[ExI] Price changes and regulation/was Re: Psychology of markets explanations

[Dan]

--- On Sat, 6/20/09, Stathis Papaioannou <stathisp at gmail.com> wrote:
[big snip]
[me]
>> Also, EMH assumes instantaneous or at least very rapid
>> changes in prices and the economy.  Actual information is
>> not only imperfect, but takes time to flow through an
>> economy.  This is so for government interventions, whose
>> immediate impact might be indiscernible.  Were this not so,
>> there would no such thing as unintended consequences and no
>> government intervention would backfire: markets would
>> instantly and perfectly adjust.  (The same goes for
>> inflation.  Inflation doesn't instantly impact an economy
>> causing all prices to rise.  If it did, as I mentioned in
>> earlier posts, there would be little or no problem with
>> inflaton -- and NO incentive to inflate in the first place
>> because all possible benefits would be neutralized.  And
>> yet it moves!  Yet there is inflation and specific groups
>> not only lobby for it, they benefit from it.  So, the
>> theory (EMH, New Classical Economics, and the like) must be
>> wrong, no?)
> 
> House prices move sluggishly, partly because it takes a
> long time to
> buy or sell a house. But that doesn't mean you can exploit
> this
> "inefficiency" to make a profit. You still don't know what
> the market is going to do until it does it.

Actually, I wasn't specifically talking about housing prices, but about prices in general.  It does NOT necessarily take a "long time to buy or sell a house."  Yes, in general, houses don't turn around as quickly as, say, blue chip stocks.  My point was merely was information on real markets is imperfect and that information and price changes take time.  Some such changes are, naturally, more rapid than others -- there is no fixed rate of change.

That said, your point might still apply, but some individuals do have better information, pay closer attention, know what to look for, or are just better at predicting market outcomes.  EMH presumes all actors pretty much have the same information, do the same things with it, have the same motives, and aim for the same outcomes.  Were this so, one wonders why there would be any trading at all, especially in assets.  After all, if everyone held the same views and had the same information about asset prices -- even if this information were imperfect -- wouldn't one expect them to have exactly the same behavior?  Why would there be, e.g., both short and long positions on a given asset?  Would would someone sell call or put options and another person buy those?  Why would anyone sell or buy futures?

And, as a final escape, you might admit people have different visions of the future (e.g., whether IBM will trade higher or lower today) and different information, that this still wouldn't lead to anyone making a profit.  Yet it seems, empirically (and is not ruled out by correct theory), that some people do not just hold different predictions but actually hold better ones.  (Yes, there are also lucky people, but luck would, all else being equal, evaporate over the long haul, no?)

[another big snip]
> The chosen fiscal policy may not have the intended effect,
> simply
> because economies are very complicated and difficult to
> predict.
> However, it will have an effect, and the effect will not
> necessarily be a negative one.

Oh, there's actually an objective means to predict a negative outcome: Pareto optimality.  In a nutshell, a solution is Pareto optimal if it makes no one worse off.  (Running a regression on this -- viz., backward in time -- allows one to uncover past instances of departing from Pareto optimality.)  And this can be further made objective by coupling with demonstrated preferences and the impossibility of comparing values.  When one forces anyone to deviate from her or his preferences -- the ones that would be demonstrated by her or his actions absent the force -- one necessarily deviates from Pareto optimality.  Thus, fiscal interferences (and all other coercive interferences) force someone to be worse off -- even if they make someone else better off.  (In fact, the typical coercive policy benefits specific individuals or groups at someone else's expense -- resulting in, often, a wealth transfer.)

The impossibility of comparing values means that, objectively, one can't tell whether the harm or benefit one does to one person is equal to, less than, or greater than the harm or benefit done to another.  This means Pareto optimality can't result in a measure of the specific magnitudes of costs (or harms) and benefits -- but instead leads to comparisons of the sort that this policy causes someone to be harmed or not.  (And the regression analysis is necessary to uncover people benefiting from past harms.  After all, if someone steals your wallet, but we only look at the the Pareto optimality now, then having the thief return you wallet looks like a deviation from Pareto optimality -- it makes you better off while make the thief worse off.  But looking at the history here, we see that the thief made the first deviation in this context.)

If one accepts Pareto optimality as illustrated above, then fiscal attempts to stimulate demand -- which are otherwise flawed even without this consideration* -- one sees they can only work by making some worse off.

Regards,

Dan

*  How would the would be stimulators know where to send the stimulus?  Look at the ridiculous and failing US stimulus packages.  These have tended to shore up political insiders and big players as well as prevented prices from falling in housing and stocks (and in oil).  The long term outcome -- recall somone pointing out here that governments think long-term (which is hard to see when the stimulus plans and other rescue plans were slapped together and voted on with little debate, discussion, and, it seems, forethought) -- will be slower adjustments away from the unsustainable boom.  (In fact, in 1933, Hayek pointed out the same flaw in central bank policies aimed at stabilizing the price level -- that is, at that time, not allowing prices to fall or fall fast enough through further credit expansion and other interferences to keep prices stable.  See his "Monetary Theory and the Trade Cycle" which is now, happily, online at: http://mises.org/story/3121 
 This is a bit long, so you might want to read the intro and just skim the rest.)