Sunday, November 02, 2008

Robert Shiller on bubbles

Robert Shiller - the 'rational exhuberance' man - sees speculative bubbles as an instance of 'group-think' (yes, that is well-known) where, among experts, few will stick their neck out to present a divergent view.  It seems that taxi drivers with basic powers of observation (their eyes open?) can outperform MIT-trained PhDs in economics.  Might I suggest:

Meta-Theorem 1: When situations seem ridiculous they probably are. 

Last year I asked:
'Despite the attempts of my macroeconomic colleagues to convince me all is fine I still find it hard to understand how Australians can be in a sound credit position when 16 years into an economic expansion our credit aggregates are growing at 15.9% annually and our money stocks are growing at 15.4%. This is during a phase where inflation looks like peaking at around 3%'.
I have still not heard anything like a sensible answer to this question but I will 'stick my neck out' and make the bold prediction that the answer to this question will, in the medium-term, determine Australia's fate in the current financial crisis.  Who needs economists and finance experts? Give me astute taxi drivers anyday. The RBA told us that our low savings rates were an illusion because our investments in the stock market and the capital gains were were earning on our debt-financed love-affair with housing made us, in fact, one of the highest savings countries in the developed world - only the US beat us!

It is not only private sector heads who should roll in the current crisis.  The comforting noises made by the RBA were misleading.

Update: To be fair there were many misleading voices. James Galbraith estimates only 2 or 3 out of 15,000 economists in the US foresaw the mortgage crisis. Gregory Mankiw estimates about 10 or 12.  we all need to eat a bit of humble pie over this one but macroeconomists should be assigned large slices.


conrad said...

You're being a bit harsh HC -- perhaps the present times are pretty poor (or will become so), but 15 years without a recession is a pretty good run -- far better than the times you would have grown in up (and myself also -- being lucky enough to finish my degree in 1992). Perhaps the RBA wasn't perfect, but how much more could they have done ? we already had far higher interest rates and so on than many countries.

It also seems to me that part of the problem has nothing really to do with economists. I think that once people have good times for too long, basically they stop trying since they don't need to (and some growing up in these times never start), or take risks based on a poor ability to imagine the future (it's not surprise the younger generation that have never experienced bad times are still the last ones left borrowing). You then get the Clive Hamiltons of the world reinforcing this view, who, not surprisingly, disappear all of sudden when things get serious again. I think this is just human nature, and it's very hard to stop.

rabee said...

My understanding is that a necessary condition to classify an increase in prices as a "bubble" is that it should have been obvious to a careful analyst exante that this is a bubble.
Which in the case of US real estate prices it wasn't.

But I do suspect that the few economists that called the crash are now super rich.

The financial crash had little to do with real estate. There was no clearing house for credit default swaps and apart from rudimentary analysis by Duffie on the pricing of these things they are not well studied.

The priority now is to set up market clearing mechanisms for CDS.
The collapse would have likely not occurred had there been a CDS exchange with its own market maker. Even if real estate prices had crashed further.

Mind you its rather curios that macroeconomic education ignores financial engineering.