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.