straight out and put some money on it to……go up?… go down..? Hell, let’s just buy a Tatts ticket.

But it gets more specific (and consequently more wrong) as the article progresses. Mr. Ash claims that for the next day “it is critical if the AUD can spend 24 hours above 90 cents.” Like Uri Geller and John Edwards though, he never actually completes the prediction of what might happen after that. But he is clearly saying that Tuesday Feb 23 is critical. Forget any notion of EMH or martingales. The claim is that the value Vt of the aussie dollar satisfies the condition

 if inf{Vt:t ε Feb 23} > 0.90

then ∂EVt/∂t>0 ….. or perhaps ∂EVt/∂t<0. Take your pick.

Ms. Battersby then chimes in to describe technical analysis as

a search for patterns which not only “provides a theoretical basis” for traders but “removes sentiment and gut feeling” from trading.

The straw man strikes again. The only possible trading strategies apparently are pattern searching or gut feeling. Forget any research on the company you want to own. Someone tell Warren Buffet and his acolytes.

But I have been a little unfair to Mr. Ash in claiming that he never makes a prediction. He does actually come out with one towards the end. He says that if the AUD gets above the “non-confirmed resistance line” of 91.7 cents “then we would say with confidence that the AUD is on an upward trend.”

Anyone heard of a tautology? Since it is below 91.7 now, if it gets to 91.7 it will be on an upward trend. Gentlemen. Place your bets!

Hat tip to Mike Smith for slipping this article under my door.

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Conversation with Ariel Kalil

Ariel Kalil

Ariel Kalil is a Professor of Public Policy at the Harris School, University of Chicago. She is a developmental psychologist by training, and her work links developmental psychology with economics, e.g., the effect of parental job loss on child development. I had a conversation with Ariel about her work and thought it would be of great interest to our readers.

Kwang: Congrats on the NY Times feature last week. Not many social scientists make it to the front page. How do you feel about that?

Ariel: It was very exciting! It was fun having friends e-mail to tell me they’d read the article on their train ride that morning. What I was especially happy about was that the reporter got the story right. He was a very curious and thorough guy, and we spent a lot of time on the phone and exchanging e-mails over the past few weeks. He read all of my original papers carefully, and came up with some very good questions for me. And the families that he interviewed had stories to offer that really illuminated some of the quantitative findings from my work.

Kwang: Tell me a little more about your work. What are main themes you’ve researched and what motivates you to pursue these questions?

Ariel: I’m interested in how socio-economic conditions are associated with families’ well-being and children’s development. So, I’m interested in parents’ mental health and their interactions with one another and their children, and I’m interested in children’s behavior and academic performance. In many instances, there is a link between, say, family income or families’ employment experiences and these outcomes. I care, as all economists do, about whether these links are causal. But, in thinking more like a developmental psychologist, I am also interested in “getting inside the black box” to understand why these links exist, and what kinds of individual differences shape how strong these links are for different types of children and families. I’ve always been interested in applying social science to real world problems. The idea that my work might someday shape public policy that could help improve the lives of families and children is very motivating!

Kwang: In the paper featured last week by the NY Times, you show that young people are badly affected when their parents lose their jobs, and that this is true in single parent and dual parent families [paper]. Could you tell us more about these effects and what you think drives the differences between single mothers and dual-parent families? Between male and female parents becoming unemployed?

Ariel: I think there are likely different factors at play for single parent vs. dual-parent households when jobs are lost. First, these families look a lot different from one another in terms of a whole set of demographic characteristics. So, in some sense, it’s a bit difficult to compare the two kinds of families. One of the biggest and most obvious differences is that when a single mother loses a job, the family has typically lost its only breadwinner. These families are likely to already be strained economically, and to have few (if any) people in their set of friends and relatives who can help them out. In many cases, a job loss sets off a cascade of adverse events that can be hard to stop, such as getting evicted or having to move in with others to save housing expenses, and this might disrupt child care arrangements or where kids go to school, and so on. There is just a lot more instability in these families related to the families’ economic circumstances.

In dual-parent families, I think the situation is a little different, and, at least in the short term, I think the impact on well-being and child outcomes has less to do with the economic impact of the job loss than the psychological one; for instance, in the way that parents relate to one another and to their children. For example, most dual-parent families have two earners, and so the family hasn’t lost all of its income at once. And many of these families also have some resources they can draw on, either savings or help from other family members. The immediate economic threat may not be quite as great. Also, in the families from whom I’ve collected data, I’ve found that parents will typically try to cut back on other things before they cut back on spending for their children, so the kids are often spared disruptions in their daily lives. In these families I think the adverse impacts that we see have a lot more to do with stress and anxiety, which we know can be very damaging to family relationships and ultimately to children’s development. And I think a big factor in the current recession is how long it’s taking people to find new jobs. The number of “long-term unemployed” is at an all-time high, and parents are very worried. We may eventually see more of these families exhausting their savings, losing their homes and encountering the same kinds of hardships that single-parent families have been more likely to face.

The different impact when fathers and mothers lose jobs is a really interesting one. In our work, we have consistently found that the negative impact of fathers’ job losses is greater. And this is not simply because fathers’ earnings losses are greater than mothers’ (in fact, in the US, in 40% of dual-earner households women are the primary earners). This is an interesting puzzle that I’d like to try to figure out; unfortunately the data are not readily available on this particular issue!

First, I think that “stereotypical” gender roles are still alive and well in many families and that the idea of being the “breadwinner” is still very important to many men and that is may be a bigger psychological blow to them when they lose their job.  Second, working women occupy a variety of roles – we see in time use data that women still do the lion’s share of caring for children and tasks around the house (cooking, cleaning, etc), even when they are employed full-time.  It turns out that working mothers cut back on their sleep and leisure time to do all of these things. So it may be that during periods of unemployment these women spend their time at home more effectively than a similarly unemployed man – because they were already occupying those roles anyway. Also, in the families from whom I’ve collected data, there seems to be more strife over figuring out what fathers’ “roles” are going to be during a period of unemployment. Many fathers viewed spending 40 hours per week in an outplacement office or a networking group searching for a new job as a full-time job, whereas many of their working wives thought they could usefully be spending more of that time helping out around the house or with the children. And that created a lot of conflict, which I think is rooted at least in part in “societal” or individual views about how the responsibilities of running a family should be divided between mothers and fathers.

Continue reading “Conversation with Ariel Kalil”

Which production factor gets destroyed in major recessions, part II?

In a post a few weeks back, I raised the question of what additional production factor one would have to include into the current production function framework in order to have a plausible story about the recent crisis.

That post included a set of conditions any candidate would have to pass in order to fit the current crisis and be interpretable as a true factor of production. From the ensuing reactions, two main candidates emerged: a mystery factor that gives a role to lines of credit (suggested by James A); and input and output linkages (suggested by doctorpat, Ian King, and, implicitly, _Tel).
Let us now add more information to this question and see whether the proposed production factors have something to say about other major economic crises that we have known in relatively recent economic history.

The hope is that we need only one factor to generate a reasonable story for several major downturns. If  we’d need a very different new factor to explain each different major economic downturn, then the exercise of looking for new production factors becomes more futile because there is then less hope that having a good  explanation for each of the previous downturns will say anything of much use to inform us about what to do to prevent or cope with the next one.

Below is a graph that summarises the GDP movement of three other major economic downturns.

GDP movement during major recessions in the US, Russia and Indonesia
GDP movement during major recessions in the US, Russia and Indonesia

The blue line shows the Great Depression, in which case the 0 point on the X-axis denotes 1929; the red line shows the collapse of the Russian economy after the changes in 1990; and the green line shows the Indonesian collapse after the Asian Financial Crisis of 1997. In each case, GDP is normalised to be 100 at the start of the crisis and time is re-set to 0 at the start.
The first striking observation is that these three crises are far bigger in magnitude than the current crisis. Indeed, the Russian collapse was so spectacular that I have long wondered how it is possible that our macro-textbooks are not full of insights gained during such a spectacular macro-event. Stiglitz already noted in the 90s that the Russian collapse shouldn’t have occurred under the conditions we still teach as good descriptions of the aggregate economy, but it clearly hasn’t mattered for Western textbooks that a large economy on the periphery did something interesting.
The main question to briefly consider though, is whether the two candidate factors X are known to have been involved in these downturns too? Lines of credit were certainly important in the Russian case (as in the whole of the former USSR), where firms had large amounts of outstanding debt with other firms and the unwinding was a tricky business.

Lines of credit were also important in Indonesia and the Great Depression. Hence credit lines can at least potentially ‘fit’, though it should still be worked out via which actual production factor they affect sold production.

Linkages are clearly of relevance in the Russian case where the whole central coordination mechanism fell away and the ensuing ‘disorganisation’ (A phrase used by Blanchard and Kremer 1997) created many firms who had no suppliers and no clients. Campos and Coricelli in their 2002 Journal of Economic Literature article also point to within-sector reorganisation of links as a probable factor in the collapse.

Whilst linkages are probably relevant in the Asian Financial crisis, it is not well-documented how they might have played a role. We know many city labourers went back to the countryside, however exact numbers are unknown because most people who originally came from the country to find urban employment are unregistered and therefore not included in unemployment and migration data etc (explanation paraphrased from a paper by Tran Tho Dat).
We also know that the capital embedded in collapsing firms was not quickly re-used by others, but there’s no specific account I know of that  discusses the collapse in terms of broken linkages.

For the Great Depression, on which acres have been written, I also do not know of anyone looking at it through the lens of links. One might say it is implicitly there when people talk about the issue of bankruptcy, as bankruptcy to a perfect market economist merely means the freeing up of previously inefficiently used production factors. From a link point of view, the importance of bankrupcy is that people and capital are idle for quite a while before they are ‘re-linked’.

Any ideas on how we should think of disruptions in lines of credit and its impact on the real economy via a production factor in these three crises or the current one? Any anecdotes on links?

WSJ on Aussie Mac

I’ve been a little busy so haven’t had time to comment on the Government’s ramping up of its residential mortgage-backed securities intervention of last week. Chris Joye has done an excellent job of laying out the pros and cons of that intervention. The pro being that it is a necessary intervention especially given the Governments other guarantees in this sector and the cons being that it is hardly a long-term solution.

Anyway, four days after the Government’s moved, the Wall Street Journal finally popped its head up to condemn it. This is the speed that you will be paying good money for soon. Their contention is that the Government’s intervention looked like “Aussie Mac in the making” and that if you think about “Mac” then you are thinking Fannie and Freddie and that was terrible so the Australian Government learned nothing. Let me just spell out that an intervention into the RMBS market by a branch of the Treasury is not the same as a privatised and obscurely guaranteed and largely unregulated couple of firms dominating the market. The fact that the Government is not doing that and moving more cautiously is an indicator that it is learned from the spectacular US regulatory errors here. Indeed, it may look further north to Canada to see how a “Mac” institution should really work (for some references see here).

But in reading the WSJ article, there is a derisive sense against securitisation as if no one sensible does that anymore. I don’t have the numbers but it was my impression that most new mortgages in US are still securitised and I think there is underlying government backing there. If someone has those numbers, please share.

An expanded version of this post appeared in Crikey today (over the fold). Continue reading “WSJ on Aussie Mac”

Doubleplus Good Financespeak

Has anyone noticed how the vocablary of the finance industry is heavily laden with moral overtones?

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Consider the following list of financial terms and the images they conjure: `assurance’, `bond’, `credit’, `consolidation’, `equity’, `interest’, ‘mutual’, ‘obligation’, `redemption’, `reconciliation’, ‘security’, `trust’, ‘venture’.  I wonder how many of these terms have their origins in the Protestant business philisophy of the nineteenth century – that wealthiness is next to godliness.  

Even the trashy housing loans that got us into this mess are called “sub-prime”, which to me sounds like a cut of beef only slightly more chewy than eye fillet. “Lambs to the slaughter” might have been a more honest marketing strategy.

And my favourite bit of financial jargon is ‘efficient market hypothesis’ as Doublespeak for complete bloody randomness. 😉

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Letter in Crikey

I have an opinion piece in Crikey today (over the fold) on that letter mainly trying to talk about things other than the ‘Peoples’ Bank,’ a term that is a media invention today. Of course, the title of the Crikey piece that they substituted in appears contrary to what I was trying to do (Sigh!). That said, Bernard Keane in Crikey today does an excellent job of accurately reporting what we were trying to do in the letter.

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“Gans: Why the People’s Bank makes good sense”

Crikey, 8 July 2009.

If there is one thing Australian governments have been good at over the past three decades, it is periodically reviewing the banking system and its regulation. Starting with Campbell in 1981 and then Wallis in 1996, governments have found that the best way to consider banking policy is to move it above the political fray, take its time, look at all parts and independently charge a panel with reviewing the state of affairs and providing clear and evidence-based recommendations.

In an open letter today, six economists (including myself) making the case for another similar inquiry to take place over the next year or so. In the letter we note that the Australian financial system has weathered the global storm relatively well but at the same time a significant and often radical set of policies have been put in place. ACTU president, Sharon Burrow, called many of these policies necessary “band aids.” At the same time, however, it is believed that those policies while shoring up our major banks have disrupted the smooth workings of the financial system. Right now, that isn’t a problem but into the future as we come out of this crisis the costs of those might be felt.

This is not simply a timely review but a necessary one. Economists have come to realise the gaps in their knowledge of how regulation performs and what the best institutions are for on-going government intervention in the financial sector. The Prime Minister is well aware of these as he articulated in his much talked about essay for The Monthly. For these reasons, it is important to step-back and assess the new knowledge gained here and around the world and consider a greenfields approach to our set of financial regulations.

It is interesting that the proposal, floated although not necessarily endorsed in the letter, that a government-owned institution might have a competitive and stabilising role was picked up so strongly in the media. That policy likely has costs and benefits and only further investigation will determine its appropriateness. The media attention surrounding it only adds grist to the mill that considered policy evaluation is necessary in this sector. Indeed, it is in the major banks’ interest to get behind a new independent inquiry lest policies directed towards them continue to be enacted on the fly or in the midst of some new political storm in relation to bank profits.

Our goal here is to decouple of review cycle from the electoral cycle for banking. That is surely something many interested groups can support.

Joshua Gans is an economics professor at Melbourne Business School. The open letter can be viewed here: https://economics.com.au/?p=3816

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Macroeconomics in Online Opinion

It is one of those days. I wrote an article for Online Opinion on the GFC a week or so ago. It appeared today and is reproduced below.

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The crisis and the textbooks

Joshua Gans, Online Opinion, 8th July 2009.

In August, 2008, a month before the Global Financial Crisis hit with unmistakable impact, I received the galleys for the 4th edition of my textbook, Principles of Economics. It is the adaptation of Greg Mankiw’s leading US text (co-written with Stephen King and Robin Stonecash). The edition had changed only a little from the one three years earlier. Perhaps the most significant addition was an extended discussion of climate change policy but also the juicier examples coming from the Freakonomics-like microeconomic research that had so captured popular enjoyment of economics. By the time the text was finally published, the GFC was among us and it was hard to imagine how this could not be the central part of macroeconomic discussion, let alone be absent from this most recent of writings.

In many respects, this anecdote is as much about the lags in traditional publishing as it is about economics being somehow off-base. But it is also true that the speed with which the crisis developed from something familiar to something scarily unfamiliar was striking. How could it not change the way economics is taught?

Fast forward just a few more months to the present and my concerns that the crisis was not front and centre in the book have been allayed. This is not to say it will not feature next time around, it is that it will impact on 5 per cent rather than 50 per cent of your average first year economics class.

My reasoning for this is quite straightforward. Macroeconomics is a discipline that deals with the movements of aggregates. There are two things that drive these:

First, there are accounting identities such as how the components of national expenditures must sum to the level of production or how the capital account balance must offset the current account. These are immutable and do not change – crisis or no crisis.

Second, there are behavioural relationships. These describe how broad sets of individuals make decisions and how they interact with one another. Being behavioural, these are hardly immutable and what is more, we do not know as much as we would like to know about them.

To take an example: the notion that consumption rises with current income. This assumption started with Keynes and was critical in understanding how actions that might stimulate income (such as a tax rebate or a handout) might lead to higher consumption and stimulate private activity. The rate at which this occurs drives the all important multiplier effect. However, for the better part of half a century, economists have noted that if you give someone $900 extra today, this does not change their lifetime income very much. So even if you happen to spend 80 per cent of your income, you might save more of that $900 than is your usual pattern. And if that occurs, so goes the multiplier.

So there is a debate about these measures. And in the textbook, it turns out that the precise relationship likely hinges upon liquidity. After all, you can manage or smooth your income over time quite easily if you can readily borrow during downtimes and save during uptimes. But take away a functioning banking system and that assumption does not necessarily hold. In that situation, interest rates may drop during downtimes but borrowing doesn’t occur. Hand someone some money then and it may well be spent.

What recent events have reinforced to economists is that there are three kinds of macroeconomics. First, there is the long-run, where if you wait, the cycle does not matter and you want to have your house in order, so as to grow in a sustainable fashion. Second, there is the short-run, where fluctuations do occur and government interventions such as keeping the money supply stable and allowing fiscal policy to move with the ebb and tide of the economy, smoothing the bumps.

But, finally, there is a liquidity crisis, where the financial sector stops working for a time and so forestalling crisis or reducing its effects requires active government intervention and management. It is scary because there is little science to this. And it is worrisome because there is an extent to which those actions may incur a debt of their own and slow recovery back to normalcy.

In the US, Europe and Japan, there is a liquidity crisis (for Japan it is their second in two decades). In Australia, for reasons that will be debated for years, we do not have that same crisis and are instead in the macroeconomics of the short-run. But even there with the storm coming over the horizon our policy-makers switched to a degree of crisis macroeconomic management with a pre-emptive stimulus package. There has been criticism that such measures were not necessary but it is equally possible that such measures did their job as intended.

The schism in modern macroeconomics between its three types is something that textbooks partition around but the current crisis has demonstrated that such compartmentalisation is inadequate to the task. Somehow, we need indicators as to whether we are moving from short-run to crisis mode and a way of agreeing upon a course of action for the latter. The last time this occurred globally, governments reacted very differently to the way they have now. Maybe not in the next edition but in future editions we will have learned enough about what worked given that massive bet to write a better textbook.

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