Economics models as quantitative parables

A while ago in internet time, John Cochrane wrote an interesting post called “Policy Penance” where he discusses how academia and central banks are interacting in 2014, at least in the US with the Federal Reserve and macroeconomists from different schools of thought.

The central thrust of the post is that central banks can’t just make speeches and guide expectations, on some level they have to follow rules because the moment they “break their own rules” they incur a credibility cost – it’s more expensive in terms of output or inflation trade-offs – to achieve their inflation target, output or unemployment rate goals.

Time consistency of monetary policy is hard in an environment where central banks are close to academia but not as close to finance as you’d expect. This means that a lot of actors in the markets the Federal Reserve plays in are still fumbling in the dark following the balance sheet expansion of QE and the subsequent, long-awaited and still misunderstood “taper” or reduction in Federal Reserve purchases of MBS, Treasuries and other bonds.

When you then look at the regulatory response to the global financial crisis, and how Dodd-Frank has changed the way that the desks with the largest notional exposure to interest rate sensitive derivatives do business, and how all of these factors are interacting in an environment where to many financial market actors it seems like the central bank is making it up as they go along then you aren’t making the system more stable – you’re making asset prices ever more closely entwined with market participants interpretations of central bank action than they ever have been in history.

If you look at long term interest rates – the US 10 Year at 2.11%, 10 year gilts at 1.83% and German 10 year bunds at 0.63% the conclusion is that market participants expect low interest rates and low inflation for quite some time to come. What academics aren’t getting their heads around fast enough is that in order for the goals of the central bank to be met, capital losses will be imposed on the bondholders.

Forcing interest rates higher is a complete reversal of the “protect the bondholders” mantra from the onset of the global financial crisis. When interest rates rise, bond prices fall. Total returns can still be positive if held to maturity but that’s not guaranteed with changes in how capital flows into and out of the bond markets. The massive expansion of central bank balance sheets has been accompanied by massive increase in outstanding bonds. The New Zealand government has been a major issuer through the crisis for example.

I think that looking at broader labour market indicators as a driver of central bank action is a devil’s bargain. A central bank is about price stability and financial stability, not labour market outcomes or terms of trade. It’s concerning how much attention Janet Yellen is giving to the legitimate issues in the US labour market – this is stuff Congress and the Department of Labour should be sorting out!

We know that a floating currency is essential for New Zealand’s easy access to global capital and far from adding more instruments or targets to the Reserve Bank’s mandate, or indeed any central bank’s mandate, ensuring the correct policy settings are there to achieve the outcomes people want is more important than using the central bank as some enabler of other policy goals far outside their core competency.

Diminishing returns from social media interaction

I’m convinced that we are several “killer apps” past this point.








It’s a story of  devolution as opposed to evolution.

We are going backwards as a society as we move closer and closer towards inane instantaneous interactions that can easily be taken out of context and spawn self-reinforcing negative feedback cycles that end in false ignominy for the poor individual who stuffs up online.

Does automation make us dumb?

Over at the Wall Street Journal:

We are learning that lesson again today on a much broader scale. As software has become capable of analysis and decision-making, automation has leapt out of the factory and into the white-collar world. Computers are taking over the kinds of knowledge work long considered the preserve of well-educated, well-trained professionals: Pilots rely on computers to fly planes; doctors consult them in diagnosing ailments; architects use them to design buildings. Automation’s new wave is hitting just about everyone.

I don’t think automation makes us dumb, but it sure does mean that end-to-end understanding of complex processes is less likely for someone starting out in the workforce.

I am not convinced that not repairing anything is good for anyone. We buy new when problem solving down to component level could bring about increased levels of specialised knowledge to make systems more resilient to failure.

The rising entry level requirement for cognitive ability in many roles means that even though more people are attending university than ever before, the gap in on-job performance will become even larger because of the complementarity between highly skilled workers and machines.

But the great conceit here is that everyone thinks that they’re above average – their psyches resent the idea that a machine can do a better job – and have mountains of data to back that judgment up.

The downside of these great leaps in technological innovation is that they are likely to be thwarted by politicians attune to how important feelings and emotions are to most of the human population.

It won’t be the automation that makes us “dumber” – it’ll be the attempts to put the brakes on automation that lead to unintended consequences and a less efficient allocation of resources by firms.

Coursera – Financial Markets with Robert Shiller

If you’re interested in what Coursera has to offer, Financial Markets with Robert Shiller would be a good place to start.

Id recommend watching Coursera videos at 1.5x speed in order to save time. There are mini-quizzes that pop up during some videos to check that you’ve been retaining what the lecturer is saying.

The lecturer and guest lecturer for this course function as another data point on winner take all markets and how MOOCs will gain market share by packaging the contributions of several superstars in their respective fields.

I’m coming round to the view that online education will never replace the signalling function of bum-in-seat tertiary education – which is unfortunate for fans of technological disruption – but takes into account the sociological issues that stem from the tertiary education arms race, namely credentialism where more and more degrees are required to gain entry into labour market niches where an excess return can be earned.

Some #inequality Books I’ve Read Recently

The Establishment: And how they get away with it by Owen Jones

Behind our democracy lurks a powerful but unaccountable network of people who wield massive power and reap huge profits in the process. In exposing this shadowy and complex system that dominates our lives, Owen Jones sets out on a journey into the heart of our Establishment, from the lobbies of Westminster to the newsrooms, boardrooms and trading rooms of Fleet Street and the City. Exposing the revolving doors that link these worlds, and the vested interests that bind them together, Jones shows how, in claiming to work on our behalf, the people at the top are doing precisely the opposite. In fact, they represent the biggest threat to our democracy today – and it is time they were challenged.

Just because this book is about the United Kingdom doesn’t mean that there aren’t parallels to New Zealand. The revolving door details are quite interesting, also the links between the media barons and the political elite in the UK.

The New Class Conflict by Joel Kotkin

In ways not seen since the Gilded Age of the late nineteenth century, America is becoming a nation of increasingly sharply divided classes. Joel Kotkin’s The New Class Conflict breaks down these new divisions for the first time, focusing on the ascendency of two classes: the tech Oligarchy, based in Silicon Valley; and the Clerisy, which includes much of the nation’s policy, media, and academic elites.

The New Class Conflict is written largely from the point of view of those who are, to date, the losers in this class conflict: the middle class. This group, which Kotkin calls the Yeomanry, has been the traditional bulwark of American society, politics, and economy. Yet under pressure from the ascendant Oligarchs and ever more powerful Clerisy, their prospects have diminished the American dream of class mobility that has animated its history and sustained its global appeal.

This book is definitely interesting. If you’ve visited Joel Kotkin’s website New Geography, you’ll find this an interesting insight into the changes in the US over the past few decades. It’s always hard to understand another country’s politics from the outside, but this book helped fill in some gaps in my knowledge.

Foreign Intervention

The situation in the Levant isn’t going to improve soon. Does New Zealand really have a strategic interest in the defeat of Islamic State? I’m not convinced, and the softening up of the New Zealand public over the past few months for “boots on the ground” should concern anyone capable of thinking clearly.

If the risk to New Zealand is elevated because of Islamic State, then a direct military contribution will only increase that risk. The more reasonable response is to take advantage of the fact that New Zealand is a long way from the Middle East and allocate resources towards improved security within New Zealand and around New Zealand assets overseas such as embassies and diplomatic missions.

Our imminent presence on the UN Security Council doesn’t mean we have to put troops on the ground. It’s actually an opportunity for New Zealand to promote a non-crazy attitude towards foreign intervention. Even humanitarian aid in the Middle East is actually helping Islamic State – so if we are currently doing any of that, it should grind to a halt until they start acting like civilised people.

As that is unlikely to happen, the best approach is to stay as far away as possible from foreign entanglements. The rhetoric around this whole situation is concerning, the same people who lied about Iraq are talking heads on US news shows and the same people who haven’t incurred any personal costs for their mistakes are shilling for greater intervention!

Matt Nolan hits the Blue-Green nail on the head

Over at TVHE, Matt Nolan has a good rant about that Blue-Green thing many people on Twitter have been up in arms over recently. I don’t think there is a need for any real change in the Green Party’s positioning because demographics is destiny for the Green Party.

This really stood out to me:

How many people who accuse the “other side” of not caring about people have actually tried to understand the other sides argument?  How many have actually gone through detailed empirical policy work trying to understand what trade-offs exist, and trying to figure out what we can know about social issues?  I tell you what it is a lot of work to do and no-one has the hours in the day – but I find it amazing anyone can have such a negative view of others intentions after doing all this work, let alone before doing it.

My mental of politics and political activists is that it’s all about teams, policy be damned, except when it’s important. That isn’t to say parties don’t have good policies from time to time – just pointing out that confirmation bias is a major risk for everyone involved in politics. Think about how some politicians are able to reframe any topical issue in the language that appeals to their voter base.

But there is a major misunderstanding of the Green Party that political journalists are trying to project onto it – it’s member driven and simply won’t “move to the centre” because that’s not what the Green Party *is*. It should make people on the left raise their eyebrows when right wingers seem to think Stuart Nash is the right person to lead the Labour Party and that the Greens should “move to the centre”. Who really benefits from those two things happening? Bueller? Bueller?

Elected governments are temporary

The most important post-election documents are not coalition and supply agreements. They’re the Briefings to incoming Ministers that each government department prepares for whomever has been appointed responsible Minister for their department. That’s obviously just my opinion.

Elected governments are temporary, bureaucracies are permanent. The structural reforms in the New Zealand public sector over the past 30 years have lead to a high level of corporate-like behaviour, but there is still a major lack of understanding around how power is actually distributed in Wellington.

The shenanigans the Labour Party is currently going through around David Cunliffe are a sideshow. The election was a sideshow. Democracy itself is a side show. Every day, thousands of people go to work and open up Word documents that detail policies, regulations, interpretations and draft legislation. They do this under the nominal control of the government of the day, but no one is dictating every single word to them.

For some, this isn’t a big deal. I’m not that concerned about the public service – almost every public servant has the public’s best interests at heart. They’re not evil conspiratorial creatures, they’re just people. New Zealand has a highly competent public sector relative to almost all the others. The attacks on the public sector by the right is something I don’t understand. The changes in policy and move towards more intervention in our day to day lives didn’t just happen through legislation – it happened through substantial changes in the people who start with blank Word documents.

In Wellington Central, there is a bubble. And this bubble doesn’t much like the National government, but it is immaterial if National or Labour form the government. If Grant Robertson is the new Labour leader this afternoon, and the National party doesn’t win the next election, the bubble will be very pleased. It makes things easier if the temporary government is very much aligned with the permanent government.

Comparing the cost of insurance online

Insurers are reluctant to share details on an insurance cost comparison site according to the Herald.

What are the people behind iCompare doing wrong?

LifeDirect was bought out by TradeMe if I recall correctly, and you can easily compare life insurance quotes on that site.

Refusal to give data to an independent website isn’t necessarily anti-competitive behaviour, but there are clear rents to be earned in the insurance sector.

With the move to sum insured instead of full replacement in the aftermath of the Christchurch earthquake disaster, insurance needs to be on the regulatory radar.

Most people don’t have diversified portfolios and carry debt, so any upset in their situation is tough to deal with.

Fed chair Janet Yellen was right when she said the other day that asset building is key to making households more resilient to future financial crises.

High debt, house price risk and income inequality

Over at Capital Ideas, published by Chicago Booth School of Business, there is an excerpt from Amir Sufi & Atif Mian’s book “House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again“.

Debt plays such a common role in the economy that we often forget how harsh it is. The fundamental feature of debt is that the borrower must bear the first losses associated with a decline in asset prices. For example, if a homeowner buys a home worth $100,000 using an $80,000 mortgage, then the homeowner’s equity in the home is $20,000. If house prices drop 20%, the homeowner loses $20,000—his full investment—while the mortgage lender escapes unscathed. If the homeowner sells the home for the new price of $80,000, he must use the full proceeds to pay off the mortgage. He walks away with nothing. In the jargon of finance, the mortgage lender has the senior claim on the home and is therefore protected if house prices decline. The homeowner has the junior claim and experiences huge losses if house prices decline. 

I recommend reading the full article if you have time. The reason why this makes sense is that one household’s debt is another household’s asset. A key risk to the New Zealand economy is the outsized proportion of household assets made up by home equity. A way to reduce that risk is to build up the financial assets of households. This is the real benefit of Kiwisaver and state wealth funds like ACC and the NZ Super Fund. They’re reducing the severity of any house price collapse induced recession in the future. If your household has a diversified portfolio of assets – including across asset classes – then house prices dropping 20% won’t have as much of an impact than if your household has almost 100% of its assets in home equity.