tag:blogger.com,1999:blog-22325879515927613902024-03-08T00:24:21.312-06:00EconWeeklyUnknownnoreply@blogger.comBlogger213125tag:blogger.com,1999:blog-2232587951592761390.post-32679216840723736532017-01-26T10:48:00.000-06:002017-01-26T10:48:08.206-06:00Tear down this wall, Mr. 46th president<div class="separator" style="clear: both; text-align: center;">
<a href="https://3.bp.blogspot.com/-pZNyS2HqKdM/WIooExKw03I/AAAAAAAAGtk/oCL7SwU3g_UE9l3o9_4c-EM9moze9PEFwCLcB/s1600/View-of-the-border-line-between-Mexico-a-large_trans_NvBQzQNjv4BqpiVx42joSuAkZ0bE9ijUnGH28ZiNHzwg9svuZLxrn1U%255B1%255D.jpg" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="200" src="https://3.bp.blogspot.com/-pZNyS2HqKdM/WIooExKw03I/AAAAAAAAGtk/oCL7SwU3g_UE9l3o9_4c-EM9moze9PEFwCLcB/s320/View-of-the-border-line-between-Mexico-a-large_trans_NvBQzQNjv4BqpiVx42joSuAkZ0bE9ijUnGH28ZiNHzwg9svuZLxrn1U%255B1%255D.jpg" width="320" /></a></div>
<br />
<br />
Excellent <a href="https://www.cato.org/blog/border-wall-impractical-expensive-ineffective-plan" target="_blank">article</a> on the wall with Mexico, by the Cato Institute.<br />
<br />
My questions and comments:<br />
<br />
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1) Since a) the only effective wall would have to be a fully finished wall from ocean to ocean; b) legal and bureaucratic barriers make it unlikely that the Big Wall (Muro Grande?) gets built within four or even eight years (see the Cato article); and c) political support for a (half-finished) wall would likely decline under the next administration, then how likely is it that this project is a complete waste of taxpayer money?</div>
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2) Suppose the wall gets built, somehow, after all. Would then political support for the wall increase or decrease? </div>
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3) Once the wall is built, tearing it down looks like an invitation to illegal immigrants. Which arguments could a future president use to persuade voters that it's best to tear down the wall? (The only plausible one I can think of is the cost of maintaining the wall, likely to be in the billions). </div>
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Final comment: An effective wall would also have to be the longest, tallest, deepest wall that it’s physically possible to build, which means the most expensive of all possible walls (and even then I question whether it would be effective). But political horizons being relatively short term, it’s unlikely that the super-expensive wall will get built. We’ll wind up with the worst kind of wall: a kind-of-expensive, but ineffective wall.<o:p></o:p></div>
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-13330734531998379952017-01-03T15:43:00.000-06:002017-01-03T15:43:28.006-06:00Economist of the month: Richard CantillonWas Cantillon the real father of economics, or just the first modern economist?<br />
<br />
Harry Landreth and David Colander, on <i>History of Economic Thought</i>, heap praise on Cantillon's accomplishments (<b>emphasis</b> added):<br />
<blockquote class="tr_bq">
Richard Cantillon (c. 1680-1734) was an unusual figure in the history of economic ideas. His birth date and place of birth are not completely certain, but the consensus is that he was born between 1680 and 1690 in Ireland. He lived most of his life in Paris and was successful in amassing a fortune as a banker. His one book was evidently written around 1730 and was widely read in both France and England by intellectuals who were interested in economics. He died in England in 1734; his book was not published until 1755.</blockquote>
<blockquote class="tr_bq">
What is unique about Cantillon is that his book was unusually sophisticated and<br />advanced in its understanding of economic questions, yet it was not given much attention in England after the publication of Adam Smith’s Wealth of Nations in 1776. In 1881 William Stanley Jevons rediscovered Cantillon’s book and heaped praise on it, describing it as “the first systematic treatment in political economy” and “the cradle of political economy.” </blockquote>
<blockquote class="tr_bq">
What is Cantillon’s place in the history of economic thought? He evidently had little<br />subsequent influence on writers, although his book was read by the physiocrats and cited by Smith in his Wealth of Nations. Even though it is a brilliant and insightful work, its only important influence that can be traced is on the physiocrat Frangois Quesnay. Cantillon himself acknowledged the influence of John Locke, for his theory of money, and William Petty, for his emphasis on the importance of measuring economic phenomena. Cantillon was part mercantilist (mostly in his views on foreign trade), part physiocrat (in his emphasis on the primary role of agriculture in the economy), and part physiocrat- classical (in his vision of the interrelatedness of the various sectors of the economy). Unlike Petty, who produced works of a practical nature exploring various topics in economics, Cantillon was modern in that (1) he started with the goal of establishing basic principles of economics through the process of reasoning, and, more important, (2) he wanted to collect data to use in the process of verifying his principles. Unfortunately, his statistical work is lost.</blockquote>
<blockquote class="tr_bq">
<b>Cantillon’s seminal vision, which was to a lesser extent possessed by some of the</b><b>physiocrats and liberal mercantilists, was of a market system that coordinated the activities </b><b>of producers and consumers through the medium of individual self-interest. The key actors </b><b>in this self-regulating system were entrepreneurs, who, in their pursuit of profit, produced </b><b>social results superior to ones that could be produced by government interference.</b> Given competitive markets in which entrepreneurs pursue customers in final goods markets and compete with one another in factor markets, Cantillon was able to point to the adjustment processes as demands, costs, technology, and other factors change. He did not make the plea for laissez faire with the force of Smith, however, which may account for his neglected recognition. </blockquote>
<blockquote class="tr_bq">
<b>He tended always to treat any element of the economy as part of an integrated</b><b>structure; for example, population changes were endogenous to his system, not exogenous. </b><b>His explanation of the forces that determine prices was surprisingly modern in that he </b><b>distinguished between market prices, determined by short-run factors, and what he called </b><b>intrinsic value, long-run equilibrium prices. </b>He was able to apply his analysis of prices and markets to international trade and view the adjustment processes that take place there.</blockquote>
<blockquote class="tr_bq">
Some of his most accomplished technical analysis was not in microeconomics but in the macroeconomic aspects of the effects of changes in the supply of money on prices and production. He divided the economy into sectors and analyzed the flow of income between them; although he did not explicitly formulate an economic table to represent these flows, he clearly influenced Quesnay, who did. Cantillon acknowledged his debt to John Locke and his early statement of the quantity theory of money, but Cantillon was able to see subtleties in Locke’s analysis that escaped Smith and his contemporaries. The consequences of an increase in the quantity of money were not simply macroeconomic effects on output or prices. In an early examination of the microeconomic foundations of macroeconomics, Cantillon saw that the points at which the new funds entered the economy would influence their impact. Accordingly, the general level of prices could change, but relative prices could also change, with subsequent impacts on the various sectors of the economy.</blockquote>
<blockquote class="tr_bq">
As we suggested in the closing pages of Chapter 1, historians of economic thought must make choices about how much attention to give to various economists. Our criteria assign great weight to the impact of a given writer on the subsequent development of economic ideas, not to his or her creativeness or brilliance. <b>If our criteria emphasized who said it first </b><b>or who said it best, Cantillon would have a place alongside Smith as a founder of political </b><b>economy.</b></blockquote>
<b><br /></b>
More on Cantillon:<br />
<br />
<ul>
<li><a href="https://www.jstor.org/stable/1827232?seq=1#page_scan_tab_contents" target="_blank">Joseph Spengler: Richard Cantillon, First of the Moderns</a></li>
</ul>
<br />
<br />
<ul>
<li>MRUniversity (4-minute <a href="https://youtu.be/W9YEO88c2DM" target="_blank">YouTube video</a>, in their course on Great Economists).</li>
</ul>
<br />
<br />
<ul>
<li>The Mises Institute, with a link to Cantillon's main (only?) <a href="https://mises.org/library/essay-economic-theory-0" target="_blank">opus</a>, and his <a href="https://mises.org/library/biography-richard-cantillon-1680-1734" target="_blank">biography</a>.</li>
</ul>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-62182131488094175202017-01-03T15:02:00.000-06:002017-01-03T15:02:30.151-06:00What does a futurist do?<table cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="https://1.bp.blogspot.com/-R_YJdzoYGUQ/WGwPwEghvmI/AAAAAAAAGtA/KfZKV-sbLCsNIKn8K6DFKorQ7sCDZIIVwCLcB/s1600/20170103%2BMetropolis.jpg" imageanchor="1" style="clear: left; margin-bottom: 1em; margin-left: auto; margin-right: auto;"><img border="0" height="298" src="https://1.bp.blogspot.com/-R_YJdzoYGUQ/WGwPwEghvmI/AAAAAAAAGtA/KfZKV-sbLCsNIKn8K6DFKorQ7sCDZIIVwCLcB/s400/20170103%2BMetropolis.jpg" width="400" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Metropolis</td></tr>
</tbody></table>
<blockquote class="tr_bq">
"<span style="color: #333333; font-family: "Chronicle SSm", serif; font-size: 16px;">What futurists actually do is facilitate as groups of people work through a highly structured, sometimes months-long process of coming up with as many hypothetical futures as they can, in order to prepare for more or less anything."</span></blockquote>
<blockquote class="tr_bq">
<span style="color: #333333; font-family: "Chronicle SSm", serif; font-size: 16px;">[...]</span></blockquote>
<blockquote class="tr_bq">
<span style="color: #333333; font-family: "Chronicle SSm", serif; font-size: 16px;">"</span><span style="color: #333333; font-family: Chronicle SSm, serif;">When Ms. Webb and I settled on the future of self-driving bus transit, we at first imagined that the group transport services proposed today by Lyft Inc. and Uber Technologies Inc. might be the death of bus stops and pre-planned bus routes. But as we picked apart our assumptions, it became clear that the predictable nature of most commutes would mean not dynamic bus routes, but routes that were simply better informed by data about where and how often people actually need mass transit."</span></blockquote>
<blockquote class="tr_bq">
<span style="color: #333333; font-family: Chronicle SSm, serif;">[...]</span></blockquote>
<blockquote class="tr_bq">
<span style="color: #333333; font-family: Chronicle SSm, serif;">"One thing all the futurists I talked to had in common was disdain for anyone willing to attempt to predict the future. In futuring circles, paradoxically, this is the mark of an amateur.</span></blockquote>
<blockquote class="tr_bq">
<span style="color: #333333; font-family: Chronicle SSm, serif;">Actually practicing futurism, even if only for a day, showed me the reason the future is so confounding: Aside from the fact that anything can happen, those unexpected events rapidly compound on one another. This leads to second, third and nth-order effects that can seem completely beyond the realm of plausibility until they happen. Hence the impossibility of predicting financial crises, wars and technological revolutions."</span></blockquote>
<span style="color: #333333; font-family: "Chronicle SSm", serif; font-size: 16px;"><br /></span>
<span style="color: #333333; font-family: "Chronicle SSm", serif; font-size: 16px;">That's from the Wall Street Journal, in an <a href="http://www.wsj.com/articles/think-like-a-futurist-to-be-prepared-for-the-totally-unexpected-1483272006" target="_blank">article about futurism</a> (as a profession, not an artistic movement). Now that's a job that grabs my imagination.</span>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-50284640400168752442016-07-25T10:34:00.000-05:002016-07-25T10:34:00.771-05:00New(ish) paper on the Shiller CAPE ratio, by J. Siegel<div class="tr_bq">
Published in the <a href="http://www.cfapubs.org/toc/faj/2016/72/3" target="_blank">May/June issue of the Financial Analysts Journal (vol. 72, no. 3)</a>. I'm not sure it it's gated, so you can find a working paper (from 2013!) version <a href="http://www.q-group.org/wp-content/uploads/2014/01/2013fall_siegelpaper.pdf" target="_blank">here</a>.</div>
<br />
Abstract:<br />
<br />
Robert Shiller’s cyclically adjusted price–earnings ratio, or CAPE ratio, has served as one of the best forecasting models for long-term future stock returns. But recent forecasts of future equity returns using the CAPE ratio may be overpessimistic because of changes in the computation of GAAP earnings (e.g., “mark-to-market” accounting) that are used in the Shiller CAPE model. When consistent earnings data, such as NIPA (national income and product account) after-tax corporate profits, are substituted for GAAP earnings, the forecasting ability of the CAPE model improves and forecasts of US equity returns increase significantly.<br />
<br />
The gist of the paper:<br />
<br />
<blockquote class="tr_bq">
"In this article, I offer an alternative explanation of the elevated CAPE ratio. The nature of the earnings series that is substituted into the CAPE model has not been consistently calculated for the long period over which Shiller has estimated his CAPE equations. Changes in accounting practices since 1990 have depressed reported earnings during economic downturns to a much greater degree than in the earlier years of Shiller’s sample."</blockquote>
<blockquote>
[...]</blockquote>
<blockquote>
"Companies report their earnings in two principal ways: reported earnings (or net income) and operating earnings. Reported earnings are earnings sanctioned by the Financial Accounting Standards Board (FASB), an organization founded in 1973 to establish accounting standards. Those standards—the generally accepted accounting principles, or GAAP—are used to compute the earnings that appear in annual reports and that are filed with government agencies (earnings filed with the IRS may differ from those filed elsewhere). GAAP earnings, which are the basis of the Standard & Poor’s<br />reported earnings series that Shiller used in computing the CAPE ratio, have undergone significant conceptual changes in recent years. </blockquote>
<br />
<blockquote>
A more generous earnings concept is operating earnings, which often exclude such “one-time” events as restructuring charges (expenses associated with a company’s closing a plant or selling a division), investment gains and losses, inventory write-offs, expenses associated with mergers and spinoffs, and depreciation or impairment of “goodwill.” But the term operating earnings is not defined by the FASB, and companies thus have some latitude in interpreting what is and what is not excluded. In certain circumstances, the same charge may be included in the operating earnings of one company and omitted from those of another. Because of these ambiguities, several versions of operating earnings are calculated."</blockquote>
<blockquote>
[...]</blockquote>
<blockquote>
"The definition of reported earnings has undergone substantial changes in the last two decades. In 1993, the FASB issued Statement of Financial Accounting Standards (FAS) No. 115, which stated that securities of financial institutions held for trading or “available for sale” were required to be carried at fair market value. FAS Nos. 142 and 144, issued in 2001, required that any impairments to the value of property, plant, equipment, and other intangibles (e.g., goodwill acquired by purchasing stock above book value) be marked to market.9 These new standards, which required companies to “write down” asset values regardless of whether the asset was sold, were especially severe in economic downturns, when the market prices of assets are depressed. Furthermore, companies were not allowed to write tangible fixed assets back up, even if they recovered from a previous markdown, unless they were sold and recorded as “capital gain” income."</blockquote>
<blockquote>
[...]</blockquote>
<blockquote>
"A distortion related to the Standard & Poor’s methodology for computing the P/E of an index—what I call the “aggregation bias”—overestimates the effective ratio of the index when a few companies generate large losses, as happened during the financial crisis. S&P adds together the dollar profits and losses of each S&P 500 company, without regard to the weight of each company in the index, to compute the aggregate earnings of the index. This procedure would be correct if each company were a division of the same conglomerate and one wished to determine the P/E of that conglomerate"</blockquote>
<blockquote>
[...]</blockquote>
<blockquote>
"Because of changes in the definition of GAAP earnings, it is important to use a definition of corporate profits that has not changed over time, as in the series computed by the national income economists at the Bureau of Economic Analysis (BEA), which compiles the national income and product accounts (NIPAs)."</blockquote>
<blockquote>
[...]</blockquote>
<blockquote>
"In forecasting future 10-year real stock returns, the highest R squared is achieved by using NIPA profits for specifications of the CAPE regression, with either the price index portfolio or the total return portfolio."</blockquote>
<br />
Siegel offers alternative estimates of how over-valued the S&P is, according to each CAPE measure, as well as estimates of future returns. The CAPE that uses the NIPA profit measure produces the lowest over-valuation and the highest expected returns. I'm generally sceptical of such estimates, so I won't go into those details.<br />
<br />
What I got from this paper is a reminder that the S&P measure of profits (and perhaps other measures that rely on reported earnings) has changed over time, due to accounting changes, so one has to be careful when using it.<br />
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-6018397170537607432016-05-13T10:43:00.000-05:002016-05-13T11:04:12.240-05:00Robots for everything: Teaching assistantsFrom the Washington Post:<br />
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<a href="https://www.washingtonpost.com/news/innovations/wp/2016/05/11/this-professor-stunned-his-students-when-he-revealed-the-secret-identity-of-his-teaching-assistant/" target="_blank"><img border="0" height="83" src="https://4.bp.blogspot.com/-FKhWQgp04Fg/VzXzwO1CoUI/AAAAAAAAGgk/9HnUGtDqYYEV1DsGCmwL-mwP4O26rYQqQCLcB/s640/screenshot-www.washingtonpost.com%2B2016-05-13%2B10-21-46.png" width="640" /></a></div>
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(Thanks to @JustinWolfers for his tweet.)<br />
<br />
My thoughts after reading this article:<br />
<br />
1. Robots can be more valuable when there is more technology in the environment. In this example, a chatbot was superior to humans in the context of a massive online open course (MOOC),<br />
<blockquote class="tr_bq">
"where students often drop out and generally don’t receive the chance to engage with a human instructor. With more human-like interaction, Goel expects online learning could become more appealing to students and lead to better educational outcomes." </blockquote>
This brings up the possibility of increasing returns to capital, at least up to a point. Here, the internet made MOOC's possible, which in turn made robots more valuable.<br />
<br />
2. If it's important to make the interaction with the bot human-like, make your robots more human: program them to respond with a delay, to make mistakes, etc. In this example:<br />
<blockquote class="tr_bq">
"I had the same doubt last week [whether the TA was a chatbot] because we were getting such speedy responses from TAs."</blockquote>
3. Context may be important for how well customers accept artificial intelligence. In this example, the users were taking an AI-related class, so it's natural the chatbot would be welcome:<br />
<blockquote class="tr_bq">
" 'A really fun thing in this class has been once students knew about Jill they were so motivated, so engaged. I’ve never seen this kind of motivation and engagement,' Goel said. 'What a beautiful way of teaching artificial intelligence.' "</blockquote>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-40069472157929107952016-05-05T09:57:00.000-05:002016-05-05T09:57:45.567-05:00"I still hold out some hope": James Bullard on the U.S. becoming Japan<div class="tr_bq">
Refreshingly outspoken James Bullard, from the St. Louis Fed, gives an <a href="http://www.nytimes.com/2016/05/05/upshot/outspoken-fed-official-frets-about-following-japans-path.html?smid=tw-upshotnyt&smtyp=cur" target="_blank">interview</a> to the New York Times. Some great quotes (emphasis mine):</div>
<br />
<blockquote>
"The general rule of thumb within the Fed is that <b>labor market data trumps G.D.P. data.</b>" </blockquote>
<blockquote>
"Once major central banks hit the zero lower bound, <b>the key issue was whether central banks would be able to keep inflation expectations consistent with inflation targets.</b>" </blockquote>
<blockquote>
"<b>I think the Brexit vote, there are a couple of aspects of this that make it much less of an international macroeconomic event. </b>It’s a scheduled event; you can track which way the vote is going to go by looking at polling; and it’s a long-term strategic vote on the part of the U.K. The day after Brexit — even if they vote to leave — nothing would actually change in terms of the trade arrangements. Those would continue for at least two years." </blockquote>
<blockquote>
"The norm in central banking, away from the zero bound, is to say, “We have set the policy rate exactly where we think it should be for today, given everything that’s going on in the economy, and in the future we’ll look at the data.” <b>You didn’t do this kind of dot-plot thing. </b>[...] I’ve wondered if we should get back to something that’s more akin to that. We don’t want to give unintentional commitments." </blockquote>
<blockquote>
"I’ve actually argued that unconventional policy works reasonably well. But it’s far less clear how it works, or how effective it is." </blockquote>
<blockquote>
"<b>I’ve always been worried that the long run here is the Japanese outcome. </b>I still hold out hope that that’s not the case, but I am worried about it, and it’s been going on for a very long time. If you talk to people in Tokyo, they say, 'Well, we’ve been through this and tried all these things, and you guys are just following us.' <b>I hope that’s not exactly true. [...] I still hold out some hope.</b>" </blockquote>
<blockquote>
"I’m not as big an advocate of fiscal policy as some other people. <b>It’s very hard to do very much on a business cycle time scale, given the fact that you’ve got to work with Congress.</b>" </blockquote>
<blockquote>
"At some point something will happen and we’ll be back in recession, and by almost any reckoning we will not have much that we can do in the way of lowering our policy rate."</blockquote>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-22260164549519304872016-04-28T09:28:00.000-05:002016-04-28T09:28:08.097-05:00Q1 GDP nowcasts<span style="color: #343a41; font-family: Segoe, Helvetica, Arial, sans-serif;"><span style="font-size: 15px; line-height: 20px;"><a href="https://www.frbatlanta.org/cqer/research/gdpnow.aspx?panel=1" target="_blank">Atlanta Fed's nowcast</a> of Q1 GDP (0.6%) was really close to preliminary estimate announced today by BEA (0.5%). Atlanta's was much closer than the <a href="https://www.newyorkfed.org/research/policy/nowcast.html" target="_blank">New York Fed's nowcast</a> (0.8%). <b>The question is which of the two nowcasts will be closer to the final estimate, after revisions</b> (available in late June).</span></span><br />
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<a href="https://4.bp.blogspot.com/-YngPMhGR7fc/VyIax205OHI/AAAAAAAAGdc/rXuOBJSmiyARt-_NiTije4QtGQH1mfYEgCLcB/s1600/screenshot-www.newyorkfed.org%2B2016-04-28%2B09-14-02.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="408" src="https://4.bp.blogspot.com/-YngPMhGR7fc/VyIax205OHI/AAAAAAAAGdc/rXuOBJSmiyARt-_NiTije4QtGQH1mfYEgCLcB/s640/screenshot-www.newyorkfed.org%2B2016-04-28%2B09-14-02.png" width="640" /></a></div>
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<span style="color: #343a41; font-family: Segoe, Helvetica, Arial, sans-serif;"><span style="font-size: 15px; line-height: 20px;"><a href="https://twitter.com/gavyndavies" target="_blank">Gavyn Davies</a> and <a href="https://twitter.com/JuanAntolinDiaz" target="_blank">Juan Antolín-Díaz</a> <a href="http://blogs.ft.com/gavyndavies/2016/04/20/important-developments-in-us-nowcasting/" target="_blank">explain</a> why these two nowcasts can differ so much from each other, and from their own nowcast at Fulcrum Asset Management. The Atlanta Fed's approach consists of "bean counting," i.e. they mimick the way the BEA calculates GDP by aggregating monthly data as they are released. The New York Fed's and Fulcrum's methodologies are both dynamic factor models, which extract a "common factor" from multiple time series (not only those used by BEA to estimate GDP). This underlying growth can then be scaled to match certain properties of the GDP time series (as the New York Fed does), or not be scaled (which is the approach they prefer at Fulcrum).</span></span>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-49302391996440063972015-12-21T12:49:00.000-06:002015-12-21T12:49:19.460-06:00Brief comments on the elections in SpainA little closer to Italy. The fragmentation of the vote was the expected and actual result of yesterday's general election. Incumbent Partido Popular (PP - moderate right) won the most votes, but came far short of the majority it had obtained in 2011.<br />
<br />
The main other party, Partido Socialista (PSOE - moderate left) might be able to form a government coalition with the new Podemos (far left), but they will still need the support of a motley crew of smaller parties in order to reach the 176-seat majority. Another possibility is a core coalition of PSOE with Ciudadanos (C's - center), plus somebody else. But that seems even less likely, as Ciudadanos promised during the campaign that they wouldn't join forces with either Podemos or nationalist parties. A grand coalition of PP and PSOE, <a href="https://en.wikipedia.org/wiki/Bundestag" target="_blank">à la Germany</a>, would be unpalatable for PSOE - and its demise as the leading party on the left.<br />
<br />
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="http://3.bp.blogspot.com/-5hUC8qFQlX8/VnhGAbpKGHI/AAAAAAAAGVI/jHv50ycv-Ys/s1600/20151221%2BSpain%2Belections%2B2.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="336" src="http://3.bp.blogspot.com/-5hUC8qFQlX8/VnhGAbpKGHI/AAAAAAAAGVI/jHv50ycv-Ys/s640/20151221%2BSpain%2Belections%2B2.png" width="640" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;"><span style="font-size: 12.8px;">Source: </span><a href="http://resultados.elpais.com/elecciones/2015/generales/congreso/" target="_blank">El País</a><span style="font-size: 12.8px;">.</span></td></tr>
</tbody></table>
<br />
After the first vote to form a government, which the incumbent prime minister will presumably lose, the parties have two months to form a government coalition before they must call fresh elections.<br />
<br />
Any coalition will be uneasy and precarious. Partido Popular has made bitter enemies during its four years in government. It's been an acrimonious election campaign. The programs differ wildly across parties. Whatever government they form, I think significant advances on important legislation are unlikely over the next four years (labor market, changes to the Constitution, education, Catalonia's independence referendum).<br />
<br />
Another important (and surprising to me) result was the decline of nationalist parties in Catalunya and Euskadi, and the rise, in those same regions, of the new left-wing party, Podemos. As a pro-referendum force, Podemos could actually do more for the independence cause than either the Catalan or Basque nationalists on their own. Yesterday's elections gave Podemos 69 seats, more than all the nationalist parties combined ever got in any general election. It's still doubtful, however, whether Podemos will be part of the new government. Moreover, those 69 seats won't belong to a single parliamentary group, as Podemos is itself an umbrella brand that includes a cluster of regional, left-wing parties with their own agendas.<br />
<br />
Messy. Bumpy. And thoroughly entertaining.<br />
<br />
<div style="text-align: center;">
<b><br /></b></div>
<div style="text-align: center;">
<b>Election results, town by town</b></div>
<div style="text-align: center;">
Can you spot which two regions are different?</div>
<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="http://1.bp.blogspot.com/-NJsoJBRSTwE/VnhDltbwsQI/AAAAAAAAGU8/0Ju_3n2ArKs/s1600/20151221%2BSpain%2Belections.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" height="523" src="http://1.bp.blogspot.com/-NJsoJBRSTwE/VnhDltbwsQI/AAAAAAAAGU8/0Ju_3n2ArKs/s640/20151221%2BSpain%2Belections.png" width="640" /></a></td></tr>
<tr><td class="tr-caption" style="text-align: center;">Source: <a href="http://elpais.com/elpais/2015/12/18/media/1450461184_895079.html" target="_blank">El País</a>.</td></tr>
</tbody></table>
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-80684031787241953742015-12-16T14:23:00.000-06:002015-12-16T15:54:09.149-06:00The hawkish shift of monetary policy recommendationsA <a href="http://www.igmchicago.org/igm-economic-experts-panel/poll-results?SurveyID=SV_0kXNVic9IQwmmjz" target="_blank">recent poll by Chicago Booth</a> (<a href="http://marginalrevolution.com/marginalrevolution/2015/12/economists-dont-know-what-they-are-talking-about.html" target="_blank">thanks, Tyler!</a>) asked a panel of economists in early December to agree or disagree with the following statement<br />
<blockquote class="tr_bq">
The Fed should raise its target interest rate when it meets in mid-December.</blockquote>
The respondents (all of whom are "senior faculty at the most elite research universities in the United States") were largely in favor of a hike. Forty-eight percent either agreed or strongly agreed; and 19% disagreed. Nobody disagreed strongly.<br />
<br />
Digging through previous questions to the same panel, I found a puzzling <a href="http://www.igmchicago.org/igm-economic-experts-panel/poll-results?SurveyID=SV_4Mgzm4jIDpiQBHT" target="_blank">result from early April</a>. The question then was:<br />
<blockquote class="tr_bq">
The Fed should wait until its preferred measure of inflation (Core PCE) is clearly rising — and not just forecast to rise — before it begins hiking interest rates.</blockquote>
Here's how the results of the two polls compare:<br />
<br />
<div style="text-align: center;">
<b>April</b></div>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://2.bp.blogspot.com/-obEIJmEZd_Q/VnG4DE4ikgI/AAAAAAAAGTw/orOjcwlU3OU/s1600/20151216%2BApril%2Bpoll%2Bresults.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://2.bp.blogspot.com/-obEIJmEZd_Q/VnG4DE4ikgI/AAAAAAAAGTw/orOjcwlU3OU/s1600/20151216%2BApril%2Bpoll%2Bresults.png" /></a></div>
<div class="separator" style="clear: both; text-align: center;">
<br /></div>
<div class="separator" style="clear: both; text-align: center;">
<br /></div>
<br />
<div style="text-align: center;">
<b>December</b></div>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://4.bp.blogspot.com/-jcKoJeVY4U0/VnG4ENUk35I/AAAAAAAAGT4/oEPXu_t9K-g/s1600/20151216%2BDecember%2Bpoll%2Bresults.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-jcKoJeVY4U0/VnG4ENUk35I/AAAAAAAAGT4/oEPXu_t9K-g/s1600/20151216%2BDecember%2Bpoll%2Bresults.png" /></a></div>
<br />
The hawkish swing is dramatic. In April 40% of respondents thought the Fed should wait for core inflation to rise. In December, <a href="https://research.stlouisfed.org/fred2/series/PCEPILFE" target="_blank">even though core inflation had not risen at all</a>, only 19% didn't think the Fed should raise immediately. What's going on? (Remember, both statements were about what respondents thought the Fed <i>should</i> do, not predictions of what the Fed <i>would</i> do.)<br />
<br />
1) Unemployment went down. But I find this hard to believe, because the unemployment rate fell just 0.5% between March and November, and the consensus forecast in March was already that unemployment would go down.<br />
<br />
2) Despite the wording of the April question, respondents did have in mind forecast inflation, not just actual inflation. But <a href="http://www.federalreserve.gov/monetarypolicy/fomccalendars.htm" target="_blank">forecasts of core inflation</a> barely changed between April and December. If anything, medium-term forecasts went down slightly.<br />
<br />
3) There is a third (fourth, fifth?) variable in the respondents' mental Taylor rule. However, this additional variable would have to produce a hawkish leaning by December. Output didn't grow particularly fast, in the U.S. or globally. Perhaps a heightened awareness that low interest rates are destabilizing the global financial system? I'm not convinced because, if anything, the consensus is probably that the system is more fragile now than in April. An interest rate hike, at the wrong time, could trigger the crisis.<br />
<br />
4) Respondents are concerned about the Fed's credibility. The Fed had been beating the hiking drum from October through December. Doing nothing in December would have undermined the effectiveness of future Fed communications.<br />
<br />
5) The respondents, by December, believed that the December hike was largely testimonial, a mere assertion that the Fed is still "in charge," and the hike is to be followed by a gentle tightening cycle. This was not the consensus in April yet.<br />
<div>
<br /></div>
6) The poll statements are poorly written, because they fail to account for a behavioral bias that makes respondents more likely to agree than disagree with whatever statement they face.<br />
<br />
7) Respondents are unconsciously conflating the normative statement with predictions of what the Fed will do. (The consensus prediction shifted dramatically between April and December, mostly because the Fed itself gave strong guidance of an interest rate hike in October and November.)<br />
<br />
8) <a href="http://marginalrevolution.com/marginalrevolution/2015/12/economists-dont-know-what-they-are-talking-about.html" target="_blank">Tyler is right</a>, and economists don't know what they're talking about. Moreover, their ignorant self-confidence produces time-varying biases.<br />
<br />
I think a combination of #3, #4, and #5 is most likely, but (as a respondent to opinion polls myself) I can't completely dismiss behavioral biases of the respondents.Unknownnoreply@blogger.com4tag:blogger.com,1999:blog-2232587951592761390.post-6731663964455495262015-10-28T10:00:00.001-05:002015-10-28T10:00:05.745-05:00Talking worth hearing: Accounting for profitsStan Pignal, Patrick Foulis, and Philip Coggan (all three from The Economist), talk about how managers find (mostly) legal ways to puff up corporate earnings.<br />
<br />
~<b>12 minutes</b><br />
<b><br /></b>
<br />
<object classid="clsid:D27CDB6E-AE6D-11cf-96B8-444553540000" codebase="http://download.macromedia.com/pub/shockwave/cabs/flash/swflash.cab#version=9,0,47,0" height="390" id="flashObj" width="595"><param name="movie" value="http://c.brightcove.com/services/viewer/federated_f9?isVid=1" /><param name="bgcolor" value="#FFFFFF" /><param name="flashVars" value="videoId=4582199599001&linkBaseURL=http%3A%2F%2Fecon.st%2F1jOYRK6&playerID=1425961410001&playerKey=AQ~~,AAABDH-R__E~,dB4S9tmhdOo20g03jDsDgNBGDcclfHEU&domain=embed&dynamicStreaming=true" /><param name="base" value="http://admin.brightcove.com" /><param name="seamlesstabbing" value="false" /><param name="allowFullScreen" value="true" /><param name="swLiveConnect" value="true" /><param name="allowScriptAccess" value="always" /><embed src="http://c.brightcove.com/services/viewer/federated_f9?isVid=1" bgcolor="#FFFFFF" flashVars="videoId=4582199599001&linkBaseURL=http%3A%2F%2Fecon.st%2F1jOYRK6&playerID=1425961410001&playerKey=AQ~~,AAABDH-R__E~,dB4S9tmhdOo20g03jDsDgNBGDcclfHEU&domain=embed&dynamicStreaming=true" base="http://admin.brightcove.com" name="flashObj" width="595" height="390" seamlesstabbing="false" type="application/x-shockwave-flash" allowFullScreen="true" swLiveConnect="true" allowScriptAccess="always" pluginspage="http://www.macromedia.com/shockwave/download/index.cgi?P1_Prod_Version=ShockwaveFlash"></embed></object>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-68150671431219560812015-10-22T10:16:00.000-05:002015-10-22T10:16:23.400-05:00Talking worth hearing: ChinaTyler Cowen talks about the rise and fall of the Chinese economy: how they grew so fast, and why they're in trouble now.<br />
<br />
~<b>12 minutes</b><br />
<br />
I like Tyler's insight that decades of high growth distorted the assessment of the risk/return of new investment projects, which is distinct (but compatible) from a decline in the marginal productivity of capital.<br />
<br />
<br />
<iframe allowfullscreen="" frameborder="0" height="315" src="https://www.youtube.com/embed/fZwEDa9TrfE" width="560"></iframe>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-24875033642127534882015-10-16T11:30:00.000-05:002015-10-16T11:30:28.753-05:00QE: What if investors don't buy it?John Authers has written another good <a href="http://www.ft.com/intl/cms/s/0/381bea08-7382-11e5-bdb1-e6e4767162cc.html#axzz3oiltQNB2" target="_blank">column</a>. It's about "what happens if rates never rise." Among many interesting things, he reminds us to watch profits (payrolls and GDP are secondary, really). He also walks us through the (increasingly plausible) scenario where the Fed doesn't raise rates at all, and the central bank needs to resort to QE to counter an economic slowdown.<br />
<br />
He writes, in passing, something with disturbing implications:<br />
<blockquote class="tr_bq">
<b>The risk continues to be that investors at some point give up on monetary policy and its power to make a difference</b> — and that would be bad for stocks. So rather than plan for a continued indiscriminate rally in US stocks, it is probably better to focus on those that can show some sustained pricing power, and on those that pay a decent yield.</blockquote>
That first sentence (emphasis mine) entails a mind-blowing possibility. What it the emperor has no clothes? What if the main (only?) effect of QE is through higher asset valuations? What if QE works because investors think it works and nothing else? What if investors wake up and decide that QE doesn't work?Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-57532343558147175382015-10-14T10:19:00.000-05:002015-10-14T10:19:48.223-05:00Unemployment rate and employment growth: Reasonable expectationsStephen Williamson wrote a fantastic <a href="http://newmonetarism.blogspot.com/2015/10/some-unpleasant-labor-force-arithmetic.html" target="_blank">post</a>, where he bounds reasonable numbers for employment growth and the unemployment rate, in the U.S., in coming months.<br />
<br />
Takeaways:<br />
<br />
-200k jobs added per month, which many observers find normal, is more than we can reasonably expect.<br />
<br />
-Recent trends and the current level of labor force participation suggest that employment can't grow faster than 0.5% for too long. 200k jobs per month imply a 1.7% growth rate, given the current level of unemployment.<br />
<br />
-The unemployment rate can't probably get much lower than 4.6%.<br />
<br />
-Going forward, monthly employment growth should be closer to 60k (population growth) than the "normal" 200k.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-84901610581585240922015-10-14T09:48:00.000-05:002015-10-14T09:48:12.370-05:00Talking worth hearing: GDPStan Pignal and Ryan Avent (from The Economist), and Mike Jakeman (from the Economist Intelligence Unit), discuss whether GDP is an appropriate indicator of an economy's health.<br />
<br />
~<b>12 minutes</b><br />
<br />
(I wish they wouldn't implicitly endorse the popular definition of recession, i.e. two consecutive quarters of negative GDP growth. It's truly an awful notion.)<br />
<br />
<object classid="clsid:D27CDB6E-AE6D-11cf-96B8-444553540000" codebase="http://download.macromedia.com/pub/shockwave/cabs/flash/swflash.cab#version=9,0,47,0" height="390" id="flashObj" width="595"><param name="movie" value="http://c.brightcove.com/services/viewer/federated_f9?isVid=1" /><param name="bgcolor" value="#FFFFFF" /><param name="flashVars" value="videoId=4555500301001&linkBaseURL=http%3A%2F%2Fecon.st%2F1VQM5Xg&playerID=1425961410001&playerKey=AQ~~,AAABDH-R__E~,dB4S9tmhdOo20g03jDsDgNBGDcclfHEU&domain=embed&dynamicStreaming=true" /><param name="base" value="http://admin.brightcove.com" /><param name="seamlesstabbing" value="false" /><param name="allowFullScreen" value="true" /><param name="swLiveConnect" value="true" /><param name="allowScriptAccess" value="always" /><embed src="http://c.brightcove.com/services/viewer/federated_f9?isVid=1" bgcolor="#FFFFFF" flashVars="videoId=4555500301001&linkBaseURL=http%3A%2F%2Fecon.st%2F1VQM5Xg&playerID=1425961410001&playerKey=AQ~~,AAABDH-R__E~,dB4S9tmhdOo20g03jDsDgNBGDcclfHEU&domain=embed&dynamicStreaming=true" base="http://admin.brightcove.com" name="flashObj" width="595" height="390" seamlesstabbing="false" type="application/x-shockwave-flash" allowFullScreen="true" swLiveConnect="true" allowScriptAccess="always" pluginspage="http://www.macromedia.com/shockwave/download/index.cgi?P1_Prod_Version=ShockwaveFlash"></embed></object>Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-47058297357705184872015-07-23T10:55:00.000-05:002015-07-23T10:55:55.717-05:00Core inflation around the worldI put together a chart of the 12-month percent change of measures of core inflation for a selection of countries. The definition of core inflation varies across countries.<br />
<br />
Green (red) means lower (higher) inflation. The color scale is meaningful within rows only. So, for example, the deep-green that the U.K. shows for June 2015 means that the core inflation in that month is among the lowest observed in the U.K. between June 2012 and June 2015 (but not necessarily low across countries; in fact, Switzerland's is lower).<br />
<br />
The two lines at the bottom, below the legend, show the median core inflation rate and a measure of cross-country dispersion (the median absolute deviation).<br />
<br />
<b><span style="font-size: x-small;">Click on the picture to enlarge</span></b><br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://2.bp.blogspot.com/-pQNv6Fk9GXQ/VbEL_pX9mVI/AAAAAAAAGJQ/bDVZmaqoBxc/s1600/20150723%2BCore%2Binflation%2Bheatmap.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="426" src="http://2.bp.blogspot.com/-pQNv6Fk9GXQ/VbEL_pX9mVI/AAAAAAAAGJQ/bDVZmaqoBxc/s640/20150723%2BCore%2Binflation%2Bheatmap.png" width="640" /></a></div>
<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-8007682931978596582015-07-21T11:15:00.002-05:002015-07-21T14:28:17.375-05:00Market crashes that never happenedHere's an <a href="http://fundreference.com/articles/2015/1000555/the-clowns-of-wall-street/" target="_blank">article</a> from FundReference.com on market analysts who kept predicting (incorrectly) that the stock market would crash.<br />
<div>
<br /></div>
<div>
(Hat tip to my old colleague and accomplished investment manager: P. M. I'm not sure if I can say his name, since I got his pointer through LinkedIn.)<br />
<div>
<br /></div>
<div>
I love this table, towards the end of the article:</div>
<div>
<br /></div>
<div class="separator" style="clear: both; text-align: center;">
<a href="http://1.bp.blogspot.com/-UDqtUlG7hnU/Va5tlt-7OcI/AAAAAAAAGIw/Hasxwd6afNk/s1600/table%2Bsummary.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="640" src="http://1.bp.blogspot.com/-UDqtUlG7hnU/Va5tlt-7OcI/AAAAAAAAGIw/Hasxwd6afNk/s640/table%2Bsummary.png" width="617" /></a></div>
<div>
<br />
<div>
I'm not trying to say that bearish calls are nonsense. In fact, I'm bearish more often than bullish. But I'll stay away from specific market calls.</div>
</div>
</div>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-17082112478065515602015-05-19T14:59:00.000-05:002015-05-19T14:59:03.847-05:00Graphic content: Unemployment rates town by town, in SpainBeautiful map on unemployment rates on <a href="https://datosmacro.cartodb.com/viz/805f4bc0-f6a0-11e4-a2d0-0e4fddd5de28/public_map" target="_blank">datosmacro.com</a>. If you go to the website you can click on each town and see its name and unemployment rate.<br />
<br />
Notice the clusters of high unemployment in Castilla La Mancha, Cádiz-Huelva-Sevilla, and León-Galicia.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://2.bp.blogspot.com/-fvln1tBvURw/VVuT3z9aJzI/AAAAAAAAGHI/gNNlm4PzXf0/s1600/20150519%2Bunemployment%2Bby%2Btown%2Bmap%2BSpain.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" height="474" src="http://2.bp.blogspot.com/-fvln1tBvURw/VVuT3z9aJzI/AAAAAAAAGHI/gNNlm4PzXf0/s640/20150519%2Bunemployment%2Bby%2Btown%2Bmap%2BSpain.png" width="640" /></a></div>
<br />
The map, however, is misleading if you try to infer comparisons of regional unemployment. For instance, it would seem that Galicia's (northwest) unemployment rate is much, much higher than Catalonia's (northeast). Wrong: <a href="http://www.datosmacro.com/paro-epa/espana-comunidades-autonomas" target="_blank">Galicia's jobless rate in 2015:Q1 was 21.8%, whereas Catalonia's was 20.1%</a>.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-71749506519212962015-05-11T10:20:00.001-05:002015-05-11T10:20:58.335-05:00Government consolidation, à la française<div class="tr_bq">
The Economist is running <a href="http://www.economist.com/news/europe/21650564-redrawing-regional-boundaries-causing-big-rows-and-will-save-little-new-kids-block?fsrc=scn/tw/te/pe/ed/newkidsontheblock" target="_blank">this article</a> on the re-organization of French regions, whose number will be consolidated from 22 to 13 by Jan. 1, 2016.</div>
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://cdn.static-economist.com/sites/default/files/imagecache/original-size/images/print-edition/20150509_EUM934.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://cdn.static-economist.com/sites/default/files/imagecache/original-size/images/print-edition/20150509_EUM934.png" height="400" width="296" /></a></div>
<br />
The piece illustrates the difficulties of consolidating the government administration in a country with strong regional identities, and where civil servants have a rooted sense of entitlement.<br />
<br />
Best passages and quotes from the article:<br />
<blockquote class="tr_bq">
Far less clear is whether the merged region will bring budget savings. French public-sector jobs are protected, so there will be no headcount cull after the merger.</blockquote>
<blockquote class="tr_bq">
Those employed in Montpellier have been told they will not have to move to Toulouse. Nor will seats be cut in the merged regional assembly. And, as Mr Alary points out, there will also be extra costs, such as from merging the two regions’ incompatible computer systems.</blockquote>
<blockquote class="tr_bq">
“In practice,” says Jean-Jacques Pons, leader of the centre-right opposition in the regional assembly, “there won’t be economies of scale, or only at the margin.” No candidate in December’s regional elections wants to campaign on a cost-cutting platform.</blockquote>
And my favorite:<br />
<blockquote class="tr_bq">
<b>“We’ll have to drive nearly two hours up the motorway to get subsidies,” grumbles a town-hall employee in Picardy.</b></blockquote>
Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-80849006684711596582015-04-20T09:40:00.003-05:002015-04-20T09:40:42.452-05:00More deep thoughts about macro models<a href="http://www.bruegel.org/scholars/scholar-detail/scholar/39-jeremie-cohen-setton/" target="_blank">Jérémie Cohen-Setton</a> at Bruegel does a great job, as usual, rounding up recent blog posts on a specific topic. This time: <a href="http://www.bruegel.org/nc/blog/detail/article/1613-the-critique-of-modern-macro/" target="_blank"><b>a critique of modern macro</b></a>. Can the models built during the Great Moderation explain what happened after the Great Recession?<br />
<br />
I would say that "raising the profile" of the financial sector within macro models helps--but I don't know whether a Copernican revolution is necessary. But, ultimately, we will always (literally, always) have to live with model uncertainty. <a href="http://noahpinionblog.blogspot.com/2015/04/did-macro-theory-fail-us-in-crisis.html" target="_blank">Noah Smith</a> makes this point well.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-16805402119103395222015-04-16T23:28:00.002-05:002015-04-16T23:30:26.008-05:00Global financial stability: the IMF reportFinancial stability has been a bubbling topic since 2008--although it never really stopped simmering since the emerging market crises of the 1990s. Over the past year or so, a dominant view seems to be forming that financial instability risks are rising, particularly among some emerging-market countries.<br />
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Here's a list of great articles or papers, and one oral presentation, on the topics of financial instability, financial crises, etc. I have perused recently:</div>
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<li><a href="http://www.cgdev.org/sites/default/files/CGD-Essay-Rojas-Suarez-Emerging-Market-Macroeconomic-Stability_0.pdf" target="_blank">Emerging market macroeconomic resilience to external shocks: today versus pre-global crisis</a> (pdf) by Liliana Rojas-Suárez at the Center for Global Development.</li>
<li><a href="http://www.moneyandbanking.com/commentary/2015/4/13/the-mythic-quest-for-early-warnings" target="_blank">The mythic quest for early warnings</a>, by Cecchetti and Schoenholtz.</li>
<li><a href="http://www.project-syndicate.org/commentary/emerging-market-debt-crisis-by-andres-velasco-2015-03" target="_blank">The coming emerging-market debt squeeze</a>, by Andrés Velasco at Project Syndicate.</li>
<li><a href="http://www.bruegel.org/nc/blog/detail/article/1591-negative-rates-and-financial-intermediation/" target="_blank">Negative rates and financial intermediation</a>, by Jérémie Cohen-Setton at Bruegel.</li>
<li><a href="http://www.ft.com/intl/cms/s/0/39f09e54-a0b1-11e4-9aee-00144feab7de.html?siteedition=intl#axzz3SaAF0t3X" target="_blank">Do eerie parallels presage new crisis?</a> by Satyajit Das at the Financial Times.</li>
<li><a href="http://www.ft.com/intl/cms/s/0/29d31b02-3fe8-11e4-936b-00144feabdc0.html#axzz3E47aUK84" target="_blank">The glaringly obvious guide to the next crash</a>, by James Mackintosh at the Financial Times.</li>
<li><a href="http://faculty.som.yale.edu/garygorton/documents/GettingUpToSpeed_Jan-11-2012.pdf" target="_blank">Getting up to speed on the financial crisis: A one-weekend-reader's guide</a> (pdf), by Gary Gorton and Andrew Metrick.</li>
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<li><a href="http://eml.berkeley.edu/~dromer/papers/RomerandRomerFinancialCrises.pdf" target="_blank">New evidence on the impact of financial crises in advanced countries</a> (pdf), by Christina Romer and David Romer.</li>
<li><a href="https://www.youtube.com/watch?v=HJvwwJW7I3w&app=desktop" target="_blank">Private credit, public debt, and financial crises</a> (30 min lecture), by Òscar Jordà.</li>
<li>Articles by Jesse Colombo, on Forbes, on why the <a href="http://www.forbes.com/sites/jessecolombo/2013/11/21/heres-why-the-philippines-economic-miracle-is-really-a-bubble-in-disguise/" target="_blank">Philippines</a>, <a href="http://www.forbes.com/sites/jessecolombo/2013/11/04/thailands-bubble-economy-is-heading-for-a-1997-style-crash/" target="_blank">Thailand</a>, <a href="http://www.forbes.com/sites/jessecolombo/2013/10/15/malaise-is-ahead-for-malaysias-bubble-economy/" target="_blank">Malaysia</a>, and <a href="http://www.forbes.com/sites/jessecolombo/2014/01/13/why-singapores-economy-is-heading-for-an-iceland-style-meltdown/" target="_blank">Singapore</a> are heading for trouble. </li>
<li><a href="http://econbrowser.com/archives/2014/01/guest_contribut_38" target="_blank">Financial openness and currency crises</a>, by Jon Frost and Ayako Saiki, guest post at Econbrowser. </li>
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<a href="https://www.imf.org/External/Pubs/FT/GFSR/2015/01/pdf/c1.pdf" target="_blank">Chapter 1 of the IMF's Global Financial Stability Report</a> (pdf), published this week, warns of the main risks to global financial stability. Here's a summary of the report:</div>
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1. Financial stability risks have increased since October. Lower growth prospects and disinflation have prompted central banks to respond by loosening policy. The BoJ and the ECB are the most notorious examples, but other central banks have relaxed their monetary policy stances as well.</div>
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2. Emerging market financial stability risks have increased. Commodity price declines have hurt commodity exporters, while the corporate sector has increased its foreign currency indebtedness. Lower energy prices have impacted negatively firms in the energy sector. </div>
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3. The fall in nominal yields, and flattening of the yield curve, are a threat to the life insurance and pension fund sectors, especially in Europe.</div>
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4. Monetary policy divergence has lead to a sharp increase in volatility in foreign exchange markets amid the appreciation of the U.S. dollar. Term premia are narrow in all three main currencies (dollar, euro, and yen). Asset valuations remain elevated, in part because of persistently loose monetary policy. Market volatility in general has increased.</div>
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5. Quantitative easing can boost inflation and growth, but it also encourages greater financial risk taking, so monitoring and addressing financial excesses is necessary. Additional policy measures are necessary to enhance the effectiveness of monetary accommodation.<br />
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The report also has special boxes for two sub topics:<br />
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<li>The oil price fallout, explaining the channels through which the abrupt fall of oil prices could spawn financial vulnerabilities.</li>
<li>Russia's financial risks and potential spillovers.</li>
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Here are a few charts from the report that caught my attention. Having a good legal system helps a country de-leverage. According to the chart below, an index of the strength of the legal system explains 45% of the cross-sectional dispersion of de-leveraging:</div>
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<a href="http://4.bp.blogspot.com/-Zec8HfS0E_s/VTAqpdsoBAI/AAAAAAAAGFA/Gw_jg2EeoFs/s1600/Figure%2B1-8.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-Zec8HfS0E_s/VTAqpdsoBAI/AAAAAAAAGFA/Gw_jg2EeoFs/s1600/Figure%2B1-8.png" height="390" width="400" /></a></div>
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An increasing number of short- and long-term European government bonds have a negative yield:</div>
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<a href="http://4.bp.blogspot.com/-8ad42RyKR_A/VTArlP7GkyI/AAAAAAAAGFI/_zN_3YAT0m0/s1600/Figure%2B1-9-3.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-8ad42RyKR_A/VTArlP7GkyI/AAAAAAAAGFI/_zN_3YAT0m0/s1600/Figure%2B1-9-3.png" height="276" width="400" /></a></div>
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QE in the eurozone and Japan could lead to significant portfolio outflows. Eurozone investors might allocate up to €1.3 trillion abroad by the end of 2015, a good chunk of which would go to the U.S. Insurance companies and pension funds in Japan could invest as much as $559 billion, or 12.8% of GDP, in foreign assets by the end of 2017 (that's if announced policies are fully implemented and work to their fullest extent across the three reform arrows): </div>
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<a href="http://3.bp.blogspot.com/-84ThRPjkzww/VTAzXoHDPfI/AAAAAAAAGGM/F6rAFIHdfjI/s1600/Figure%2BA1-2-1.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://3.bp.blogspot.com/-84ThRPjkzww/VTAzXoHDPfI/AAAAAAAAGGM/F6rAFIHdfjI/s1600/Figure%2BA1-2-1.png" height="400" width="320" /></a></div>
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Non-performing loans and write-offs are frighteningly high in the eurozone and Japan:</div>
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<a href="http://3.bp.blogspot.com/-wNE2UGXrml8/VTAuDANe89I/AAAAAAAAGFc/keSVKWksUXc/s1600/Figure%2B1-12-3.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://3.bp.blogspot.com/-wNE2UGXrml8/VTAuDANe89I/AAAAAAAAGFc/keSVKWksUXc/s1600/Figure%2B1-12-3.png" height="400" width="390" /></a></div>
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European life insurers are in the unsustainable business of writing long-term policies without assets of a correspondingly long duration, which has resulted in negative duration gaps. Moreover, many policies contain high return guarantees, which are unsustainable in a low-interest-rate environment. Insurers in Sweden and Germany have the largest mismatches: </div>
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<a href="http://4.bp.blogspot.com/-IMuyq7LclX0/VTAvSM6ffSI/AAAAAAAAGFo/k_ndzCzfp70/s1600/Figure%2B1-13-1.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-IMuyq7LclX0/VTAvSM6ffSI/AAAAAAAAGFo/k_ndzCzfp70/s1600/Figure%2B1-13-1.png" height="299" width="640" /></a></div>
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Despite the recent round of monetary policy easing in emerging markets, real rates are expected to rise in 2015 in almost all of them:</div>
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<a href="http://3.bp.blogspot.com/-PEj1BaHqzM4/VTAw1J-Or5I/AAAAAAAAGF0/n31wXc2VQWk/s1600/Figure%2B1-21-3.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://3.bp.blogspot.com/-PEj1BaHqzM4/VTAw1J-Or5I/AAAAAAAAGF0/n31wXc2VQWk/s1600/Figure%2B1-21-3.png" height="259" width="640" /></a></div>
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Debt of the non-financial (private and government) sector of emerging markets has increased dramatically since 2007:</div>
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<a href="http://2.bp.blogspot.com/-r-Hh3fwDOFI/VTAxsvCyqPI/AAAAAAAAGF8/wVraTIe-W7o/s1600/Figure%2B1-26.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://2.bp.blogspot.com/-r-Hh3fwDOFI/VTAxsvCyqPI/AAAAAAAAGF8/wVraTIe-W7o/s1600/Figure%2B1-26.png" height="346" width="640" /></a></div>
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A significant share of debt is owed by firms with poor interest-coverage ratios:</div>
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<a href="http://2.bp.blogspot.com/-_fN101j87D4/VTAyaxnGgtI/AAAAAAAAGGE/Jf0Sq_XJn1A/s1600/Figure%2B1-28-3.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://2.bp.blogspot.com/-_fN101j87D4/VTAyaxnGgtI/AAAAAAAAGGE/Jf0Sq_XJn1A/s1600/Figure%2B1-28-3.png" height="400" width="331" /></a></div>
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Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-63029098971655441682015-04-10T21:55:00.002-05:002015-04-10T21:55:29.263-05:00Global activity: mixed nowcasts<a href="http://blogs.ft.com/gavyndavies/2015/04/05/global-growth-report-card-world-slowdown-causes-concern/" target="_blank">Fulcrum's nowcasting model</a> shows that advanced economies have decelerated so far in 2015:<br />
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<a href="http://3.bp.blogspot.com/-OjKdHHv4prg/VSiLM3a979I/AAAAAAAAGDw/3DlyEukvaI0/s1600/advanced%2Beconomies.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://3.bp.blogspot.com/-OjKdHHv4prg/VSiLM3a979I/AAAAAAAAGDw/3DlyEukvaI0/s1600/advanced%2Beconomies.png" /></a></div>
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The slowdown is particularly persistent in the U.S., which is now estimated to be growing at 2% a year, half the pace of last fall:<br />
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<a href="http://1.bp.blogspot.com/-FaLwCgQ1nqE/VSiLScewgnI/AAAAAAAAGD4/S1GAWDZeFhg/s1600/US.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://1.bp.blogspot.com/-FaLwCgQ1nqE/VSiLScewgnI/AAAAAAAAGD4/S1GAWDZeFhg/s1600/US.png" /></a></div>
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China is growing at a fairly steady pace, and the eurozone's economy keeps picking up:<br />
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<a href="http://3.bp.blogspot.com/-gUdeE-HAc7Y/VSiLV6WiAZI/AAAAAAAAGEA/-GEDJai9qmU/s1600/China.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://3.bp.blogspot.com/-gUdeE-HAc7Y/VSiLV6WiAZI/AAAAAAAAGEA/-GEDJai9qmU/s1600/China.png" /></a></div>
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<a href="http://4.bp.blogspot.com/-BFHUkwxjrAg/VSiL5S1yqLI/AAAAAAAAGEg/oKP23Xb4WH4/s1600/eurozone.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-BFHUkwxjrAg/VSiL5S1yqLI/AAAAAAAAGEg/oKP23Xb4WH4/s1600/eurozone.png" /></a></div>
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According to the Institute of International Finance's <a href="https://www.iif.com/publication/html-publication/march-2015-em-coincident-indicator" target="_blank">EM Coincident Indicator</a> "EM GDP may have grown in 2015Q1 at its weakest pace since early 2009", or 1.8% q/q saar:<br />
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<a href="http://4.bp.blogspot.com/-F6Kl_JdmzYU/VSiLaKAtVCI/AAAAAAAAGEI/YnsyuKlMeCQ/s1600/EM-IIF.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-F6Kl_JdmzYU/VSiLaKAtVCI/AAAAAAAAGEI/YnsyuKlMeCQ/s1600/EM-IIF.png" height="263" width="320" /></a></div>
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That's at odds, however, with the J.P. Morgan <a href="http://www.markiteconomics.com/Survey/PressRelease.mvc/29a6f1bcf0bd43358458fd301141a6d1" target="_blank">global composite output index</a>, which picked up slightly from an average of 53.0 in Q4 (53.0) to 53.9 in Q1:<br />
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<a href="http://2.bp.blogspot.com/-ukYLQ8y5n2s/VSiLhwDEYKI/AAAAAAAAGEQ/wgv1deFrHoc/s1600/JP%2BMorgan%2Bcomposite%2BPMI.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://2.bp.blogspot.com/-ukYLQ8y5n2s/VSiLhwDEYKI/AAAAAAAAGEQ/wgv1deFrHoc/s1600/JP%2BMorgan%2Bcomposite%2BPMI.png" height="180" width="320" /></a></div>
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And, despite a plunge of the <a href="http://www.markiteconomics.com/Survey/PressRelease.mvc/8bf81bec1dc54c04acb6fec388744e9f" target="_blank">J.P. Morgan U.S. composite</a> in earlier months, output has rebounded of late:<br />
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<a href="http://1.bp.blogspot.com/-G1I3N4YLOQE/VSiLu_tn2JI/AAAAAAAAGEY/_arC26YkBTA/s1600/JP%2BMorgan%2BUS%2Bcomposite.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://1.bp.blogspot.com/-G1I3N4YLOQE/VSiLu_tn2JI/AAAAAAAAGEY/_arC26YkBTA/s1600/JP%2BMorgan%2BUS%2Bcomposite.png" height="218" width="320" /></a></div>
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And the <a href="http://www.markiteconomics.com/Survey/PressRelease.mvc/c79611624c41456e96ba8ff59dec06ee" target="_blank">HSBC emerging markets composite index</a> looks fairly stable, not falling:<br />
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<a href="http://4.bp.blogspot.com/-wxdlhdTl0Bw/VSiMtLRtfaI/AAAAAAAAGEs/VlCn322DaHU/s1600/HSBC%2Bemerging%2Bmarkets.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-wxdlhdTl0Bw/VSiMtLRtfaI/AAAAAAAAGEs/VlCn322DaHU/s1600/HSBC%2Bemerging%2Bmarkets.png" /></a></div>
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-14447962840854478732015-04-02T09:18:00.000-05:002015-04-02T09:18:35.747-05:00Guest post: Are Australian investors (relatively) conservative?<i><a href="http://europacifica.com/contact/" target="_blank">Naomi Fink</a>, CEO and founder of <a href="http://europacifica.com/" target="_blank">Europacifica Consulting</a>, is my guest today, writing about the risk preferences of Australian investors.</i><br />
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In one of the preliminary documents leading to Australia’s <a href="http://fsi.gov.au/publications/interim-report/03-funding/funding-from-overseas/" target="_blank">Financial System Inquiry</a>, authors speculated that the abundance of overseas financing for Australia might owe to a gap in risk preferences between domestic and foreign investors (no supporting evidence or parameter calibration was cited).<br />
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Anecdotally, yet consistent with this viewpoint, many players within the domestic financial sector tout about the supposed conservatism of Australian domestic investors. But is there empirical evidence of such conservatism?<br />
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Firstly, following the argument made in passing in the preliminary FSI documents, if divergent risk preferences were the best explanation for Australia’s chronic current account deficits, they would explain Australia’s investment income deficit (the largest component of Australia’s external deficit), given the sensitivity of investment rather than trade to relative risk preferences. <br />
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The argument implies, first, that foreign investors should be categorically more risk-tolerant than Australians, who pay higher premiums to compensate for the higher risk of capital they export than what they receive on their lower-risk investments overseas.<br />
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The second implication of the argument is less obvious. Risk preferences in financial economic models are typically parametric rather than variable. Extending this logic, Australia’s investment income deficit is the result of more consistently conservative attitudes among domestic investors in comparison to consistently risk-tolerant overseas counterparts. This may seem to be splitting hairs, but the distinction is non-trivial.<br />
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Risk premiums may wax and wane alongside risk perception, while risk preferences among rational investors are typically more consistent over time. But if this were so, we would expect to see behavioral evidence of consistently greater risk-aversion among Australian investors than their overseas counterparts.<br />
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We took it upon ourselves to perform our own stylised version of the missing calibration; a comparison of risk preferences among OECD countries (using equity market participation, per <a href="http://faculty.haas.berkeley.edu/vissing/p1_01.pdf" target="_blank">Vissing-Jorgenson</a> (1997), <a href="http://faculty.haas.berkeley.edu/vissing/p1_01.pdf" target="_blank">Guiso</a> (2002), and <a href="http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6261.2008.01408.x/full" target="_blank">Guiso et al.</a> (2008)). <br />
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This basic examination of parametric measures of relative risk tolerance undermines the hypothesis that Australian investors are relatively risk-averse.<br />
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Our results, shown in the chart below, not only argue against the notion that Australia is more risk-averse than the rest of the world: they show that Australia is one of the most risk-loving players in the OECD. In this light, it is highly doubtful that relative risk preferences somehow structurally rationalize Australia’s income deficit.<br />
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<table align="center" cellpadding="0" cellspacing="0" class="tr-caption-container" style="margin-left: auto; margin-right: auto; text-align: center;"><tbody>
<tr><td style="text-align: center;"><a href="http://3.bp.blogspot.com/-STyhOD0mt1g/VRwyCvHckBI/AAAAAAAAGDM/uTAPBkkwbrc/s1600/risk%2Btolerance%2BOECD%2Bcountries.png" imageanchor="1" style="margin-left: auto; margin-right: auto;"><img border="0" src="http://3.bp.blogspot.com/-STyhOD0mt1g/VRwyCvHckBI/AAAAAAAAGDM/uTAPBkkwbrc/s1600/risk%2Btolerance%2BOECD%2Bcountries.png" height="496" width="640" /></a></td></tr>
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Note: Arguments that Australia pays a higher premium on its debt because Australians are more risk-averse than the rest of the world fail to hold up to our calibration.</div>
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Source: Europacifica, OECD</div>
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<br />Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-72251348635539923692015-03-27T06:34:00.000-05:002015-03-27T06:34:14.642-05:00Forecasting long-term stock returns: the two-hour recipe (II)<a href="http://www.econweekly.com/2015/03/forecasting-long-term-stock-returns-two.html" target="_blank">Last week</a> I started writing up a quick (?) methodology to forecast equity returns. Specifically, the question was<br />
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Forecast the real total return of U.S. equities over the next ten years. Show your work. <b>Time: two hours.</b></blockquote>
I wrote down a decomposition of the total return into three components:<br />
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$$\frac{R_{t,t+k}}{(1+\widehat{\pi}_{t+1, t+k})^k} = \frac{V_{t+k}}{V_{t}} \frac{(1+g_F)^k} {(1+\widehat{\pi}_{t+1, t+k})^k} (1+\widehat{dy}_{t+1, t+k})^k$$<br />
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The three components are:<br />
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1) Income, which boils down to the geometric average of the dividend yield:<br />
$$(1+\widehat{dy}_{t+1, t+k})^k$$<br />
2) The 10-year change of a valuation ratio.<br />
$$\frac{V_{t+k}}{V_{t}}$$<br />
3) The real growth of the fundamental used in the construction of the valuation ratio.<br />
$$\frac{(1+g_F)^k} {(1+\widehat{\pi}_{t+1, t+k})^k}$$<br />
Since this is meant to be a quick estimation, I decided that I would use either the historical average or the ten-year rolling average of the relevant data to forecast each of the three components.<br />
<br />
Pulling the <a href="http://www.econ.yale.edu/~shiller/data.htm" target="_blank">Shiller long-term data set</a> (<a href="http://www.econ.yale.edu/~shiller/data/ie_data.xls" target="_blank">xls</a>) on stock prices, earnings, and dividends, I took the geometric average of the dividend yield between 2005 and 2014 as my forecast for the dividend yield over the next ten years: 2.0082%. <b>So my forecast for</b> \(\widehat{dy}_{t+1, t+10}\) <b>is 0.02</b>.<br />
<br />
For the valuation ratio, we can calculate two from the Shiller dataset. The first one is the CAPE ("cyclically-adjusted" P/E ratio, or "Shiller's P/E"). A casual observation of the time series chart since 1880 suggests that the CAPE either experienced a shift sometime after the 1980s, or is experiencing upward drift. Today's CAPE (27.9) is significantly higher than the historical average (16.6) or the ten-year rolling average (22.6). We'll take those two values as alternative forecasts of the CAPE ten years from now. <b>The historical CAPE implies that the ratio of valuation metrics,</b> \(V_{t+k} / V_{t}\), <b>is 0.595</b> (16.6 / 27.9). <b>The ten-year rolling average CAPE implies a ratio of 0.81</b> (22.6 / 27.9).<br />
<br />
The second valuation ratio we can compute from the Shiller dataset is the dividend yield (or rather, to fit the total return formula above, the price-to-dividend ratio):<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://4.bp.blogspot.com/-z3exbhpZj6Y/VRR_NImrIgI/AAAAAAAAGCw/ud9yJYUpgQE/s1600/Price-dividend%2Bratio.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-z3exbhpZj6Y/VRR_NImrIgI/AAAAAAAAGCw/ud9yJYUpgQE/s1600/Price-dividend%2Bratio.png" height="464" width="640" /></a></div>
Just like the CAPE, the price/dividend ratio seems to have experience either a shift or drift some time after the 1980s. Today's multiple (55.8) is close to the 10-year rolling average, but much higher than the historical average (27.9). As with the CAPE, we'll consider both to forecast the 10-year-ahead price/dividend ratio. <b>Using the historical P/D, the ratio of valuation metrics,</b> \(V_{t+k} / V_{t}\), <b>is 0.50</b> (27.9 / 55.8), <b>whereas using the 10-year rolling average, the ratio is 0.93 </b>(51.9 / 55.8).<br />
<b><br /></b>
<b>Growth of the fundamental</b><br />
<br />
The third component of the total return is the real growth rate of the fundamental:<br />
$$\frac{(1+g_F)^k} {(1+\widehat{\pi}_{t+1, t+k})^k}$$<br />
Which fundamental we use is determined by the valuation ratio we pick. For the CAPE, the fundamental is the 10-year rolling average of earnings. For the price-dividend ratio, the fundamental is dividends.<br />
<br />
The real growth rate of (the 10y average) of earnings has been 1.66% per annum. The rolling 10-year counterpart fluctuates quite a bit (even though this is the rolling average growth rate of a rolling average of earnings), and is now at 3.5%. <br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://4.bp.blogspot.com/-Tu86TdSEFHI/VRR_IvdH3hI/AAAAAAAAGCo/VK3-96c4lII/s1600/Real%2Bearnings%2Bgrowth%2Brate.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://4.bp.blogspot.com/-Tu86TdSEFHI/VRR_IvdH3hI/AAAAAAAAGCo/VK3-96c4lII/s1600/Real%2Bearnings%2Bgrowth%2Brate.png" height="464" width="640" /></a></div>
For real dividends, the historical (10-year rolling average) growth rate is 1.34% (5.1%).<br />
<br />
<b>Putting everything together</b><br />
<b><br /></b>
I have proposed two forecasts for each of two possible valuation ratios and their corresponding fundamentals, for a total of four forecasts (the income component is the same for all four). The following table combines the forecast components of real returns to produce the total return forecast:<br />
<br />
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<br />
<table class="tg">
<tbody>
<tr>
<th class="tg-e3zv"></th>
<th class="tg-hgcj"><span style="font-weight: normal; text-align: start;">\(V_{t+k} / V_{t}\)</span></th>
<th class="tg-e3zv">\(g_F\)</th>
<th class="tg-e3zv">\((1+g_F)^k / (1+\pi)^k\)</th>
<th class="tg-e3zv">\(dy\)</th>
<th class="tg-e3zv">\((1+dy)^k\)</th>
<th class="tg-e3zv">\(R_{t,t+10} / (1+\pi)^k\) </th>
<th class="tg-e3zv">Annual real return</th>
</tr>
<tr>
<td class="tg-e3zv">CAPE (historical avg.)</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.595</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.0166</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.179</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.02</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.219</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.855</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
-1.55%</div>
</td>
</tr>
<tr>
<td class="tg-e3zv"><div style="text-align: left;">
CAPE (10y rolling avg.)</div>
</td>
<td class="tg-huh2"><div style="text-align: center;">
0.81</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.035</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.411</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.02</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.219</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.393</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
3.37%</div>
</td>
</tr>
<tr>
<td class="tg-e3zv"><div style="text-align: left;">
Dividend yield (historical avg.)</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.50</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.0134</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.142</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.02</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.219</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.696</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
-3.56%</div>
</td>
</tr>
<tr>
<td class="tg-e3zv"><div style="text-align: left;">
Dividend yield (10y rolling avg.)</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.93</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.051</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.644</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
0.02</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.219</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
1.864</div>
</td>
<td class="tg-s6z2"><div style="text-align: center;">
6.43%</div>
</td>
</tr>
</tbody></table>
<br />
The last column shows that the forecast real return, per year, varies from -3.6% to 6.4%.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-39171184289899434232015-03-25T10:25:00.001-05:002015-03-25T10:25:29.110-05:00Links: Deep thoughts about macro models1. <a href="http://mainlymacro.blogspot.com/2015/03/why-do-central-banks-use-new-keynesian.html" target="_blank">Why do central banks use the New Keynesian model</a>?, by Simon Wren-Lewis.<br />
<blockquote class="tr_bq">
What is a NK model? It is a RBC model plus a microfounded model of price setting, and a nominal interest rate set by the central bank. Every NK model has its inner RBC model. You could reasonably say that these NK models were designed to help tell the central bank what interest rate to set. In the simplest case, this involves setting a nominal rate that achieves, or moves towards, the level of real interest rates that is assumed to occur in the inner RBC model: the natural real rate.</blockquote>
<blockquote class="tr_bq">
[...]</blockquote>
<blockquote class="tr_bq">
Why not just use the restricted RBC version of the NK model? Because the central bank sets a nominal rate, so it needs an estimate of what expected inflation is. It could get that from surveys, but it also wants to know how expected inflation will change if it changes its nominal rate.</blockquote>
<blockquote class="tr_bq">
[...]</blockquote>
<blockquote class="tr_bq">
To say that the RBC model assumes that agents set the appropriate market clearing prices describes an outcome, but not the mechanism by which it is achieved.</blockquote>
<blockquote class="tr_bq">
That may be fine - a perfectly acceptable simplification - if when we do think how price setters and the central bank interact, that is the outcome we generally converge towards. NK models suggest that most of the time that is true. This in turn means that the microfoundations of price setting in RBC models applied to a monetary economy rest on NK foundations. The RBC model assumes the real interest rate clears the goods market, and the NK model shows us why in a monetary economy that can happen (and occasionally why it does not).</blockquote>
2. <a href="http://noahpinionblog.blogspot.com/2015/03/a-case-where-rbc-works.html" target="_blank">A case where RBC works</a>, by Noah Smith.<br />
<br />
<blockquote class="tr_bq">
The Arezki et al. paper is a victory for that kind of simple RBC-type model. But it's a limited victory, since the fluctuations produced by oil news shocks don't look like most business cycles, and because simple models like this don't explain things like the Great Recession. </blockquote>
<blockquote class="tr_bq">
[...]</blockquote>
<blockquote class="tr_bq">
...it's very interesting that simple RBC-type models should be so good at explaining something like an oil shock and so bad at explaining things like big recessions. This fact could lead economists toward something incredibly valuable: an understanding of the scope conditions of RBC-type models.</blockquote>
<blockquote class="tr_bq">
Scope conditions are the conditions under which a model works well. (**Physics analogy alert**) For example, we know that a model of frictionless motion works pretty well on an ice skating rink and pretty badly under the ocean. And we know exactly why. In decision theory, I personally think that experiments are starting to teach us the scope conditions of super-basic econ 101 demand theory: it works well for one-shot decisions, and not very well for dynamic situations with lots of uncertainty.</blockquote>
<blockquote class="tr_bq">
But for macro, it's inherently very hard to identify scope conditions, because there's so much going on at once that you can't get a clean comparison between the cases when a model works and the cases when it fails. </blockquote>
<blockquote class="tr_bq">
[...]</blockquote>
<blockquote class="tr_bq">
Having a case where RBC models actually work helps us narrow down the list of possible reasons why they usually fail.</blockquote>
<blockquote class="tr_bq">
There will inevitably be many such differences, but they narrow down the types of models we want to consider. If a model fits the Great Recession but doesn't reduce to the Arezki et al. result when applied to an oil discovery shock, we should be skeptical that that is the right model of the Great Recession.</blockquote>
3. <a href="http://hope.econ.duke.edu/sites/default/files/Rational%20Expectations%20Panel%20_30%20May%202011_.pdf" target="_blank">Rational expectations: retrospect and prospects</a> (pdf). Transcript of a 2011 panel discussion with Michael Lovell, Robert Lucas, Dale Mortensen, Robert Shiller, and Neil Wallace.Unknownnoreply@blogger.com0tag:blogger.com,1999:blog-2232587951592761390.post-80654607308362814742015-03-20T12:26:00.000-05:002015-03-20T12:26:21.310-05:00Forecasting long-term stock returns: the two-hour recipe (I)<div class="MsoNormal">
Suppose you are given the following task:</div>
<blockquote class="tr_bq">
Forecast the real total return of U.S. equities over the
next ten years. Show your work. <b>Time:
two hours.</b></blockquote>
<div class="MsoNormal">
<o:p></o:p></div>
<div class="MsoNormal">
This post describes how I would go about fulfilling this assignment.</div>
<div class="MsoNormal">
<o:p></o:p></div>
<br />
<div class="MsoNormal">
<br /></div>
<div class="MsoNormal">
The first thing is to define total return:</div>
$$R_{t,t+k}=\frac{P_{t+k}}{P_{t}}\prod_{s=1}^{k}(1+dy_{t+s})$$
<br />
<div class="MsoNormal">
where \(R_{t,t+k}\) is the gross total return between year \(t\) and year \(t+k\), \(P_{t}\) is the price of the stock or index at time \(t\), and \(dy_{t}\) is the income yield at time \(t\). (The income from a stock is dividends plus net repurchases by the issuer.)
You can get to that equation by "rolling over" the one-period total return, as I show below.
<br />
<br />
The total return can be further decomposed into more manageable bits. If you divide the price level by a "fundamental" \(F\):</div>
$$R_{t,t+k}=\frac{(P_{t+k} / F_{t+k})}{(P_{t} / F_{t})} \frac{F_{t+k}}{F_{t}}\prod_{s=1}^{k}(1+dy_{t+s}) = \frac{V_{t+k}}{V_{t}} (1+g_F)^k (1+\widehat{dy}_{t+1, t+k})^k$$<br />
Now the total return is a function of three things:<br />
<br />
1) The change of a valuation ratio \(V\).<br />
<br />
2) The growth of a fundamental \(F\): \(g_F\).<br />
<br />
3) The (geometric) average of income yield: \(\widehat{dy}_{t+1,t+k}\)<br />
<br />
The question asked to forecast the <i>real</i> return, but for that you just need to divide through by the inflation factor \((1+\widehat{\pi}_{t+1, t+k})^k\), where \(\widehat{\pi}_{t+1, t+k}\) is the geometric average of the inflation rate between \((t+1)\) and \((t+k)\):<br />
<br />
$$\frac{R_{t,t+k}}{(1+\widehat{\pi}_{t+1, t+k})^k} = \frac{V_{t+k}}{V_{t}} \frac{(1+g_F)^k} {(1+\widehat{\pi}_{t+1, t+k})^k} (1+\widehat{dy}_{t+1, t+k})^k$$<br />
<div>
<br /></div>
The "fundamental" \(F\) that goes in the valuation ratio could be anything, but you should probably pick a variable such that:<br />
<br />
1) The resulting valuation ratio is "mean reverting" (over the relevant forecasting horizon, in this case ten years), and<br />
<br />
2) You can forecast the growth of the "fundamental." Once you pick a particular valuation ratio, you are also committing to forecasting the growth rate of its corresponding fundamental.<br />
<br />
Several such valuation ratios have been proposed in the finance literature. I list them in the following table:<br />
<br />
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<table class="tg">
<tbody>
<tr>
<th class="tg-e3zv">Valuation ratio (V)</th>
<th class="tg-hgcj">Fundamental (F)</th>
</tr>
<tr>
<td class="tg-e3zv">Price/dividend</td>
<td class="tg-s6z2">Dividend</td>
</tr>
<tr>
<td class="tg-e3zv">CAPE (a.k.a. Shiller's PE)</td>
<td class="tg-huh2">Ten-year average of real earnings</td>
</tr>
<tr>
<td class="tg-e3zv">q ratio</td>
<td class="tg-s6z2">Net worth of corporations at market value</td>
</tr>
<tr>
<td class="tg-e3zv">Market capitalization / GDP</td>
<td class="tg-s6z2">GDP</td>
</tr>
<tr>
<td class="tg-e3zv">Price/total income</td>
<td class="tg-s6z2">Total cash flow (dividend + net repurchases)</td>
</tr>
</tbody></table>
<br />
The last ratio, price/total income, is really just a generalized version of the price/dividend ratio. I expect the two to be highly correlated, but I'll keep both for now.<br />
<br />
Next you need a forecasting strategy, i.e. you need to put values on \(V_{t+k}\), \(\frac{(1+g_F)^k} {(1+\widehat{\pi}_{t+1, t+k})^k}\), and \((1+\widehat{dy}_{t+1, t+k})^k\) You only have two hours to do this whole thing, so you can't do a lot.<br />
<br />
Off the top of my head, I would say you can either:<br />
<br />
1) Use historical averages, using the entire history of data available.<br />
2) Use the historical averages from a recent subset of the data available.<br />
<br />
The strategy should depend on (a) how long are your historical time series, and (b) whether you suspect structural changes that shifted those averages over time, or make them drift.<br />
<br />
Where should you get the data for this exercise? A lot of people use the <a href="http://www.econ.yale.edu/~shiller/data.htm" target="_blank">Shiller's time series</a> that go back to 1870. You won't get q-ratios or total cash flow or total market capitalization from Shiller's spreadsheet, so you would be limited to the CAPE and the dividend yield as valuation ratios. For today that will suffice.<br />
<br />
<b>The income component</b><br />
<br />
Let's start with the last component of the return, the dividend yield: \( (1+\widehat{dy}_{t+1, t+k})^k\).<br />
<br />
A cursory inspection of the time series suggests the dividend yield has declined over its entire history, but it seems relatively stable since the late 1990s. I would then use the most recent ten years to forecast the dividend yield over the next ten.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://3.bp.blogspot.com/-yOyWFhAEkV8/VQxU6jGnecI/AAAAAAAAGB0/9OpIUxYjKIg/s1600/dividend%2Byield.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://3.bp.blogspot.com/-yOyWFhAEkV8/VQxU6jGnecI/AAAAAAAAGB0/9OpIUxYjKIg/s1600/dividend%2Byield.png" height="464" width="640" /></a></div>
The Shiller dataset is monthly. For each December, I take the 12-month trailing average of the dividend series (column C), and I divide it by the price (column B). That's my estimated dividend yield for the year ended in December. Next I calculate the geometric average of the dividend yield between 2005 and 2014, which is 2.0082%. So my forecast for \(\widehat{dy}_{t+1, t+10}\) is 0.02.<br />
<br />
<b>The valuation ratio</b><br />
<br />
Next, the valuation ratio. Let's start with the CAPE (cyclically-adjusted PE ratio). The chart below shows that the historical average (in green, 16.6) is much below today's CAPE (27.85) and also below today's ten-year rolling average (in red, 22.6). It does seem like the CAPE shifted upward sometime in the 1980s or 1990s, but we don't know whether that shift is permanent. We can use both the historical average and the ten-year rolling average to come up with alternative forecasts of the CAPE ten years from now.<br />
<br />
<div class="separator" style="clear: both; text-align: center;">
<a href="http://1.bp.blogspot.com/-Dferu6NbIes/VQxXjo3GdCI/AAAAAAAAGCI/ZlL5NuOVXig/s1600/CAPE.png" imageanchor="1" style="margin-left: 1em; margin-right: 1em;"><img border="0" src="http://1.bp.blogspot.com/-Dferu6NbIes/VQxXjo3GdCI/AAAAAAAAGCI/ZlL5NuOVXig/s1600/CAPE.png" height="464" width="640" /></a></div>
[I ran out of blogging time today! I will continue next time.]<br />
........................................................................................................................................................<br />
<b>Derivation of the multi-period total return formula:</b><br />
<br />
The one-period total return is given by<br />
$$R_{t,t+1} = \frac{P_{t+1}+D_{t+1}}{P_{t}}$$<br />
If you reinvest the income \(D_{t+1}\) into the stock, that will buy you \(D_{t+1} / P_{t+1} \) additional stock units, for a total return of<br />
$$R_{t,t+1} = \frac{P_{t+1}(1+D_{t+1} / P_{t+1})}{P_{t}} = \frac{P_{t+1}(1+dy_{t+1})}{P_{t}}$$<br />
Next period you do the same thing, reinvesting \(D_{t+2}\) at price \(P_{t+2}\), for a total return<br />
$$R_{t,t+2} = \frac{P_{t+2}(1+dy_{t+1})(1+D_{t+2} / P_{t+2})}{P_{t}} = \frac{P_{t+2}(1+dy_{t+1})(1+dy_{t+2})}{P_{t}}$$<br />
When you generalize to \(k\) periods you get<br />
$$R_{t,t+k}=\frac{P_{t+k}}{P_{t}}\prod_{s=1}^{k}(1+dy_{t+s})$$Unknownnoreply@blogger.com0