Lots of economics this week. We celebrated the Dr. Jekyll side of Paul Krugman (after having lamented his Dr. Hyde a week ago), explored the economics of college admissions and of work and play, and ended the week with a pop quiz. I’ll discuss some of the quiz answers in the near future.
Midweek we took a break to celebrate the centenary of the great Johnny Mercer.
To round out the week’s economics theme, here’s some recommended reading from around the web:
- John Cochrane’s devastating rebuke of Paul Krugman
- Bill Easterly on the perils of declaring health care a “right”.
- Robert Murphy takes on the Efficient Markets Hypothesis. I don’t completely agree with this one, but Murphy definitely scores some points and it’s way fun to read.
I’ll be back next week with more economics, along with some math, science and philosophy. Keep coming back and you’ll see names like Darwin and Godel at least as often as the likes of Krugman. (And if there’s something in particular you’d like addressed, feel free to suggest it in comments or at questions at landsburg dot com.) See you Monday!
Steve,
I think you have confused the term “devastating rebuke” with puerile and whiny tirade“
The efficient markets hypothesis is provably wrong. The proof is Warren Buffett.
Buffett is an investor who (through his company, Berkshire Hathaway) has beaten the market for many years. But that’s not the proof, since maybe he just got lucky.
The proof comes from the fact that whenever Buffett’s thoughts about a certain stock or commodity become known (generally because information about his purchases or sales become public when reported to the SEC), the market reacts strongly. If Buffett likes Gillette, the price of Gillette goes up. If Buffet hates silver, the price of silver goes down.
So the market itself is saying that Buffett knows more than the market. Either the market is right about this, in which case the market is inefficient, or the market is wrong about it, in which case the market is inefficient. Therefore, the market is inefficient. QED.
(As far as I know, this proof is original to me.)
Maurile: The efficient markets hypothesis (at least in the form most people have in mind when they talk about the efficient markets hypothesis) says that prices reflect all publicly available information. If Warren Buffet’s opinion gets factored into the stock price as soon as it becomes publicly known, that’s a confirmation of the hypothesis, not a refutation.
If Warren himself can consistently beat the market using nothing but publicly available information, that tends to refute the hypothesis. But if he can beat it using something *other* than publicly available information—whether it’s private information, or ESP, or revelations from God—then the hypothesis is not refuted. And again, in that case the hypothesis predicts exactly the phenomenon you’re describing.
Yes, I should have explicitly stated my premise that Buffett himself uses only publicly available information to evaluate securities. He has said as much — though I suppose he might be fibbing.
Would either of these cases be considered refutations of the efficient market hypothesis:
1. Buffet has all the same information as everyone, but he knows a “tell” about the stock market, i.e. a week after a public scandal a stock price is undervalued or most tech stocks become overvalued a year after IPO.
2. An economist believes that according to his theories and observations, housing prices are due to fall and so he invests accordingly.
I could see in the second one that the actions (and theories) of the economist would lower housing prices to the point where prices are balanced between his distrust and the faith of most other investors. Would it be fair to say that this not a refutation of the EMH because as soon as his theories yield correct results, investors will begin to consider his theories when investing in the future? Is there anything in the formal postulation of the EMH that refers to the level of acceptance of the public information?
A few years ago I read a book about Warren Buffett’s business career, and I don’t think he counts as a violation of EMH. Warren Buffett studied accounting and the management of businesses. When he was deciding whether or not to buy part or all of a business, he inspected and evaluated the business himself. Buffett actually traveled to their facility, interviewed their employees, inspected their equipment and procedures, et cetera. He didn’t depend only on market prices or other public information about how much other people said the business was worth. He made his own assessment with his own eyes and ears of their assets and how good their strategy and management was. In some cases, he got involved in the management of the business or chose who the managers would be. In those cases, he was changing whether or not the business succeeds, not just guessing and seeing if he got lucky. The investment returns one sees in Buffett’s career are only partially the result of speculative investment. The non-speculation part does not violate EMH. I don’t think Burton Malkiel ever wrote that guys who are really good at studying and running businesses can’t be more successful than people who aren’t, because that isn’t speculation, that’s real work. I think EMH only applies to speculative investing. It’s been years since I read about EMH or about Buffett, so I wouldn’t be surprised if I’ve made errors here.
I’m sure there are errors in my recollection, but this is my recollection of how Buffett invested. Buffett isn’t what one would call a “trader” or a “stock picker”. He’s a long-term buyer of businesses. He tends to purchase large shares of businesses, after doing his own professional evaluation (an evaluation that the public and investors in general do not have the time or expertise to perform) of the business, and he owns them for as long as he finds it worth owning. The share of it that he owns is often large enough that he can have decision making authority in the business, and (I think) in at least one case he served as CEO of a business in which he owned stock, for some period of time. He doesn’t sell and re-buy to try to take advantage of market fluctuations. I think he once said that his favorite holding period is forever. He also tends to buy them based on whether or not he believes they will be profitable, not whether or not he thinks their share price will go up on a stock market. That’s why he was able to make his billions living in Nebraska, instead of having an office in New York City or London. It’s like he doesn’t even attempt to do the things that someone would do if they had the magic ability to overcome the EMH.
George Soros is more of a speculator about markets and their timing than Buffett, and I think he’d be more interesting to examine if you want to challenge your confidence in EMH.
Sorry about the long and redundant posts but it turns out that I am on tons of caffeine. I’ll try to make this one shorter. The EMH (or at least my fuzzy recollection of it) was like a theorem where the premises are simplified, not 100% true, but not entirely ridiculous either. They’re usually true, or mostly true. Buffett does business in a way that deviates from the simplified assumptions, so he fails to fit the conclusion of the theorem without being a counterexample to the theorem. If he perfectly fit the premises, and was the opposite of the conclusion, then he’d be a counterexample to the theorem. I consider EMH an imperfect model whose assumptions are not entirely true, and whose conclusion isn’t entirely true either, but which is still similar enough to reality that it could be used to sensibly answer general questions like “why aren’t economics professors wealthy if they’re so smart and know so much about prices and markets?”
I is a small thing but it is “Mr. Hyde”, not “Dr. Hyde”.
The only reason I even bring it up is that when Krugman forgets his economics it is perfect that he is no longer a professor but merely a “Mr.”
Cochrane has argued for the “Treasury View” — the idea that government spending cannot increase output b/c government spending must be financed out of saving and therefore decrease investment 1-for-1.
Krugman was taking the view of John Maynard Keynes arguing against the Treasury…
Can you explain in your blog why you believe the Treasury View is correct?
After all, the British Treasury eventually conceded to Keynes, but here Cochrane is 70 years later…
the idea that government spending cannot increase output b/c government spending must be financed out of saving and therefore decrease investment 1-for-1.
If you believe this is Cochrane’s view, then you cannot possibly have read the piece I linked to (see the section headed “Stimulus”). I suggest that you read it.
I suggest you read this: http://faculty.chicagobooth.edu/john.cochrane/research/Papers/fiscal2.htm
I’ll give the mike to John Cochrane, and let him say what he believes:
“Most fiscal stimulus arguments are based on fallacies, because they ignore three basic facts.
First, if money is not going to be printed, it has to come from somewhere. If the government borrows a dollar from you, that is a dollar that you do not spend, or that you do not lend to a company to spend on new investment. Every dollar of increased government spending must correspond to one less dollar of private spending. Jobs created by stimulus spending are offset by jobs lost from the decline in private spending. We can build roads instead of factories, but fiscal stimulus can’t help us to build more of both1 . This form of “crowding out” is just accounting, and doesn’t rest on any perceptions or behavioral assumptions. ”
That is the Treasury View. John Cochrane wrote that, presumably because he believes it. You say you back John Cochrane. Krugman and DeLong attacked John Cochrane for re-inventing the Treasury View. Now is your time, defend the Treasury view. I.e., tell your readers why you believe, in Cochrane’s words, that: “Every dollar of increased government spending must correspond to one less dollar of private spending.”
Well, Steven, we’re all waiting. I think you owe it to your blog readers to say whether you support John Cochrane and the Treasury View, or whether you’re analysis is that Paul Krugman and Brad DeLong are right, and that Keynes was right to call it a logical fallacy.
Which is it?
Thorstein Veblen: Under certain ideal conditions, government debt does not affect aggregate demand. The list of important ways in which those ideal conditions can fail is well understood. There’s a good summary in the Cochrane article I pointed to, and another in the chapter on debt in my book “The Armchair Economist”. If you’re technically inclined, you can try reading Barro’s paper, posted at http://hussonet.free.fr/barro74.pdf , where all this was sorted out long ago.
Steven wrote: “Thorstein Veblen: Under certain ideal conditions, government debt does not affect aggregate demand.”
To which I say, paraphrasing Keynes, that those ideal conditions (described in the Barro article) represent the specific case, not the general case, and certainly not the conditions of the economic society which we actually live, with the result that its teaching is misleading and disastrous if we attempt to apply it to the facts of experience.
For example, Barro assumes that poor people can borrow as much as they want. (Actually, there are no poor people in his model…)
Cochrane’s argument was that “Every dollar of increased government spending must correspond to one less dollar of private spending.” b/c of an accounting identity which always holds. That’s a logical fallacy. Cochrane did not say “under certain ideal conditions”. You did not answer the question.
Cochrane’s article is actually worse than this. For although he does say that the assumptions of Barro’s theorem may not hold, he then says: “when you take this into account we are all made poorer by deficit spending, so the multiplier is most likely negative.”
Do you believe the multiplier is negative, even in a deep recession, when excess reserves are piling up like pancakes, short-term interest rates are near zero and factories are sitting idle.
Cochrane then proceeds: “Nobody ever “asserted that an increase in government spending cannot, under any circumstances, increase employment.” ”
But this is also false, yes, because John Cochrane had apparently forgotten what John Cochrane himself had just written: “Every dollar of increased government spending must correspond to one less dollar of private spending.”
So, again, I’m asking you if you believe John Cochrane when he wrote: “Every dollar of increased government spending must correspond to one less dollar of private spending.”
My second question is if you believe John Cochrane when he wrote: “the multiplier is most likely negative”.
After all, you linked to Cochrane approvingly. These two arguments of Cochrane (echoed by Fama, Zingales, Prescott, etc.) are what the whole debate was about.
“The multiplier is most likely negative” of course, is 10X crazier than saying it’s zero.
Where does Steven Landsburg stand?
Ricardian equivalence states that the timing of taxes does not affect aggregate expenditure. However, government spending does affect aggregate expenditure in Barro’s formulation(In the short run). This simply requires Chicago-school economists to actually understand the model that underpins their abhorrence to the fiscal stimulus package.
But Ricardian equivalence simply means that tax cuts aren’t stimulative, which many on the right prefer to spending. This means that according to the predictions of Ricardian equivalence, the stimulus package should have been weighted more heavily towards spending and less towards tax cuts.
De Long has already addressed this back in March:
http://tinyurl.com/ylrosk3