Monthly Archives: November 2008

Krugman refutes Friedman and Schwartz…

…or so he thinks. Our friend David Beckworth points Krugman to Christina Romer’s excellent work on the Great Depression (which I have mentioned here and here).

My thoughts on Krugman’s take are in the comments on Beckworth’s site.

Wow! How Things Change

Greg Mankiw in the NYT on November 28, 2008:

IF you were going to turn to only one economist to understand the problems facing the economy, there is little doubt that the economist would be John Maynard Keynes. Although Keynes died more than a half-century ago, his diagnosis of recessions and depressions remains the foundation of modern macroeconomics. His insights go a long way toward explaining the challenges we now confront.

Contrast that with Greg Mankiw in the European Economic Record in 1992:

The General Theory is an obscure book … We are in a much better position than Keynes was to figure out how the economy works.

Quote of the Day

“Some who promoted the first stimulus package have reacted to its failure by saying that we must now switch to large increases in government spending to stimulate demand. But government spending does not address the causes of the weak economy, which has been pulled down by a housing slump, a financial crisis and a bout of high energy prices, and where expectations of future income and employment growth are low.”

John Taylor

Big Players and Uncertainty

There has been a great deal of discussion lately with regards to the ever-changing role of the Troubled Assets Relief Program (TARP).  Initially, the program was designed to purchase the troubled assets of financial institutions in an attempt to cleanse their balance sheets and get them lending again.  I have previously come out against this plan as it fails to take into account the limitations and dispersal of knowledge within markets.  Perhaps this and other objections were heeded by the Treasury Department, which inexplicably abandoned this stated goal in favor of direct equity injections in troubled financial institutions.  In the aftermath of this decision, little has been done to instill confidence in the financial markets and the capital infusions have done little to increase the lending by the recipient institutions.  Given that many noted economists preferred capital infusions to the purchase of troubled financial assets, recent events beg the question as to why this change in policy has been unsuccessful.

The answer can be found in Fairleigh Dickinson economist Roger Koppl’s theory of Big Players.  Koppl defines a Big Player as a market participant that is substantially large, immune to profit and loss mechanisms, and yields ample discretionary power to have an impact on the market as a whole.  Central banks are perhaps the clearest example of a Big Player and this theory indeed might explain much about the artificial boom that preceded the current mess.  However, the theory is perhaps more applicable in the aftermath of the boom.  Since the onset of the crisis, the Federal Reserve and the Treasury department have acted as Big Players.  They continue to wield significant discretionary power and often take unprecedented action – and at times unexpected restraint.  In other words, to use a tired saying, they are flying by the seat of their pants.  One need not look beyond the TARP for an understanding of the discretionary power of these entities.

The effect of this discretionary power is to increase uncertainty within the financial markets.  Firms that receive capital infusions refuse to increase lending precisely because the rules are changing on a daily basis.  The same goes for investors who must not only predict what the market is going to do, but also the behavior of the Big Players.  Of course, the ability to predict what the Treasury and the Fed are going to do next is substantially difficult.  The result is the herd-like behavior that has been prevalent in the stock market for the last few months.  When there is a high level of uncertainty in markets, participants start relying more on what they believe that others believe than the prospective yield of a particular investment.  The empirical evidence presented by Koppl and his colleagues confirms these claims.  Uncertainty breeds uncertainty.

Nevertheless, some pundits continue to press on.  The same individuals who advocated using capital infusions and who were surprised to find the institutions unwilling to lend are now advocating forcing the financial companies to lend. Markets function well when the surrounding institutional framework is sound.  If the government really wants to help, they can start by setting the rules now and following through on their promises.  So long as they continue to change the rules on a daily basis, uncertainty will prevail, the stock market will remain volatile, and the credit markets will remain frozen.  

You Cannot Make This Up

Driving in this morning I saw a Dodge with Ontario license plates and a bumper sticker that read “Out of a job yet? Keep buying foreign!”

Analyzing the Blog

The Dow is down 400 points, so how about a little fun?

Via our friends at Three Sources I discovered a site that analyzes blogs. Here is what the site says about this blog (and your humble blogger himself):

INTJ – The Scientists

The long-range thinking and individualistic type. They are especially good at looking at almost anything and figuring out a way of improving it – often with a highly creative and imaginative touch. They are intellectually curious and daring, but might be pshysically hesitant to try new things.

The Scientists enjoy theoretical work that allows them to use their strong minds and bold creativity. Since they tend to be so abstract and theoretical in their communication they often have a problem communcating their visions to other people and need to learn patience and use conrete examples. Since they are extremly good at concentrating they often have no trouble working alone.

Selgin on Free Banking

Our friend George Selgin discusses free banking on EconTalk.