Saturday, September 12, 2009

Cochrane's Complaint

by the Sandwichman
Paul Krugman has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do. "Irrationality" and advice to spend like a drunken sailor are pretty superficial compared to all the fascinating things economists are writing about it these days.

How sad.
How sad, indeed. All the fascinating things economists are writing about "it" these days! What does the word "it" refer to? What caused our current financial and economic problems? What policies might have prevented it? What might help us in the future? Perhaps a little math would help:
Math in economics serves to keep the logic straight, to make sure that the "then" really does follow the "if," which it so frequently does not if you just write prose.
That depends on what the meaning of the word "if" is. Or the word "it". And "what". Professor Cochrane's mistake was not waiting a week before uncorking his rant and giving himself the opportunity of filing it in the unsent-rants file where it belongs.

I did learn this from Cochrane's essay: "the central empirical prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going.... . This is probably the best-tested proposition in all the social sciences." Hello? That is indeed a fascinating thing. Markets are efficient because nobody can tell where they are going. That is to say, if nobody can tell where they are going; then markets are efficient. Or, to put it more bluntly, if there is a Goldman, Sachs; then there is no such thing as an efficient market. Notwithstanding the non-trivial detail that the term "efficient" in the proposition is either a non sequitur or a tautolgy. What are efficient markets efficient at? Being inscrutable!

The catch is there will always be a Goldman, Sachs. The inherent tendency of all markets is toward monopolization and manipulation. It is precisely because people will not settle for the "nobody can tell" fairy tale that markets get rigged. To pretend that actually existing markets are somehow almost the same thing as efficient markets is no different than pretending that actually existing socialism was virtually a workers' paradise or that the moon is made of green cheese and the central bank is a green cheese factory. It's all dress up and make believe.

Like Paul Krugman, John Cochran has no interesting ideas whatsoever about what caused our current financial and economic problems, what policies might have prevented it, or what might help us in the future, and he has no contact with people who do.

13 comments:

Anonymous said...

Bam!

zubin said...

not true, check out his econtalk interview from end of '08. He was one of the first economists to talk about the significance of the pullback of the shadow banking system

Max Jr said...

Cochrane:
"the central empirical prediction of the efficient markets hypothesis is precisely that nobody can tell where markets are going.... This is probably the best-tested proposition in all the social sciences."

No. Cochrane is wrong.
The EMH is an untestable hypothesis. It is always a joint hypothesis that is tested. Also there are no critical tests that would falsify the EMH.

Further, what is tested is never the ability of a powerful paricipant in the market to predict or manipulate very short term movements in a part of the market.

The EMH also exhibits some very common properties of pseudo-scientific nonsense:

1. Whether a paper that claims to test the EMH concludes that it has empirical support or not depends on who the author of the paper is.
2. The EMH predicts nothing, yet it explains everything - a very suspicious trait indeed.

Barkley Rosser said...

Max Jr.

Cochrane is right that it is impossible to absolutely disprove EMH. citing Fama, and noting the existence of joint hypotheses, such as that the existence of a strong upward movement in price might be rationally explained by a lowering of the risk premium.

However, it is certainly possible to investigate the hypothesis and separately test, if not by methods that Fama or Cochrane would accept. Thus, nearly 20 years ago this same argument went on in the area of forex markets and their volatility. Frankel and Froot went and did surveys of traders to determine their risk premia. Guess what, they did not change much even during periods when they would have to in order to explain observed degrees of volatility by risk premia. Fama and Cochrane would reject such surveys, but a lot of us think they should not be simply rejected out of hand as unacceptable.

The evidence is in and pretty strong. EMH is false, and Cochrane is a pompous fool.

Shag from Brookline said...

Here's what Johnny Cochrane said at page 7:

"Apparently, salacious prose, innuendo, calumny, and selective quotation from media aren't enough: Krugman added cartoons to try to make opponents look silly."

I don't know what Johnny puts in his O.J, but does he really believe that Krugman added these cartoons, perhaps drew them, provided the notations? Or was this the function of the NYTimes Magazine staff? According to Krugman's blog, his article was shortened because of space limitations. I would assume that Krugman would have preferred his deleted text over the cartoons, which by the way were not very impressive.

Some cartoons can be impressive. I had a Miss Peach comic strip by Mell Lazarus of many years ago on a wall in my law office. It depicted some of Miss Peach's students next to a banner "Future Lawyers of America Meet Here." A student asked "What do you hope to attain as a lawyer, Ira?" Ira, standing on a box, responded: "I hope to make my name a household word in the world of law. In other words, my ambition is to sue every man, woman and child in the United States." Mell used this format for other professions and jobs. I don't know if Mell is still alive and drawing, but I wonder what Ira or another classmate might say for "Future Economists of America Meet Here"?

Jack said...

The several debates taking place recently concerning what economists might have done to either predict or prevent the financial debacle of the past year seem misplaced to me. Maybe that is by design. Maybe not.
Note that the arguments are suddenly centering around the effect of economic policy. Which policies may have prevented or predicted the collapse of the financial markets? Such a misplacement of concern. What happened to the recognition that:

One, wholesale deregulation of financial agencies took place in 2000-2001? Thank you Phil Gramm. As I've noted in the recent past, Gramm and his wife had been more than amply rewarded for taking the lead in that episode.

Two, with the absence of any reasonable over sight the financial industry decided to invent new and interesting forms of risk that could be sold in huge quantities to swell their coffers with brilliant, though very short term, results? The investment communities world wide were sold a pig in a poke. Is due diligence no longer required?

Three, the real estate industry, especially the mortgage originators, took full advantage of one and two above.

Four, the financial rating agencies aided and abetted two and three above.

Did economic theories really have anything to do with those phenomenon? I don't think so. Maybe some misplaced free marketers assisted in promoting deregulation, but that was really a lobbyist's handiwork, and another example of campaign finance as it is doing its intended job. Let's stop making the financial collapse of the country (and much of the world) a theoretical issue? It was a practical matter requiring skill and subterfuge. Prevention was only a prosecutorial matter. Maybe economists are trying to take too much credit in this case, good or bad.

Anonymous said...

Jack: "Let's stop making the financial collapse of the country (and much of the world) a theoretical issue?"

Schumpeter: "Economics will
never either have or merit any prestige until it can figure out results."

Max Jr said...

Barkley Rosser:
"Frankel and Froot went and did surveys of traders to determine their risk premia. Guess what, they did not change much even during periods when they would have to in order to explain observed degrees of volatility by risk premia"

I used to wonder why nobody did such seemingly obvious studies. Wasn't aware of the Frankel/Froot work.

To me, "risk premium" always seemed to be a catch-all to try and explain away any discrepancy between theory and evidence.

Barkley Rosser:
"The evidence is in and pretty strong. EMH is false, and Cochrane is a pompous fool."

Couldn't agree with you more.

Jack said...

Sorry, but in my haste to jot down the several points outlined above I left out what may be the most important factor of all in the collapse of much of our economic activity. Only a recession, you say?
Well perhaps that's true for the top one percent of income takers. The rest of the US economy goes from paycheck to paycheck ever aware of the possibility of impending personal economic doom. That brings us to point number five
regarding the causes of the financial collapse of 2008. The link, thank you Linda:
http://www.cbpp.org/cms/index.cfm?fa=view&id=2908
which brings you to a report of something we all knew too well.
"Top 1 Percent of Americans Reaped Two-Thirds of Income Gains in Last Economic Expansion
Income Concentration in 2007 Was at Highest Level Since 1928, New Analysis Shows" By Avi Feller and Chad Stone, September 9, 2009, from The Center on Budget Policy and Priorities.

Which brings us to the question, how can 95% of the people spend enough to keep the economy humming along if 1% of the people have all the money? And no, that one percent can't spend enough of their share to make up for what the rest don't have to spend.

Shag from Brookline said...

Johnny Cochrane includes in his footnote 1:

"Krugman fans: Please don't bother emailing me to tell me what a jerk I am."

No need to, Johnny.

Shag from Brookline said...

By the way, in Johnny Cochrane's footnote 1, he provides a link for updates to his screed. Alas, no success with it.

In earlier comments on this and perhaps related posts, I questioned whether economics is a science in the manner of Einstein's science, as Johnny seemed to suggest. In searching for his link, I noted that his undergraduate degree was in physics, so I assume he knows a little bit about Einstein's science. But that does not answer the question. Maybe he'll provide an update.

rosserjb@jmu.edu said...

Max Jr.

The source is Kenneth A. Froot and Jeffrey A. Frankel (I was wrong, Froot and Frankel rather than the other way around), "Forward discount bias: Is it an exchange risk premium?" Quarterly Journal of Economics, Feb. 1989, vol. 104, no. 1, pp. 139-161.

The idea of risk premia is completely sensible. It is just that one cannot assume that they are evaluated based on rational expectations. Without doubt, people demand higher expected returns for perceived-to-be riskier bets/investments (note: "perceived-to-be"), at least risk-averse individuals, which the majority are most of the time.

Max Jr said...

Barkley Rosser:
"The idea of risk premia is completely sensible. ..."

True.
I was taking issue not with the idea of risk premium, but with the way some people use it.

This sort of rubbish, for example:

"It is true and very well documented that asset prices move more than reasonable expectations of future cashflows. This might be because people are prey to bursts of irrational optimism and pessimism. It might also be because people’s willingness to take on risk varies over time, and is sharply lower in bad economic times. As Gene Fama pointed out in 1972, these are observationally equivalent explanations at the superficial level of staring at prices and writing magazine articles and opeds..."

--from Cochrane's rant.

Criticized here by Brad deLong, you and Robert Waldmann