Level, Slope and Curve Factor Model - What's this all about?

John Cochrane recently blogged about my paper.  My co-blogger asked me to explain it a little more, and I realized that a lot is lost if you aren't deep into the finance jargon.  Additionally, what's the deeper significance of the whole endeavor.  Here is an attempt to explain my goal and interpretation in a broader context.

First, let me define a "factor." A factor is just meant to describe common movements across stocks. All technology stocks go up together when there is some good news about the tech industry. All energy stocks go down together on some bad energy news (maybe lower world energy demand). The goal is to stop describing a stock as "Ford" and start describing it as a combination of factors.

The factors we really care about aren't things like industries. We want to understand the "priced" risk factors. These are the factors that represent risk to investors. I can diversify my exposure to ups and downs in tech or industry or automotives by just buying lots stocks. So we don't expect any higher returns to holding tech stocks.

Additionally, it turns out there are lots of things that predict stock returns.  For instance, certain characteristics of companies: small companies have higher returns than large companies, "cheap" companies have higher returns than expensive companies. Each of these are associated with factors. Small stocks go up and down together and to some degree move opposite large stocks. Cheap stocks go up and down and to some degree move opposite expensive stocks.

The literature now is postulating more and more possible risk factors.  In contrast,  I am arguing a lot of those factors are manifestations of three main risk factors level, slope and curve. Here's what I do. I use all of these characteristics and I sort stocks into "high return" stocks and "low return" stocks. I sort into 25 portfolios. The 25th portfolio we expect to have really high returns. The 1st we expect to have really low returns. The factors describe how those portfolios move relative to each other.

Level describes that stocks go up and down together. This has been known for 50 years or more. On good economic news all stocks go up, on bad economic news all stocks go down. The most common model of risk, the CAPM, basically describes all stocks risk as how much they go up and down with the overall market.

The "slope factor" describes that high return stocks and low return stocks often move opposite of one another. (I think) It means that whatever risk high return stocks are exposed to changes over time. Sometimes investors need to be compensated a lot to hold risky high return stocks (with high expected returns), sometimes not so much.

The "curve factor" describes that sometimes high return stocks and low return stocks go up or down together, while medium return stocks don't even move. The curve factor is the hardest to interpret. It may be related to the volatility of the slope factor above, but that's kind of speculative.

So now I can describe every stock as some manifestation of level, slope and curve. Yesterday, I needed theories to describe hundreds of priced factors. Now I only need theories to describe THREE!!! That's pretty good. And since we've been explaining level for years, we really just have two. So, I don't know why high return stocks and low return stocks move opposite each other, maybe some risk factor, as in these companies will do badly in bad times, maybe these stocks are susceptible to fits of irrational exuberance. But if I can explain level, slope and curve, I can explain why some stocks have higher returns than others.

Executive Action on Immigration

By Robert H.

Ezra Klein has an excellent and fair take on Obama's immigration reform.  I disagree with his conclusions, though.

Congress has told the President to export over 10 million people, but they've given him the resources to export less than 500,000 people a year.  So that's a problem.  Fortunately, they've also given him broad discretion to choose which sort of cases to go after.  Given all that, you have two choices for how to manage your resources if you are the President: create clear rules for whom you will and won't deport, announce those rules, and follow them.  Alternately, just wing whom you deport in a jumble of local discretion, happenstance, and random chance.

So which of these supports rule of law?  Which supports good governance?  To me it is obviously the former. Laws should be as transparent, clear, and predictable as possible.  If our officials are choosing to prosecute some deportation cases and not others -- and they are by necessity -- we should want to know what criteria they are using.  This move gets us closer to that.

So I am not worried that this clearly legal action will somehow undermine the rule of law in America.  It will do the opposite.  But isn't it violating political norms?  Maybe.  But if there is a norm in American politics that the president should deport people in a haphazard, chaotic, and unpredictable manner rather than using his legal authority to prioritize deportations, that norm is dumb.  Thank God a president is ignoring it.

Iron Highlander Constitution

By Robert H.


Just in case Scotland goes independent, I've been flipping through its interim constitution.  I have four thoughts:


1. It's not modeled on the German constitution.  This is basically a mistake for new countries.  It's just not going to be possible, I don't think, to turn Britain's historically and culturally contingent, unwritten constitution into a concrete written document.  They should stick to the modern constitution that people have had the most success copying (ie, Germany).


2. In terms of human rights, it adopts the rights in the European Convention on Human Rights.  This is a good idea, and covers pretty much all the rights Americans think of as rights (to some degree or another) plus some economic rights and no death penalty.  BUT


3. I have no idea what Scotland's relationship with the European Court of Human Rights is supposed to be.  The constitution incorporates EU law, but the Court is rooted in the Council of Europe, not the European Union.  The constitution doesn't mention the court, and doesn't incorporate the provisions of the European Convention on Human Rights that established the court.


Very odd.  Different European countries give the court different effects: in Russia, the court's rulings are binding law.  In Switzerland, they are more very strong suggestions.  In Scotland, they are going to be I have no idea what, if the court even has jurisdiction.


4. No eternity clause (unless I missed it).  This means that, like America, ultimately the will of the people is truly sovereign, and a supermajority can amend the constitution even to remove fundamental human rights.


Caveat -- this is based on a quick skimming and a weak knowledge of European law. 

Japan Breakeven Data Update

Just for my reference, I pulled off some of the Japanese Breakeven rate info off Bloomberg.  As always, this data may have some problems.  These contracts are not very liquidly traded and have risk premiums embedded in them.

1 year, 4.38%:

5 year, 2.33%:

10 year, 1.21%:

Jason Smith sends me to this Scott Sumner quote in a comment on the previous post:

4.  Japan will be hit by an adverse supply shock next year (higher sales tax rates) which will boost inflation–making it look like they will hit their 2% target.  Don’t be fooled.  When the effects wear off Japanese inflation will slip back below 2%. Because of Japan’s fiscal situation, it has no good options.  The sales tax increase will hurt the economy, but is needed.  I used to think they should delay it, but now I think they should bite the bullet and do it.

Maybe.  Certainly the VAT is affecting the CPI and through it the break even rates.  Will inflation backslide below 2%?

The 2 year break even is 3.317%.  That implies a second year rate of 2.26%.  Using the five year, we get a final four year rates of 1.82%.  Using the ten year and five years together, we can see that the market predicts the last five years to have inflation very close to 0, about .5%.

So the market is looking forward to several years of rising prices.  That's quite a different prediction that many gave when Abeonomics started.  Will the BOJ hit it's of 2% over five years?  It looks like they are expected to be around that range.  Certainly with some help from the VAT, but even in the last four years prices are expected to rise.

On a long horizon, will they revert back to zero?  Maybe.  Maybe as soon as everyone comes around, everything will start heading backwards.  I would caution that the longer we go out in time, the worse the expectations theory probably is.  Risk premiums may be more important to model on longer horizons.  Ignoring them for several years compounds the error.  

Japan Update: We've Waited, Let's See

A few months ago, Stephen Williamson posted this unfortunate picture.

It turned out that the large drop in inflation that he thought was evidence in favor of his views on monetary policy was actually the result of an accidental misuse of Japan data (as I pointed out in this post and in the comments on his blog).  He corrected the mistake and adopted a wait and see attitude, "Thus, the Bank of Japan seems to have had some difficulty in producing inflation - but this time may be different. Given that the Bank seems intent on holding the short-term nominal interest rate at zero (essentially), I don't see it, but I'm curious to see how the data unfolds."

Well, we've waited a bit and can see a little more.  Let's update the graph:

Wow!  It's almost directly opposite of the original.  Japan yoy inflation is up close to 4%.  What liquidity trap?

It's interesting to note that way back in April of 2013, we noticed that markets were predicting a rapid rise in the second year of Abeonomics.  The market predicted .35% for year one (until April 2014) and then 2.3% the following year.  Well, the market estimate was obviously low.  Inflation actually averaged about 0.89%, but we may be seeing that the dynamics of back loaded inflation is substantially correct.  Now will the BOJ be able to hit their target?  What is their target?

In response to a comment, here are the index values: (Data)

Learn This Simple Trick To Know How To Legally Kill Dudes

By Robert H.

This is a weird contradiction I have noticed:

1. Among military and International Humanitarian Law lawyers, there is pretty widespread agreement about the standard for how to judge whether civilian casualties are excessive.  Where there are disagreements, it is over application.  But,

2. Among laymen, there not only isn't agreement about the standard by which to judge civilian casualties, almost no one adopts the standard universally agreed to by lawyers and policy makers.

So, elaboration: Under international law and most national laws, if you want to attack a military target but think you are going to hurt civilians or damage their property in the process, the main test is the Principle of Proportionality.  If the damage that will likely be done to civilians is clearly not proportional to the military advantage you will gain from the attack, it's illegal.  There is a lot to fight over within that definition -- how do we define military advantage, what's proportional, do we judge attacks on a granular or broad level (ie, do we ask "was the air offensive proportional" or "was each air strike proportional") -- but everyone from the IDF lawyers approving gaza air strikes to peacenick UN officials denouncing those same air strikes agree on the basic framework.

No laymen seem to, though.   Instead laymen seem to

1. Obsess over casualties -- especially deaths -- at the expense of property damage or the destruction of materiel.  A pro-war type will treat an attack that blows up a city block as presumptively reasonable and acceptable, provided the block was evacuated ahead of time, despite the fact that damage to civilian property is explicitly weighed in the proportionality analysis.  Just so, a pacifist type will often look at the civilian/combatant casualty ratio rather than taking a more holistic view of "military advantage."  This is in error: an air strike that kills a civilian but blows up a cache of long-range rockets and launchers may yield a higher military advantage than a strike that kills a civilian and a low-ranking Hamas militant while doing no other damage, even though the second strike has a much more favorable civilian/combatant casualty ratio.

2. Adopt extreme positions.  I can't count the number of times I've heard arguments that amount to "any attack that kills civilians is wrong" or "when your enemy hides among civilians, being touchy about civilian casualties just rewards and encourages that behavior, so bomb 'em all."

3. Effectively ignore the other side of the balancing test.  Most of these errors focus on the civilian side of the equation at the expense of the military side: Anti-war types wax eloquent for op-ed after op-ed about all the damage being done to civilians without even trying to articulate what military advantage is being gained.  Alternatively, pro-war types will talk about all the precautions being taken to avoid civilian casualties without going on to argue that civilian casualties are not only low, they are proportional to the military advantage gained.  All that said, you occasionally see people ignore the civilian side in favor of the military advantage side -- "we have to do this to enhance our security/protect ourselves/defeat Hamas" without adding "also it will likely result in bringing us close enough to effecting that goal to be worthwhile when weighed against the harm to civilians."

Anyways, maybe all that is boring, but it strikes me as genuinely weird.  If I ask some random laymen what genocide is or whether it's right to use chemical weapons, I bet they could come close to articulating the international consensus.  If I ask laymen whether it's right to use landmines, they would probably disagree with each other because there isn't an international consensus.  But in the weird world of collateral damage you've got all kinds of international consensus but no lay-understanding.  Weird!

Is The New York Ban On Tiger Selfies Constitutional?

By Robert H.

No. New York’s ban on Tiger Selfies is almost certainly not constitutional.

What is a Tiger Selfie?

It is a picture of yourself posing next to a live, unrestrained (though probably stoned) tiger.  Men in New York use them to attract women because we are a squalid culture  that  hoards and sleeps and feeds and knows not God.

Why is it unconstitutional?

Because it is a content based ban on speech.  The government actually has a lot of freedom to restrict when and where and even how you say things.  “No protests in the park without a permit,” for example.  It has way, way less authority to ban speech based on the *content* of the speech. "No protests against gay rights in the park without a permit." 

In this case, pictures are a kind of speech, “men posing with tigers” is the content of that speech, and banning it puts the government in hot water.

So New York Can’t Do This?

Maybe they can!  If you narrowly tailor your content-based restriction to promote a compelling government interest, the Courts will uphold a content based ban on speech.

Wait, “We Don’t Want Tigers Tortured and Idiots Mauled Over Dating Profiles” Isn’t a Compelling Government Interest?

It Probs is!  But the law may not be sufficiently narrowly tailored.  Here's why:

The Supreme Court very recently struck down a law banning depictions of animal cruelty.  Essentially, the law didn't let you have a photo or video of an animal being hurt or killed if it would be illegal for you to hurt or kill the animal that way in the same jurisdiction the video existed in.  So, for example, a video of someone crushing a marmoset was illegal in a city where it was illegal to crush marmosets.  The Court’s reasoning in striking the law down was that it was overbroad -- it effectively constrained lots of legitimate activity.  So, for example, imagine you go Marmoset hunting in a state where that is legal, film it, and take the video to a city where it is *illegal* to hunt marmosets.  Even though the activity being filmed was totally legal when and where you did it, even though it isn't the more morally objectionable depictions of animal cruelty the law was targeting, you are now guilty under the statute.

This looks analogous to that.  If Siegfried wants to take a picture with his pet tiger in a state where it is legal to have pet tigers, that activity seems perfectly legitimate to me, even if he later takes the picture to New York.  And while it's true that there probably isn't a whole heck of a lot of legitimate "men by tiger" depictions out there, the ratio of "legitimate" to "bad" "men with tiger pictures" seems A. hard to prove, and B. likely to mean you are taking out roughly as much legitimate as illegitimate speech. 

So why might it still be constitutional?

Because the law is complicated and stuff.  More specifically, there may be relevant laws I have missed and courts may find the analogy to the animal cruelty case weaker than I do and I haven't even read the law so what do I know.  This isn't a brief to the Supreme Court, here I'm just winging it. 

Incentives Matter

By Robert H.

I have read about 1000 articles and blog posts about how lopsided POW exchanges will incentivize and aid terrorists (see here), but exactly zero about how they will incentivize soldiers and marines.  Aren't the troops homines economici too!?

I can think of two big possible effects:

1. Troops will realize that the military will expend excessive rescources recovering them if captured, and become sloppier about avoiding capture.  This will be bad.

2. Troops will realize the military will expend excessive rescources recovering them if captured, and so fight longer and more bravely in situations where they risk capture.  This will be good.

Obviously these are two sides of the same coin.

I think there are similar trade offs if you look at the "no one left behind" philosophy more broadly:

1. Troops and civilians will realize their lives could be thrown away to save one possibly undeserving person, or even just to recover their body.  This will deject them.

2. Troops and civilians will realize that their fellows will throw their lives away in great numbers for them, even if it's just to recover their body.  This will fortify them against their worst fears and build unit cohesion.

Obviously, I'm not in a position to know whether the net effect of these policies on troop morale is positive, but it's pretty clear that military leadership has thought it was positive since at least 1942*, and purposefully inculcated a "we will not abandon you, even at seemingly irrational cost" propaganda line in order to encourage harder fighting.  And civilians seem to know about and accept this philosophy, if saving private Ryan is any judge.

So why does this "it will incentivize the troops" stuff fall off the radar when people argue about whether the cost for POW exchanges is excessive?  Isn't "we will pay an excessive cost to bring you back if you get captured" something we spend a lot of time and effort trying to credibly promise?

****

*At the outbreak of the war, the ethos seemed to be "we will never have to do anything to rescue you from a pow camp because you will never get captured because you will fight to the death, damn it."  See MacArthur's disappointment in the surrender of the troops at Bataan, or how most of the troops on Wake Island assumed they would fight to the death.    

Why Is Only Shakespeare Allowed To Create New Words?

by Charlie Clarke

Shakespeare created many new English words, including really brilliant words like amazement, laughable, lonely, majestic, suspicious and bloody.  The great English writer saw the words we didn't even know we needed and wasn't afraid to experiment.  I'm having trouble finding a list of words that Shakespeare coined that are now defunct, partly because the word defunct was itself invented by Shakespeare.  For instance, he tried unhair twice, "Like balls before me; i'll unhair thy head."  It doesn't seem to have caught on (though Scrabble will accept it).

So when did lovers of English become haters of new words?  Here is Paul Krugman:

1. How can we incentivize students to stop using “impact” as a verb?

2. How can we impact their writing in a way that stops them from using the word “incentivize”?

3. Can we make it a principal principle of writing that “principle” and “principal” mean different things, and you have to know which is which?

I have no problem with Krugman's distaste for "impact" as it doesn't seem any more useful than affect, and point three is just a usage error.  But why do so many old people hate the word incentivize?  Incentivize is a useful word.  The antineologists (not a word, should it be?) seem to prefer encourage or motivate, but they are hardly interchangeable.  Incentivize means "to motivate with incentives" or "to motivate with concrete financial rewards."  A coach motivates his players, but the GM incentivizes them.  Why insist the GM encourage them with incentives?  If the new CEO should do a better job incentivizing employees, no one would confuse that with more heartfelt speeches.

Why not insist that MacBeth's hands be covered with blood, rather than bloody.  They could be bloodstained, except that too was invented by Shakespeare.  Why do antineologists only seem to care about the creation of modern words, and when did they decide the words we had were enough?

I don't suggest we accept every new word or even every word that becomes popular, but I would like less discussion of words we dislike and more discussion of why we dislike them.  Innovation in language can be useful and new words that become popular may be useful, even beautiful. 

Liquidity Level or Liquidity Risk

Liquidity has been a pretty hot topic of finance research in the last 10 years and a lot of good work has been done.  Unfortunately, sifting through it can be a little confusing as liquidity can mean a lot of different things in different contexts.

Let's call the liquidity level of a stock, how hard it is to buy and sell.  Can you go to the market and sell as much as you want without moving the price?  Is the price pretty similar whether you want to buy or sell?  Liquidity tends to be measured by either how much trades are moving the price or how large the bid ask spread is.

Let's contrast that with liquidity risk.  We can think of total market liquidity as the average of all the liquidity levels of each individual stocks.  Sometimes the market as a whole is very liquid and sometimes not so much.  The stock market crash of 1987 and the latest financial crisis are examples of large liquidity events.  The average market liquidity dramatically fell.  Liquidity risk is usually measured by a stock returns covariance with total market liquidity.  That is run a regression of market liquidity and stock return.  That estimate (beta) is the stock's liquidity risk.

So, if you are a portfolio manager, which do you care about.  Well, the liquidity level of a portfolio may matter if your strategy requires a lot of turnover and trading, a high liquidity level will make your strategy more expensive.  But if you are worried about liquidity events, events where you may have to sell when the market is tanking, then you really care about liquidity risk.

A recent paper by Lou and Sadka shows that it's liquidity risk that mattered in the financial crisis of 2009:

The liquid stocks that have low liquidity risk do as well as the illiquid stocks with low liquidity risk, and the high liquidity risk stocks do worse than the low liquidity risk stocks whether the stocks tend to be liquid or not.

High liquidity risk stocks become more illiquid when the market becomes more illiquid.  Even if usually they have a lot of liquidity, that liquidity dries up in bad times.

Is Limited Government Possible?

By Robert H.

I'm not sure many non-lawyers give much thought to the above question, but think about it: the American government is, formally and officially, one of unlimited powers.  If you can get a constitutional amendment passed, you can do anything.* Them's the rules.

For other governments, this is not true.  The German Basic Law has an eternity clause which says that human dignity is inviolable, human rights are great, and this clause can never ever be amended or changed.  Them's their rules.

Now this is a big formal difference, but is it a big practical difference?  And even if it is, does this track what we mean by "limited government?"  For example, when Americans say they want a more limited government, do they mean they want an eternity clause?  Or do they mean they want more rules that can only be changed with supermajority votes?  And if they mean the latter, why don't they just say, "I want more supermajoritian consensus in government?" and argue for that?  And how do they intend to *get* their limits?  Amending the constitution?  That, again, means they are just advocating for supermajoritarian governance.

So, in contrast to libertarian laymen, libertarian lawyers tend to focus less on what formal "limits" should be placed on government (balanced budget amendment!) and more on what processes, procedures, checks, and government/constitutional structures could lead to smaller government (for example, Ilya Somnin's focus on foot voting).  Questions like this are why.  When you dig down into it, saying "government should be limited" is most meaningful when you are really saying "I want these practical, process checks on government."  Otherwise you're just saying "here's a policy I think is great and everyone should be forced to adopt.  Don't ask me how we'll force the issue."

*Ok, you can't deny a state its equal suffrage in the senate or end slavery before 1808, but come on.

Piketty Thoughts

By Robert H.

The book is Capital in the 21st Century, a french guy wrote it, and you can find dozens of summaries and reviews from both sides of the political spectrum if you don't know what I'm talking about.  These are my general thoughts on it.

***

Let's disaggregate possible problems with economic inequality.  Note that I think some of these are dumb and not real or likely problems, I'm just trying to be complete:

1. Negative political effects -- the elite will use their increased share of the pie to dominate the government and use it for rent seeking (er, more so).
2. Less meritocratic society -- Elites will create social and economic barriers to make it harder for people born out of the upper class to get ahead.  This will lead to wasted human capital.
3. Psychic effects -- inequality makes the bottom 99 percent jealous and unhappy.
4. Dis-utilitarian distribution -- Because of diminishing marginal utility, a more equal distribution should be preferred to a less equal one, ceteris paribus.
5. Poverty -- the real problems with historical inequality is the poverty at the bottom. It is sad when lots of people are poor.
6. Art -- The best art comes in periods of high economic mobility into and out of the upper class, during which times the Venn diagram of those who have been highly educated, have suffered poverty or repression, and who have the leisure to write has the most overlap.
7. Inherent badness -- Inequality is just bad because it is.

From what I've read, Piketty's supporters seem to want to focus mostly on four and one (inequality will have negative political effects, whereas a more equal distribution will increase total utility). His detractors are most interested in five (the living standards of the poor is what matters and taxing capital will slow growth and lower those living standards).  I think the anti-Piketty folks are mostly right.  Wages and living standards for the bottom quintiles are likely to rapidly grow if returns on capital remain high over the next century, even if inequality also increases.  This is a success story.  Piketty gets it wrong to focus on the living standards of the poor relative to the rich rather than focusing primarily on the living standards of the poor, full stop.  We shouldn't target inequality or capital accumulation or high rates of growth on capital, we should just work on making the lives of the less well off better and should do so with the most efficient taxes available.

That said, I think the problems associated with point one (negative political effects) are real, and I'm disappointed so few of Pikety's critics have latched onto them.  Relatively simple democratic reforms could make good (er, relatively good) governance much more likely in a period of high inequality -- mandatory voting, campaign finance reform, proportional representation, cash rewards for voters who pass civics tests, etc etc.  The idea is to make sure that more cash doesn't equal more ability to rent seek for rich people, and there are all kinds of ways to do that short of "have a global wealth tax."  But Pikety's detractors, while acknowledging that higher inequality is possible or likely in the future, don't seem to want to embrace any of the relatively trivial reforms that could help democracy weather inequality better.  I wish they would!

Standard Disclaimer: Obviously the books is brilliant and worth reading and Piketty's historical research is amazing.

Data and Japan

Steve Williamson has a new post on monetary policy.  He argues that the data supports his view that quantitative easing lowers the rate of price inflation and low interest rates cause low inflation.  Unfortunately, he made a pretty significant error in constructing the data, and after fixing the error I think there is reasonable evidence that he's wrong.  [As a Ph.D. student I live in constant fear of using a data set incorrectly, so it's nice to see that even high ranked tenured professors can make mistakes.]

Here is the graph he shows:

The graph is pretty striking.  So much so that I started googling for stories about Japanese deflation.  The graph shows year over year measures, so the price level has to drop about .9% in a month to get from 1.5% in February to .4% in.  That would be an annualized inflation rate of -11%.

It turns out that the March data doesn't exist yet.  From the comments, it sounds like Stephen conflated two series, the Ku-area of Tokyo CPI and the Japan area CPI.  Specifically, the way he did it created a large error, because he was using the price level of Japan CPI and inserted the price level of the preliminary March Ku-area CPI into it.  These two series are completely different and use different bases.  On his chart it looks like the price level (2010 base) fell from 100.7 to 99.8.  In reality, the Ku-area price level rose from 99.3 to 99.8.  The preliminary results show more inflation, not less.  Below are the two graphs:

We should know by April 30th what happened to Japan CPI in March.  If the Japan numbers are up as the preliminary Tokyo numbers are, then Japan CPI will be getting pretty close to the 2% target.

Stephen Williamson's model predicts in the long run that low rates and Quantitative Easing should cause low inflation.  That isn't evident here and it isn't evident in the breakeven inflation rates for Japan.

This graph shows a quick and dirty market measure of inflation over the next five years.  It shows 2.3% and has been rising.

So we have Sweden that raised rates and then deflation followed and Japan that has not raised rates and not had QE and so far has seen measured inflation and expected inflation rise.  My prediction is that if Japan inflation falls a lot, it will be because Japan raised rates or stopped QE to early and caused expected inflation to fall dramatically long before measured inflation falls.  

Constitutions are Laws, Not Alternatives to Laws

By Robert H.

Here is a mistake lots of libertarians make.  "Democracy sucks; it must be bound by strict, constitutional limits on government; so let's have more constitutional limits on government."

The problem is that Constitutions are laws.  That means that if you have a fundamental problem with the way laws are made, "rely more on constitutions" can't be the answer.  I mean, how do you select the constitutional constraints and principles of a limited government?  The current answer in America is "with a supermajority," but super majoritarian voting is even more susceptible to most criticisms of majoritarian voting than majoritarian voting itself.  Take the two criticisms kling cites in my link: 1. supermajorities don't solve the problem of voter ignorance.  Now, instead of a majority of informed people, we have to scare up a SUPERMAJORITY to create good policy. 2. Supermajorities don't solve the problem of forcing voters to join a coalition to effect change.  Now they have to join an even bigger coalition!  

Things aren't better on the enforcement side.  How do you enforce constitutional principles of limited government?  The current answer is "with elected politicians or those they appoint."  But those are the same guys who make laws!  If they can't be trusted to do the latter, why the former?

It's laws all the way down, and the fact that one set of constitutional law makers made one constitution in 1789 which libertarians like one interpretation of is not a reason to think "constitutionalism" will solve libertarian problems with democracy.  So, just for a practical example, the most popular model constitution for new nations to adopt has been, since the wall fell, the German basic law.  Germany also attracts lots of migrants, and would attract more if immigration restrictions were lifted.  But the German constitution would make a libertarian's heart seize up: it's littered with second generation rights (ie, mushy socialist stuff like rights to a clean environment or to healthcare) and isn't particularly federalist.  If both super majoritarianism and migration have created and fortified a popular constitutional model libertarians hate, what's the alternative libertarian method for creating and preserving "good" constitutions?  Military coups?

So here's the math: to make a constitutional regime libertarians like, they would have to convince a supermajority.  To just pass good laws they approve of, they would have to convince a majority.  Instead of writing off democracy and embracing the first model, libertarians who go the second route will have a far easier time.  Scoreboard time: In the last 50 years American democracy killed segregation, slashed tariffs, ended the draft, embraced LGBT rights, lowered top marginal tax rates, had an amnesty for migrants, embraced Friedman's monetary ideas, etc. etc.  Libertarian ideas can and have won at the polls. In that same amount of time, more or less no libertarian constitutional amendments were passed*.   Learn your lesson, people.

*Maybe the 24th?  

Mind the fiscal gap?

By Robert H.

Is fiscal gap accounting something I shouldn't think is stupid?

Basically the idea behind fiscal gap accounting is that you get the best estimate of our fiscal situation not by looking at US debt held by the public and maybe projecting it out over x years, but rather by adding up all our future obligations and subtracting all our future income, holding policy constant.

I've always thought it's dumb for three reasons:

1. It operates on an infinite timeline.  Assuming we are going to, to pick random examples, keep paying out SSI obligations and keep taking in gas taxes at current rates forever strikes me as an ahistorical and useless way of thinking.

That said, this may be stupid on my part.  The social discount rate means that a dollar spent on SSI 700 years from now doesn't count very much in assessing the current fiscal gap.  But that means fiscal gapers have to estimate the social discount rate for America over a decades long timeframe, and that also strikes me as crazy and impossible.

2. Related to 1, the fiscal gap gyrates from year to year in ways that don't seem helpful for policy makers.  I can't find a chart of the fiscal gap that goes back to the war (a bad sign in and of itself), but here's a chart showing the projected fiscal gap rise by 300 percent over the last ten years.  Should I be 4 times more concerned about the deficit than in 2003?  Really?  How many fiscal gapers were only 25 percent as concerned about the deficit ten years ago?

3. The market for US debt appears to be totally unrelated to the fiscal gap.  Again, the fiscal gap says our fiscal situation is four times worse off than 2003, but treasuries have significantly lower yields than ten years ago.  Fiscal gapers  seem to fail the market test.

I could use more info, though.  Has anyone correlated fiscal gaps and debt yields over time across countries?

***

So all that said, accounting is related to math and I am about as numerate as a puffin.  Is the fiscal gap more useful than I give it credit for?

To be clear, my current strategy is to figure that the markets especially and democracy less so are better than me at figuring out how worried to be about the debt, and using them to guide my thinking.  People who buy treasuries and elected politicians don't seem very worried.  As a check, I note that fiscal crises have been extremely rare over a century plus of modern welfare states.  So I'm pretty confident we will eventually get around to dealing with the deficit before it is a big deal.

Then the fiscal gapers start screaming no, every second of delay costs us 400 billion dollars, or whatever, and my equanimity gets perturbed.  Should I listen to them?

Learning Investments

By Charlie Clarke

As student studying abroad asks me how to learn the course I'm teaching next fall "Investments" independently.  Someone told him it was "near impossible."  I know that's not true, because I did it!  Here's my advice:  

I don't agree that Investments is a difficult subject to learn independently.  You must remember that wall street is filled with Mathematicians, Statisticians, Physicists and Engineers that have no formal Finance training.  That said, it requires some hard work, and more than that, a passion for the material, which makes it not feel like work at all.  Additionally, it's never been easier in the history of the world to learn something on your own as there is a tremendous amount of material available from top institutions.  

The textbook we use is Bodie, Kane and Marcus.  Here is an MIT course syllabus with lecture notes.

Coursera offers free online classes with videos, practice problems as well as certificates of completion if you end up taking it for credit.  I would probably start there.  None of the courses really replicate 3302, as they are probably more quantitative, but if you want to do investments as a career, that is not a bad thing.

Bob Shiller's Financial Markets course at Yale is online and has a lot of overlap with the Investments course.  This course is not that quantitative and pretty interested.

Here are some more quantitative courses.  I don't know your level of commitment and math background, but there is a lot of info about professional investing in these courses:

Introduction to Computational Finance and Financial Econometrics

Computational Investing, Part I 

Financial Engineering and Risk Management (this is the most mathematical/advanced)

For outside reading, I'd start with "Random Walk Down Wall Street" by Burton Malkiel.  That's the book that got me interested in Investments.  Check out what's available and follow your interests.  You don't have to follow any particular order.  You can learn a lot.

Which Hunt?

By Robert H.

Just a friendly reminder that there were not many actual witches in Salem.  Just so, in the most famous post war witch hunt a lot of the people caught up by McCarthyism were never or had long since stopped being movement communists, and very few were spies (which is impressively bad work, since the state department actually was riddled with soviet spies).

So people, stop referring to the targeting of someone for beliefs they actually hold and things they actually do as a witch hunt!  A witch hunt is when we go after people so zealously and with so few safeguards for the innocent that we burn people at the stake who aren't even witches.  It's a useful concept, word, and premise for a Star Trek: The Next Generation episode (see The Drumhead).  Don't dilute it.

Not that it's justified to burn actual witches at the stake.  But the term for that is a human rights violation.

Delong and Krugman on Cochrane

By Charlie Clarke

Brad Delong and Paul Krugman are not happy with John Cochrane.  Brad Delong says John Cochrane is wrong, and Paul Krugman says he thought of it first.

Here is the original from 2009 (except everything in bold was cut):

If we just had a credit crunch, we would expect to see stagflation – lower quantities sold, but upward pressure on prices. A credit crunch, like a broken refinery is a “supply shock.” Since we are seeing lower quantities sold and easing inflation, we must also be seeing a “demand shock,” and we need to understand its source.

The bottom line, then, is that people want to hold more of both money and government debt – and don’t particularly care which.  Trying to get it, we are trying to buy less of both consumption and investment goods. Again, this is a deflationary pressure. If the government does nothing, deflationary pressure will remain until goods are so cheap that we have the desired real value of nominal government debt.  Until deflation happens, output falls.

What do to? In this analysis, monetary policy is impotent, but not for the usual reason that interest rates are nearly zero. The Fed can arbitrarily exchange Treasury debt for money, and increase the money supply as much as we like. But nobody cares if it does so, since the “flight to liquidity” is equally towards all forms of Government debt.  If we want more fruit and less cheese, putting more apples and less oranges in the fruit basket won’t help.

Looking at it this way gives us a logical reason that fiscal stimulus might work. It leaves the private sector with a trillion more dollars of government debt in their pockets. But the Fed’s many facilities also issue government debt and money, which helps to satisfy the demand for government debt.  Which is the better path?

I think the bolded sections make clear that Paul Krugman has the right response.  Cochrane is in all senses agreeing with Brad and Paul's analysis.

Cochrane goes on to disagree with fiscal policy for much more banal reasons.  He worries the money would not be spent well.  He prefers "fiscal policy" by which he means that the Fed could buy up lots of almost safe debt, "I would be happiest if the Fed and Treasury satisfied the large demand for government debt and money by transparently buying or lending against high quality corporate and securitized debt, at market prices."

I'm Saying We Wouldn't Get Our Hair Mussed

By Robert H.

Are we allowed to start worrying about nuclear war without seeming weird?  Is the Cold War on again enough for that?  'Cause I was googling around a little, and America has a surprisingly good shot at succeeding totally in a first strike against Russia, which is obviously bad.

I say "surprisingly" not because I think the chances are high, but because I would have thought our chances of surviving a full scale nuclear war without the Russians hitting a single target would be zero.  More than that, I would have thought the odds of just losing three or four cities would be zero.  I would have thought the odds of only losing a third of our population were zero.  Basically I thought MAD was still a thing, and both Russia and America could destroy each other under any conceivable nuclear scenario.  The only way to win is not to play, how about a nice game of chess?

But that author wants to play up how risky a first strike would be, and yet he still leaves me with the impression that we have an outside chance of pulling it off totally.  

Worrying.  It makes me wonder how much further we would have to develop our ABM capability before we could shoot down any Russian nukes likely to survive a first strike, which makes me wonder if that possibility fuels erratic behavior on Russia's part.  The knowledge that an age of American nuclear primacy might be right around the corner would scare me shitless if I were Russian, and obviously the worse your future position the more aggressively you play your current advantages.  What's worse, the less likely you are to survive a first strike, the more likely you are to launch one, which means we are more likely to launch one, which means etc.  The balance of terror doesn't work without the balance.

On the bright side, nuclear war could solve the Fermi paradox.

Uncertain

By Robert H.

Andrew Cohen says some weird things about uncertainty:

We are, indeed, fallible. I don’t think anything follows from this with regard to toleration (see Chapter 7, section E). It is perfectly reasonable to think toleration is a value while recognizing one’s own fallibility. One may be wrong, but to say one thinks X is to say, “given all else I know, I think X and I will maintain X until shown that X is false.” As Joseph Schumpeter said “To realise the relative validity of one’s convictions and yet stand for them unflinchingly, is what distinguishes a civilized man from a barbarian.” Indeed, it seems entirely natural to be willing to stand for one’s beliefs unflinchingly, recognizing one’s judgments may nonetheless be wrong.

To maybe state the obvious, it is perfectly possible to hold a belief you think is the belief most likely to be correct without thinking it is likely to be correct. For example, say a delicious torta could be behind one of three doors, and you happen to think there is a 49 percent chance it is behind door one, a 20 percent chance door 2, and a 21 percent chance door three.  In that situation you might believe that you should open door one, but you would also think that the torta is probably not behind door one.  This is one way to hold a belief without being confident you are correct.

But we could have even more options: maybe not opening any doors is a possibility, and if you wait two days ta torta will simply be given to you.  Now we have to weigh our preferences: the chance of a torta now, or a certain torta later.  Here we may say, "I prefer to wait," and firmly believe that, but acknowledge that it's all a matter of taste.  This is another way to hold a belief without being confident you are correct: acknowledging that you are judging by subjective criteria that vary from person to person.

Lastly,  you could simply not know what other people know.  You've conducted some sort of investigation and come up with some sort of probability, but are you confident telling someone else to pick your door if they've conducted a separate investigation?  Maybe they've peaked behind door 3!  Maybe they have a better sense of smell!  This is another reason to be hold a belief but not be confident in it: it may be the best belief based on what you know, but you may not know enough.

Cohen seems to say, if I am reading him right, that knowledge that your beliefs could be wrong shouldn't encourage you to be more tolerant of other beliefs.  I'm not so sure.  Imagine 100 doors, and you think door number 2 is most likely to hold the prize at a 2 percent chance.  Is your tolerance of people advocating for door number 1 as low as if there are only 2 doors, and door number 2 has a 99 percent chance of being correct?

Of course, it's possible that there are a lot more "2 doors with an obvious answer" problems than "100 doors with a tricky answer" problems in the world.  I wouldn't bet on life being simple, though.

Japan Inflation Will It, Won't It?

Noah Smith brings Japan Inflation back into the discussion:

Anyway, so why is this important? Because for months now, you've been hearing that Abenomics - or at least the monetary policy part of Abenomics - has been a solid success. Japanese inflation, you've heard, is climbing up toward the 2% target. To many people, that is a sign that monetary easing can hit inflation targets if the central bank is really committed to doing so.

The problem is, the Japanese inflation that people are looking at is the Japanese "core" rate, not the "core-core" rate. In other words, those rosy numbers you're seeing include energy prices. And energy prices have gone up, partly because of supply restrictions that are unique to Japan (i.e. restrictions on nuclear power in the wake of Fukushima).

I think it is useful to recall that the markets didn't think Abenomics would work this year (one year ago).  Looking at Japanese inflation indexed bonds, as I did last April showed one year break-even inflation of .35%.  Thus, headline inflation came in considerably higher than expected by the markets one year ago.  That core inflation was still low is pretty consistent with market forecasts.  That is, core is more predictable than the volatile food and energy prices.

I wasn't able to get onto the Bloomberg today, but I expect to see inflation indexed bonds showing that the inflation gains of Japan are pretty persistent.  Last August, the Japanese bond market showed a 1 year break-even of 1.283% and a two year break-even of 1.826%.  I would expect the break-evens to be even higher when I check this week.  If the bond markets are still believing, then so am I.  

Good Government Fails Better

By Robert H.

Arnold Kling, channeling Megan McArdle, says that large firms need to fail gracefully:

A large, established firm needs to fail gracefully. Be able to kill the project without killing the company. You might think of Coca-Cola’s recovery from New Coke, but the real graceful failures are the ones we never even hear about. A large firm that fails ungracefully is denying that it is in trouble (Megan uses the example of Dan Rather and Mary Mapes of CBS News, who put out a story based on a forged document and just refused to back down from the story.)

But that government sucks at this:

Government cannot do any of these things well. Think of Obamacare... Graceful failure? No, it is a big, ugly failure.

Maybe I'm missing something, but it seems like Kling wants large firms to fail gracefully because it insulates the successful part of the company from the dumb new venture, allowing the company to continue.  They have to "kill the project without killing the company."  If that's the standard, our government seems to be really, really good at failing well.   After all, if it's a survival game then America has reached a ripe old age.  The number of two century old private firms is not large.  America's killed a lot of bad ideas (and millions of their proponents!) without killing "the company."

More broadly, Kling acknowledges that different firms need to fail in different ways (for example, he thinks startups need to fail quickly so everyone can move on to new ideas), but rather then figure out how government needs to fail, he insists on judging it by the standard of corporations.  He doesn't explore how government's *should* fail, he just says government isn't good at failing the way good firms do.  I think that's a mistake.  Here's how I would complete kling's list:

An individual needs to fail with a fallback position. 

A small startup firm needs to fail quickly.

A large, established firm needs to fail gracefully. 

A government needs to fail non-catastrophically.  Bad governance can ruin economies, enslave millions, and, these days, kill billions.  Catastrophic failure of a government program must be avoided at all cost.  As a good rule of thumb, any failure members of the next generation only know about if they are particularly literate or into history is a good failure (barring significant propaganda). 

There is a great deal of ruin in a nation, and governments can do much that is merely bad.  The goal is to keep the bad to a minimum.  A small program with minimal effects can drag on, failing for decades, and that will, in the big scheme of things, not have a damned thing to do with whether a government is relatively successful or relatively terrible.  Good government often wallows in mere failure, what it avoids is catastrophic failure.

P.S. There's another blog post to be had unpacking Kling's assumption that Obamacare will "fail."

Make it MORE Legal

By Robert H.

Arizona has passed a law which will allegedly makes it legal for business owners to discriminate against homosexuals in places of public accommodation, provided serving LGBT types interferes with the business owner's religious beliefs.  The media is in a tizzy about it.

I say "allegedly" because I'm pretty sure it already *is* legal, in Arizona, to deny service to someone because they are gay.  Federal anti-discrimination law doesn't treat sexual orientation as a protected class, and I'm pretty sure Arizona law doesn't either. So the world is crazy, I guess?  And the media really bad at reporting legal issues well?  And the culture wars are stupid?

Good, I'm glad all that's settled.

My Problem With Modern Hayekians

By Robert H.

This is how most Hayekians sound to me:

"1. Society is complex beyond our wildest imaginings.  Anyone who tells you they can predict, control, or regulate that mass of madness well enough to use government productively is insane.
2. Now here are all the massive changes I want to make in our government.  I can guarantee they will all work."

Seriously, though, I've been reading Hayek and really like him.  The dude earned his Nobel.  I wish less libertarian academics thought he was an important legal thinker, though, about which I will blog more later.

Did Shiller Predict the Burst of the Tech Bubble?

by Charlie Clarke

I've noticed that it's pretty much unquestioned that Shiller predicted the tech bubble.  But I don't think it's correct, at least not in the way most people mean when they say it.  Predicting the bursting of a bubble means (to most people) predicting prices were high and then fell or collapsed even.  What I believe the record shows and what I think used to be well known was that Shiller was too early on the tech bubble.

Here is the earliest article I could find with Shiller and the tech bubble.  The date is November 25th, 1996. David Wessel writes, "Yale University economist Robert Shiller says his measures put the ratio of stock prices to past earnings at historic highs. "When prices get high relative to fundamentals," he says, "either the fundamentals go up or the price goes down." At best, he expects the market to be stagnant for the next decade."  

Shiller would speak about his bubble prediction to Greenspan the next month who then coined the term irrational exuberance.

So how did it go:

Shiller gave a ten year horizon over, which he thought at best stocks would flat.  Instead stocks were up 90%.  That is 6.6 percent per year compounded return.  He seems to have missed the bubble in its entirety.  

But the bubble was really in the tech sector, so maybe looking at the NASDAQ will make Shiller look much better.  

No, it actually looks a little worse.  The NASDAQ was up 95% over the period and if a bubble occurred it is much later than Shiller stared predicting it.

Did Shiller do anything special?  Did he just shout bubble until stocks finally went down and then claim credit?  Maybe there is a more charitable interpretation, but I don't think it has anything to do with what people mean when they say, "he predicted the bubble."  The whole dispute between EMH proponents and Behavioral proponents is if someone can reliably say "we are in the midst of a bubble" and for prices to be lower than that date.

Let's look back at Shiller's quote, "When prices get high relative to fundamentals," he says, "either the fundamentals go up or the price goes down."  Actually, the statement is wrong.  The correct statement is, "When prices get high relative to fundamentals, either the fundamentals go up or the prices will rise more slowly."  That's a statement the whole finance profession can get behind.  When prices are high, expected returns tend to be lower.  That's exactly what happened, stocks grew at 6.6% instead of their long-term average of 9.55%.  That's not to say that over ten years that will always happen.  There is a lot of volatility in stocks, and they can have low returns for a long time.  But this episode happened to come out pretty close to what the standard efficient markets type analysis would have given.

These anecdotes are so powerful that it's important to get them right. 

Give me "Liberty" or Give me *Liberty*?

By Robert H.

We are fast approaching a world where “liberty” is not just an important, but a key constitutional principle.  Two quick examples: 1. “Liberty” has become so central to Justice Kennedy’s jurisprudence that academic clevermen are starting to argue it is the key to understanding his otherwise scattershot rulings.  That’s 1/9^th of Supreme Court rulings animated by the principle of "liberty."  2.  Among more conservative members of the Court, the word is also popping up as a guidestone.  For example, Justice Scalia’s dissent in the Obamacare case was thematically, if not legally, rooted in a desire to protect individual liberty.  Take the closing sentences of the dissent, “The fragmentation of power produced by the structure of our Government is central to liberty, and when we destroy it, we place liberty at peril. Today's decision should have vindicated, should have taught, this truth; instead, our judgment today has disregarded it.”

This focus on liberty should deeply, sincerely trouble originalists, because “liberty” is a word that has  radically changed its meaning since the foundational generation.  To get a sense of its current dominant meaning, take a look at the full paragraph from which that Scalia quote is pulled from:

The Constitution, though it dates from the founding of the Republic, has powerful meaning and vital relevance to our own times. The constitutional protections that this case involves are protections of structure. Structural protections — notably, the restraints imposed by federalism and separation of powers — are less romantic and have less obvious a connection to personal freedom than the provisions of the Bill of Rights or the Civil War Amendments. Hence they tend to be undervalued or even forgotten by our citizens. It should be the responsibility of the Court to teach otherwise, to remind our people that the Framers considered structural protections [*2677]of freedom the most important ones, for which reason they alone were embodied [**573] in the original Constitution and not left to later amendment. The fragmentation of power produced by the structure of our Government is central to liberty, and when we destroy it, we place liberty at peril. Today's decision should have vindicated, should have taught, this truth; instead, our judgment today has disregarded it.

It seems to me that “liberty” is used interchangeably with “personal freedoms” there.  Structural limits on federal power protect “personal freedom,” presumably freedom to do as we will without government interference, and therefor they protect “liberty.” 

But the founders, while they used “liberty” to mean “personal freedoms,” made important and widespread use of at least one other meaning of “liberty.”  I’ll give you two examples:

1.  Franklin’s famous quote, “Those who would give up essential Liberty, to purchase a little temporary Safety, deserve neither Liberty nor Safety” does not mean what you think it means. Benjamin Wittes has the story, but to summarize, Franklin was a member of the Pennsylvania colonial legislature when he said that, and he said it in the context of a tax dispute.  The legislature claimed it had the right to tax the Penn family in order to provide for frontier defense, the Penns were willing to offer the legislature money for frontier defense as a gift, but only so long as the legislature abrogated any right to tax them, and Franklin was speaking out against that bargain.  “You can have your money for frontier defense [temporary safety], but only if you give up a big part of your power to tax [essential liberty].”  The “essential liberty” being given up isn't personal freedoms, it’s the prerogative of a democratic legislature to tax citizens.  Not what libertarians typically mean by the word “liberty” today. 

2. Look at this quote from Federalist 18:

Philip [of Macedon] gladly seized the opportunity of executing the designs he had long planned against the liberties of Greece. By his intrigues and bribes he won over to his interests the popular leaders of several cities; by their influence and votes, gained admission into the Amphictyonic council; and by his arts and his arms, made himself master of the confederacy.

To my mind, in that context the “liberties of Greece” mean something more like “self rule” than “personal freedom” in that passage.  For one thing, it’s not clear to me as an historical matter that the average Hellene had less personal freedom under Philip.  For another, the essay in general is about the danger of loose confederacies being dominated by outside powers, and that passage specifically is about Phillip taking over Greece.  They aren't talking about the danger of tyrants to personal freedom, nor about what Phillip did to the personal freedom of Greeks after his takeover.

Those examples are not exhaustive, and they indicate some weird meaning of “liberty” used by the founders that seems to have more to do with self-government than personal freedom.  Fortunately, the foudners explained themselves.  This quote is from the declaration of the first continental congress (IE, the one that didn’t declare independence):

Resolved, 4. That the foundation of English liberty, and of all free government, is a right in the people to participate in their legislative council.

Hey, that makes sense!  To the founders, representative democracy was foundational to liberty, and liberty meant the same thing as “free government.”  There was at least a sense in which “liberty,” to the founders, didn’t mean “personal freedom,” it meant “free government,” and the cornerstone of that was the right to participate in your own, representative democracy.  The legislature not being able to tax people is an assault on “liberty” in that sense, because it robs power from the representative government.  A king taking over some democratic city states is an assault on “liberty” in that sense, because it replaces representative goveryment, however flawed, with monarchy.  Americans not getting to sit in parliament is an assault on “liberty” in that sense, because they aren't being allowed to participate in representative government.    

Note that this kind of means the exact opposite of the other meaning of liberty.  If liberty means “personal freedom, especially from the government,” then a government that can tax me is a government under which I am less free.  But if liberty means “the right to participate in an empowered, representative parliament,” then if my legislatures can’t vote to tax people I have *less* liberty.  To tie it back to Scalia’s dissent, Scalia thinks separation of power protects “liberty” because it limits government and thus promotes personal freedom.  But it is also possible that it protects “liberty” because distributed power prevents republics from turning into tyrannies, thus protecting our right to participate in representative government.  In the former calculation, the federal government having the power to make us buy healthcare is an inherent assault on liberty because it makes us (potentially) less personally free.  In the second calculation, the federal government being able to force us to buy healthcare is supportive of liberty, since it empowers the legislature, and it only harms liberty if that power helps give rise to tyrants (which isn’t to say it’s constitutional.  Obviously “how does this affect liberty” isn’t the only question you ask when determining the constitutionality of a law, under anyone’s jurisprudence).

So, originalists, beware “liberty!”  The founders meant two things by it, one of them is counterintuitive, both are in tension, and it is rarely clear which the founders were talking about without significant investigation (and maybe not even then).  Everyone else, if you see an originalist like Scalia appealing to “liberty” in a commerce clause case (IE, a clause that never uses the word), get very, very nervous.  He’s using a term with an unclear original meaning in a place he doesn’t have to (and probably shouldn’t).  That is suspicious.   

Blog News

By Robert H.

I managed to delete all the pictures I uploaded to the blog!  Hooray!

Google is largely to blame, but for boring reasons. I'll add pictures back as time allows.

Fama vs. Shiller on the Housing Bubble

by Charlie Clarke

Here is a debate between two Nobel Prize winners on bubbles.

Here is the earliest prediction I've found on Shiller and housing from June 3, 2005.

This documents Shiller predicting the tech bubble all the way back in December 1996.

This link is Oct 1996

Are these a little too early?

Potato Cartel

Sometimes financial journalism really irks me.  In this story, NPR asks if the United Potato Growers of America has become, "a veritable OPEC of spuds."  Yet, clearly the questions, correctly specified, is whether its the rise of PotatOpec.  Boom!  Nailed it!

Where Did the Moon Come From?

Economics and Finance are often criticized for not knowing enough.  The perception is that we haven't made enough progress on fundamental questions.  I've always wondered what the right amount of progress is supposed to be.  Some questions are hard to answer.  Thus, I'm always struck by scientific debates over seemingly fundamental questions.  Recently, at the new Perot Museum of Nature and Science in Dallas, I was struck by an exhibit explaining that scientists still disagreed about the moon's origins.  

Wikipedia has more information.  Consensus seems to be forming around the view that the moon was formed in a great impact with a proto-planet, though this view seems to be contradicted by some recent evidence.  Suppose this statement had been made about an economics conference, "Before the conference, there were partisans of the three 'traditional' theories, plus a few people who were starting to take the giant impact seriously, and there was a huge apathetic middle who didn’t think the debate would ever be resolved. Afterward there were essentially only two groups: the giant impact camp and the agnostics."

There are partisans of different views, some who think the debate will never be resolved.  Much less, this conference was held in 1984 and despite seeming growing consensus, none as been reached.  Would a conference today be closer to consensus?  Would it be farther?  Would the consensus views have fragmented into divergent views of what the Great Impact Hypothesis means?

My point is only that learning things is difficult.  In some cases, the answer may be that some phenomenon is a random process and the most we could ever hope to learn about it is a probability distribution.  That seems to be perfectly acceptable to the general public when a physicist cannot predict where an electron will be, but unacceptable when an economist cannot predict future movements of the economy or stock market.