It’s Not My Fault. Yes, It Is.

Shoulders of Giants
Shoulders of Giants

Ever noodle a half-baked idea incessantly in your head only to find that you can’t grasp at its essence, give it shape or form, and consequently, fail to communicate it to your meagre readership. I have and it kills me on a daily basis. In this particular, I’m talking about economics, finance and the framework within which they should be approached by anyone who claims to have a serious desire to understanding both. And then you come across a piece of writing which saves you from going through the trouble. Pure bliss. Let me set the stage first.

**

See this post for the full conversation, although its not needed. I’m posting the relevant excerpts to my post anyway.

Zolltan: …So it’s not that some bankers don’t care what they’re doing (which, granted, they may also not), it’s that they just don’t know what they’re doing. That’s not a very useful revelation, but it sure is infuriating…

Zuuko: Bankers, of course, know nothing. Bankers know that they know nothing but I’m beginning to think the point is more subtle than that. I think people have this expectation of what a banker should know and what his concerns, motivations and incentives should be. But it’s a bit of a motherhood-and-pie thing, without any basis in practicality or reality…

Once, when I was expressing my frustration in my usual colorful language when we were going through the shitstorm of legal battles over our restaurant, our lawyer said to me point-blank, “What you need to understand is that it’s not a justice system, it’s a legal system.” That shut me up.

I’m trying to think of a similar expression that can be applied to banking but all I can come up with is a weak one that doesn’t get the point across by itself (a testament to my lack of wit, I guess). What you need to understand is that it’s not a financial system, it’s a banking system…

**

Since that exchange a few months ago, my situation with my wit still hasn’t changed, despite my feeble attempts at trying to craft a post that elaborates and builds on my pet peeve. Thus, I’m forced to lean on the shoulders of the giants at Worthwhile Canadian Initiative and this post, The macroeconomics of doing nothing. Go and read the whole thing but I’ll point out specific passages that appealed to me.

Suppose there is an increase in desired saving, and the monetary and fiscal authorities do nothing. What happens?

That’s the most important practical question in macroeconomics over the last few years. And it’s also a really stupid question.

It is? Why? Well, I’m glad you asked.

And understanding why it’s a really stupid question, and changing the way that question is asked — not just in academia, but in the real world — is the most important practical task of macroeconomic theory today.

I see. Can you please elaborate? Perhaps with an example?

Let’s start with “saving”. In macroeconomics, “saving” is defined as “not spending part of your disposable income on newly-produced consumption goods and services”. It’s a purely negative definition. And it invites the supplementary question: “OK, so if you are not spending it on newly-produced consumption goods and services, what are you doing with your disposable income instead?”.

But few macroeconomists would ever ask that question. Which is unfortunate, because the answer to that question matters a lot. For example, suppose you were a Keynesian of some sort. Your immediate instinct would be to answer my original question by saying that an increase in desired saving, if the monetary and fiscal authorities do nothing, would cause a recession. But if you stopped and asked the supplementary question, and I answered “they decide to buy newly-produced investment goods instead of newly-produced consumption goods”, you would stop talking about a recession.

hmmm… you may have a point.

For example, if you say that the average Canadian owes $45,000, you think one way. If you say the average Canadian is owed $45,000, you think another way. But in a closed economy, or one with no net foreign debt, debits equal credits, so the two are the same.

Indeed.

Expectations matter. I mean real people’s expectations matter. Economics is about those real people… Economists, in part, need to be ethnomethodologists. We need to think about how people construct their own economic models, and how they think about “doing nothing”. But, like anthropologists, we need to stand apart from the natives’ own way of viewing their world. We don’t have to believe it ourselves to recognise that they believe it. And sometimes we need to be missionaries, and suggest that other ways of viewing the world might lead to better outcomes.

Given Zolltan’s curious interest in anthropologists, I’m sure he just had a semi right now.

The point I was trying to make to Zolltan a few months ago was that I’m not sure I agree with what economists, bankers, financi-people in general are being blamed for. There is cause for blame and, and if you are so inclined, it starts with looking at the systemic failings of my professional class, geared to our rather feeble and narrow world view. WCI’s post does an admirable job of starting to put a very blurry picture into focus.

**

As an aside, I have a list of half-formed blog topics, which when I get around to finishing the write-ups, end up being posts here. In a weird and surreal coincidence, I can’t help notice some of the same… I don’t know what… issues of mental frame of mind in Zolltan’s last post.

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7 Responses to It’s Not My Fault. Yes, It Is.

  1. zolltan says:

    I’m going to have to think about this for a bit. Is the connection you’re seeing between the responsibility of the financial industry in the crisis and the WCI post that the bankers “didn’t really do anything,” in the same sense that there isn’t anything “being done” about the increased savings rate?

    On the specifics of the WCI post itself, it’s a very good point that non-action is actually an action, and what that action is is important. But beyond that, it’s either it’s very vague or I’m missing something. To a non-economist, there are two economic metrics: unemployment and inflation. All this talk about expectation-setting via interest rate targets – this stuff isn’t observed in some weird caveman-like way by non-economists. It’s just ignored. Economically, people only care about unemployment and inflation. The rest is sophistry – all macro as far as I, a non-economist, am concerned, is machinery to get at these two questions. I think it gets at what is my main problem with macro: It’s basically an equilibrium science, and Le Châtelier’s Principle being what it is, a position and it’s exact reverse can be equally well argued by going one step further or less far in a chain of causation. But that doesn’t mean both positions are equally true! Sure, depending on phrasing some event can appear as beneficial or detrimental to recovery, but in actuality it is on net only one of those!

    Also, are econ blogs always this vague with their prescriptions? Just come right out and say what your claim is. Paul Dirac is often quoted: “In science one tries to tell people, in such a way as to be understood by everyone, something that no one ever knew before. But in the case of poetry, it’s the exact opposite” – well, this is not true in any poetry that is remotely good in my opinion. But it sure seems to be true in a lot of writing on economics.

  2. Zuuko says:

    No, to your first question. I’m not implying that more savings would have been better or anything. The responsibility of the financial industry isn’t to necessarily to point out that higher or lower savings rate would be ideal. Predicting the future and how to alter it isn’t and shouldn’t be the domain of financial experts (as much as some claim otherwise… I’m thinking particularly of Nasim Taleb and his godforsaken black swans). However, understanding what it means by the word savings, not using it flippantly, education the general public are parts of where the financial industry (bankers + economists) failed and can be held responsible for.

    As to your second query about focusing on unemployment and inflation only, I’m surprised. I literally raised an eyebrow and, perhaps, this is a case in point of my whole post. They are but two metrics and have been used flippantly by laypeople, which is understandable because they are lay people. However, the financial industry in incredibly guilty of the same thing. That was the point of WCI’s post, in my opinion.

    Take the word savings. What is reported in the news and headlines? Well, savings have been low. If only savings were higher, people could have dipped into it. Why can’t America save like China saves? Why aren’t Canadians saving more? The point WCI is making that altering perceptions about how savings is viewed radically alters people’s perceptions, such that these news and headlines would be different. Given how politicians and policymakers respond to headlines, my point is that it is incumbent upon the industry to dig deeper. But economists are like generals: they fight the last battle.

  3. Zuuko says:

    Economists have a tendency to propose theories that explained what happened last time around and not necessarily for the future. They certainly don’t attempt to dig deep enough for my liking into the forces that affect the economy. They focus instead on the superficialities that lay people also concentrate on, focus on past history, draw patterns from the data, proclaim it a trend and the gospel truth and bob’s your uncle.

    As I read the above paragraph, it may seem as if I’m being hard and ascribing the faults of a few to many. But, and this is my opinion, prior to the decade of the double-0s, that was what was happening. In the debates and discussions being held now, economics and banking is undergoing an introspective period. WCI’s post is but one small contribution to that.

    What drives me crazy is that despite this open acknowledgment that the language and structure of the debate (forget the content) is clearly lacking has occurred, but is still in a work-in-progress state and decisions are being made based ignorance. There’s nothing much I can do about that.

    Anyway, just remember that if there is a point to be gleaned from this… verbal diarrhea if any, its that the current accepted thinking in terms of policy suggestions, economic news and even the discussion itself of the economy (i) was in the past based on faulty and lacking nomenclature used flippantly by the people who should know better and (ii) we’re just now trying to figure out how to approach the monkey brandishing the gun straight at our eyes.

  4. Zuuko says:

    FYI, regarding your request to know what the answer is, the last economist to propose a comprehensive theory on economy was Keynes and before him Smith. I would highly urge you to read Adam Smith’s book. I have them. The answers are in that book. Every other contribution to the field of economics since Keynes has been based largely on statistics and quantitative modelling.

    Let me draw a straight line for you that outlines what led us to this sorry pass. Statistics was invented by mathematicians. It was applied by economists, which as group comprise of people too stupid to get in the Department of Math. They in turn handed it over to bankers, who are made up of people that were fully aware that they would flunk out of college if they pursued a degree that actually involved learning. These bankers collectively pretended that events with a probability 3 standard deviations away from normal were both (i) based on sound theory of what normal was because an model can perfectly capture reality in excel and (ii) three standard deviations was so far from normal that it was “impossible.” Finding that economists generally disagreed with them based on a clear understanding of basic statistical concepts, bankers hired physicists/mathematicians to run the models, who in turn did not understand the economic impacts of their mathematical monsters.

    That is how a non-recourse, mortgage-backed collateralized debt obligation was born. All the way from conception to full term. Your welcome.

  5. zolltan says:

    To me it seems there’s a big difference between economics and finance here. Economists may be at fault for poor communication. Then again, I don’t know that the discussions about economics of the crash are necessarily poorly understood or vaguely stated.

    People in finance, though, are not economists, and in fact they have no responsibility nor incentive to communicate or enrich understanding. In fact, they benefit directly if they have some sort of knowledge advantage over others. So blaming them for unclarity is not it. Basically, the fault of financiers as I see it, and you describe in the last comment, and the old people post, is a lack of a handle on understanding risk. The reason that people are so angry at the finance sector is that the price of this nonunderstanding has been felt way beyond the financial sector, and the financial sector has basically recovered while others have not. So perhaps they understood risk just fine and non-financiers have just been arbitraged. So, as finance people give advice on the economy, we have basically every reason to distrust them: either they do not understand what they are talking about or, they do but are insincere. So why listen to them?

    Of course, if you frame this question that way, it becomes who DO you listen to.

    • Zuuko says:

      Yes to this comment mostly. I would clarify that the financial sector has not basically recovered. Are people in the industry making the same money per head as they were before the crises? Yes. That doesn’t mean the industry has come back. Banks used a substantial portion of bailout funds to pay bonuses. Today, the activity that generated all profits in 2005-2008 has not come back: the collateralized securities market (the infamous alphabet soups of CDOs, MBS, etc.) is a fraction of itself, banks continue to undercapitalized especially when you look at European banks substantial exposure to the PIIGS countries, the jobs have not come back yet (I believe NY is still down several 100k in financial jobs, and on and on. No, the sector has not recovered. The people left are just being paid as if they are.

      Now, before we tar and feather everyone, important to recognize that some people, organizations, banks are better than others. most of my commentary should exclude Canadian banks. Its American and UK banks that are culprits. But which banks are doing well right now? Those in my view that are closer in structure to Canadian banks – stolid, boring banks who kept all the loans on their balance sheet and so had a vested interest in making sure that their clients paid them back and had the means to do so.

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