[ExI] Psychology of markets explanations

[dan_ust at yahoo.com]

--- On Thu, 6/18/09, Stathis Papaioannou <stathisp at gmail.com> wrote:
> Your theory is that governments never do anything because
> it's the
> right thing to do, but only because it is the popular thing
> to do
> and/or because it gives them more power or money for
> themselves and their friends.

Actually, that's not my theory -- not in terms of economics or political economy.  I was merely pointing out why governments try to (and usually succeed) in controlling money.  Glasner's particular views on this -- all of which seem salient to me, though I'm not sure what an exhaustive empirical study would find or how his theory would need to be modified after such -- also do not seem to necessarily have a moral component.

That said, however, I think it's naive to think that governments -- or people in governments -- never act in a self-interested fashion, especially when they claim to do otherwise.  I also think information and calculation problems enter into the picture when using government.  (Truly, what's the case is there are two ways we can deal with each other: voluntarily or coercively.  Government is a type of coercive interaction.  It's not the only type, but it does tend to have a bigger impact on social relations because it's longlived and tends to feedback via various institutions government controls or co-opts.)

And, yes, ethically, I'm opposed to coercion -- save for in retaliation and self-defense.  Aren't you?

> My question was, in that case what is the
> incentive for
> governments to give up their control of monetary policy to
> central banks?

Well, governments respond to various incentives and limits.  They're not all powerful -- just as they're not completely at the mercy of society (such as in the ridiculous, laughable democratic myth that the ruling class is somehow for, by, and of the people).  But the solution your offering would be for what?  It would keep the monopoly on money and banking, but just make it unresponsive to governments?  But would that make it better?  Would you want, e.g., to set up a monopoly in any other activity?  Why?  Why not just have money be voluntary like other non-governmental things in society?

Let me back up a bit.  You see the problem as one of politicization of monetary policy.  And you see the solution as a sort of separation of the central bank and state -- like separation of church and state.  And for the same reasons: religious types were actually the ones arguing in many cases for separating church and state _because_ they felt the state corrupted the church.  But none of them argued, AFAIK, that there should be one church -- one empowered to be THE church.  Why not apply the same logic to money and banking: if you want to depoliticize money and banking, then there shouldn't be a monopoly in money and banking.  There should be free entry into both areas.  Let the people who want to offer and use money and banking services then freely decide.

In my view, a such a system would be more stable, would not be prone to chronic inflation, and would not cause business cycles.  This seems backed by theory and history.  It'd also force governments, since they could NOT use monetary policy as a crutch for bad fiscal policy, bad social policy, or bad foreign policy (war ain't cheap and easy credit helped fund the Iraq invasion; if the Bush Administration had to raise taxes for that war, chances are it'd have been called off), to select better policies -- ones that might not be pleasing in the short run, but would be better than the ones selected now.

>> Put that way, not exactly but close.  I think the
>> problem is with many psychology of markets explanations
>> is they're relying on people to react to some sort of
>> market changing in broadly the same fashion -- especially
>> when that's at odds with what they take to be economic
>> intuitions.  Such economic intuitions are often wrong NOT
>> because they're based on sound theory BUT because they're
>> based on simplified models, such as the homo economicus*
>> view or the Efficient Market Hypothesis (EMH), or unsound
>> theory.  (That EMH is wrong, of course, is NOT an argument
>> for government intervention.  Government intervention won't
>> make the market any more efficient; it'll merely introduce
>> new factors into the problem, perverting incentives and
>> distorting information.  Usually, too, such interventions
>> are done to benefit elites -- even if the marketing campaign
>> for them tells us, with a straight face, that they're for
>> the common good.)
> 
> I believe the EMH is right. It simply says that, in
> general, you can't
> beat the market unless you have special information. This
> is true even
> in an economic bubble: in general it is never possible to
> pick the top
> or the bottom or say when the market will turn, no matter
> how smart
> you are, no matter how much information you accumulate, no
> matter how
> obvious it seems in retrospect. However, this is not the
> same as
> saying that a bubble is "efficient" or "rational". Also,
> there is no
> incompatibility between the EMH and government
> intervention. The
> government intervention is just another factor that impacts
> on the
> market, as an increase in the popularity of hoola hoops
> might impact
> on the share price of a toy maker. The government action
> may make the
> economy better or worse, but it won't make it easier or
> harder to beat the market.

I'm aware, but I still believe it's wrong.  Why?  The EMH assumes that market prices are in equilibrium and factor in all relevant data.  However, real world market prices are never in equilibrium and all relevant data is not factored in.  Prices are formed based on market interactions; they don't form because some divine intelligence knows all and tells all -- simply telling it in the language of prices.  (It might be better to see prices not as information, but as information surrogates.  A price rise, as information, tell us nothing about why the price rose.  The entrepreneur and economic historian might try to figure out that a rise in the price of tin is caused by reduced supply (current or expected), increased demand (current or expected), or inflation (current or expected), but the actual price doesn't reveal that.)

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?)

On, and I don't think there's a clash between interventionism and EMH.  (Though perhaps certain types of interventions would clash directly with EMH, such as those aimed at fixing prices or slowing down price change.  E.g.., the recent prohibitions (in America, Britain, and much more extensively in Australia) on short selling of financial companies' stock tends to slow down price changes of those assets.  This creates a price rigidity in the downward direction.  The asset price can still fall, but not as quickly as when short selling is allowed.  This also removes one incentive for investors to weed out overpriced stocks by removing the profit from betting against the asset.  Finally, from a sociological perspective, it tends to keep established parties in place -- meaning that anyone with a current long position is more protected, therefore, has her or his position privileged over all others.  Thus, governments that prohibit short selling are
 protecting
 monied elites.)  My point was, rather, that some use imperfect markets as a justification for government intervention -- arguing as if government interventions worked and there were no problems with government.  (And, though it's usually unheard of, there's a vast literature on "government failure."  In fact, one could say the science of economics started out by pointing out the limits of government intervention.  Discoverers of economic laws, in a sense, were relating how this or that policy couldn't work -- that there were unintended consequences and that people couldn't just set aside economic laws on a whim.)

Often, too, the problem is that people proposing interventions suffer under the Nirvana fallacy.  They compare a real world situation (imperfect markets or markets that don't work under idealizations like perfect competition, instataneous changes, homo economicus actors, and the like) with an idealized alternative (e.g., perfect markets, government regulations that aren't counterproductive, government actors who are  true public servants and who also know exactly what to do (no doubt, many government actors are well meaning people, but that alone doesn't make them better at solving problems)) -- when the actual choice is between one real world situation and another.  For instance, the choice is between imperfect real world markets with people who don't have total information, take time to act, often make mistakes, have to work with disequilibrium prices and so forth AND layering more regulation on these imperfect markets where the regulation is to be
 enforced by people who are, just like the people in the market, imperfectly informed and some of which might have vested interests that don't allign with the best market performance.

This also brings up the issue of how to measure efficiency overall.  The EMH avoids some of these problems because it's, at its core, merely about how market prices reflect all available information and quickly change to suit new information.  (Of course, a big problem here, from an Austrian perspective is that prices are often expectations about future market states -- e.g., entrepreneurs bid up factor prices because they expect their products or services to sell at prices that don't even exist.  E.g., when Apple first made the iPod, it had to speculate that not only would iPods sell, but they would sell at a price high enough to recuperate costs and provide some level of profit.  But there was no market information iPod prices.  They had to take a gamble here.)

>> If you're just going to say, e.g., that if people's
> psychology changes, so will markets, I agree, but this is a
> trivial point.  For instance, if people's demands for
> leisure, savings, goods, services, and money change, this
> can impact how any particular inflation affects the economy.
>  This doesn't, however, mean that inflation will have no
> impact and it's hard to see how everyone's psychology would
> likely change in a way that neutralizes a bad monetary
> policy.  (Also, a lot of the psychology of markets
> explanations when applied to crises seem to presume people
> are acting incorrectly to the factors in a crisis -- such as
> overestimating how far stocks might fall.  However,
> sticking with these cases, the researchers often have the
> benefit of hindsight and other information unavailable to
> the average investor.  Given imperfect information and
> uncertainty about the future (will the asset go down 10% or
> 20%? will it hit bottom and start to rise next year or
> >  ten years from now?), bounded rationality, and the
> various incentives, a lot of seemingly incorrect behavior
> looks sensible.)
> 
> I have been trying to make the point that you have finally
> acknowledged as trivially obvious. I hope it's also
> trivially obvious
> that if everyone suddenly became depressed and stopped
> spending money
> while all else was the same, the economy would also go
> into
> depression, even though such a thing is unlikely to
> happen.

But how does that wild speculation explain any real world crisis?  In fact, it explains no particular crisis and is mainly used as a rationalization for central banks to inflate or for governments to spend during panics or recessions.  What typically happens is people save so that they can spend in the future -- not because they are mindless hoarders of money but because they have plans for the use of that money at some point in the future.

Now, such savings can impact current businesses, but this need not cause a recession, especially if markets are allowed to freely adjust.  If people save, that's merely postponing consumption and entrepreneurs will try to forecast, more or less successfully, where this postponed consumption will go.  (This doesn't mean they'll always be right or that this is predictable with high precision when some of them get it right.  However, one would not expect -- and history as well as theory should be a guide here -- that this is completely unworkable.  If it is completely unworkable -- if, say, we're living in a Keynesian/Lachmannian market-world, then there's no explanation of how things ever go right much less what to do about them.  On the last point, where market entrepreneurs simply unable to work at all, there's no reason to expect regulators or economic planners to somehow get it right where market entrepreneurs always got it wrong.)

But let's say there's some change in the overall savings rate.  Let's leave alone how this happened.  (In the real world, lots of things can influence people to change their rate of savings, though, typically, few things cause broad segments of the population to change in a like direction by a similar amount.)  Further, let's posit this change is completely unforeseen -- that not one single entrepreneur bet on it, not even the ones playing Black Swan strategies.  The immediate impact would be less money chasing after the same amount of goods and services.

Chances are, in the real world, this would not be uniform.  People would likely cut off spending on some goods and services and not others.  This would depend on each person's particular preferences, specifically the marginal utility of each good or service experienced against the marginal preference to save.  (In the abstract, we need not treat savings here as something categorically different from all other goods and services.  For instance, looking at a person who has to choose between, say, apples and oranges, we might find that she prefers one more apple over one more orange.  We could just add that she now prefers saving a certain specific amount of money over one more orange.  Of course, "de-abstracted," it's probably more likely that she prefers saving for future goods and services -- say putting more money into her "2010 trip to New Zealand" fund over one more apple.)  This lower demand would translate into less goods and services
 clearing the
 market than before -- until prices adjust.

Notably, price adjustment is not instantaneous, so one might expect some surpluses for certain goods and services.  But the faster people recognize the demand has fallen for these -- e.g., the grocer notices apples and oranges start piling up or the nail salon owner notices that only 10 people come in daily instead of 15 -- the quicker they can adjust.  And the adjustment could be a fall in prices (to clear inventories; e.g., the grocer might prefer to sell even with a little loss rather than have rotting fruit on his shelves) or reducing supply (e.g., the nail salon owner might decide to lay off some of her staff since she now has one third less customers coming in).  And expectations, of course, play a role here.  People might not, e.g., close a restaurant down because of one bad weekend.

Anyhow, if the adjustments do take place, there's little reason to expect a lengthy process of reallignment.  However, let's postulate there is one.  It's long, hard, and there seems no end in sight.  We might inquire what would cause this in the first place, but let's leave that alone.  How would anyone improve on this situation?  The typical mainstream solution is to stimulate demand -- usually via inflation but also sometimes via fiscal and tax policy, such as by increasing public spending (and often public debt) or by lowering taxes.  However, if one is going to posit people just want to save more period, it's hard to see how any of these policies would stop that without some serious bad side effects.  For instance, high inflation might eat away at savings, but it causes business cycles and is hard to predict, so, even were it okay to beat up on people who simply want to save more (and it's not okay to beat up on them), there's no way to
 target
 them via inflation as inflationary effects are systemic NOT localized.

Increasing public spending, too, is likely to have systemic side effects and is likely to lead to certain groups benefiting from public largesse regardless of whether they saved or not.  And suppose relative non-savers benefit more.  What would this do?  These people were already spending at high levels.  Giving them more -- and all public spending gives someone more than she or he would otherwise have -- might not do the trick and would be heavily depend on what the spending is on.  E.g., if you give an extra $10,000 a year, I'm likely to save it.  If you give another guy that much, he might spend it on a new car.  Still another might blow it on drugs.

The same pretty much goes for reducing taxes, though the solution is preferred.  (All tax cuts are not, of course, equal, but the goal should be cut until taxes are at zero.:)  However, again, the solution presumes not unintended consequences.  If the goal is to neutralize the savings, then tax cuts will only do that if people spend [enough of] the tax cut.  (One should ask throughout this exercise, especially if one is ready to apply this to the real world, why on earth neutralize savings?  Who are we to say what the correct spending level is for all of society?  How would anyone even be able to determine the correct level outside of observing what people -- the ones who make up society -- prefer when they're not being forced to save or to spend?)

Regards,

Dan