Archive for February 1st, 2011

Iceland changes timings of its Monetary Policy Decisions

February 1, 2011

Sedlabanki (Central Bank of Iceland) announced some changes:


Wisdom from Christopher Sims

February 1, 2011

I was reading this old interview of Chris Sims of Princeton University.

Sims has argued for a long time that fiscal policy matters for monetary policy credibility. It is called the fiscal theory of price level:


Robert Shiller interview

February 1, 2011

Thebrowser has a superb interview of Robert Shiller. He picks his five favorite books and discusses several issues as well.

His first book is Theory of Moral Sentiments by Adam Smith. He has some interesting ideas on this:

Tell me why you chose it.

This is a remarkable book, because although in some cases it’s outdated, he has an interest in exposing human traits that are relevant to thinking about our daily lives, and he has, to me, a surprisingly insightful ability to do that. He doesn’t have any of the research methods of the modern social sciences; it’s all casual observation, and reading, I suppose, of other people and literature. But there are observations and conclusions in there that I never had before. They’re focused on a purpose, which is understanding how our society works and how people get a sense of mission, of purpose, that somehow makes things work as well as they do.

Can you give a particular example of a trait where you thought, ‘Wow! I hadn’t thought of that before, but he’s so right’?

Well, if you put it that way, it’s going to be disappointing – because your readers will say, ‘Yes I had thought of that before’! It’s a personal thing. But the thing he starts the book off with is sympathy. He uses the word sympathy – and he’s really focused on selfishness versus social consciousness. He sees that sometimes people are completely selfish, and that’s the problem for any economic theory – how to make a society work when people are completely, unremittingly selfish.

But he also notes something else: he doesn’t use the word ‘empathy’, because ‘empathy’ hadn’t been defined yet. But it’s a very important observation about human behaviour, which is that we are wired to feel each other’s emotions and to have a theory of other people’s minds (not that he would have used the words ‘wired’ or ‘theory of mind’ either). The English word ‘empathy’ was coined around 1900, in a translation of the German word Einfühlung from a German book by psychologist Theodor Lipps. What it means is that it’s not that I feel bad because I observe that you are suffering, it means I actually feel your feelings. So people may often be selfish, but they also have empathy.

Smith also talks about a selfish passion, which is a desire for praise. He argues that people instinctively desire praise, but that, as they mature, this feeling develops into a desire for praiseworthiness. This is a little bit different, and I haven’t seen it written about anywhere else. He points out that, suppose you were praised for something that you knew you didn’t do: it was a mistake, people thought you did something, so they’re praising you, but in fact you didn’t do it. It wouldn’t be such a good feeling – even if you could keep the lie going, and continue to receive the praise. He uses that to show that what people really want is to be deservedly praised. And that turn of mind, which develops as people mature, is what makes us into people with integrity.

I think this underlies how the economy works. We start out with selfish feelings, which are intermixed with feelings of empathy for others, and then we develop this mature desire to be praiseworthy. I think it is central to our civilisation that people do that. Adam Smith uses the example of mathematicians. Mathematicians seem to be, in his observation, totally unconcerned with popular praise. That’s because they know they’re doing good work in their mathematics, but also that the public will never appreciate them for what they do. They live in relative poverty, and they don’t seem to care about praise, except from their fellow mathematicians. And yet they’re doing all of this work which benefits humanity. This is something that happens in our society, and it makes the system work. He doesn’t go on, in this book, to explain how this develops into something that works. But this does mark the beginning of the thought process leading to his later book, The Wealth of Nations, in 1776.

Hmm..intersting view of economic development based on human feelings. From selfish to praiseworthy…

He then picks up Nudge and points out that saving more tomorrow as a nudge all should be looking at adopting. Cutural issues are raised:

But in the savings example, isn’t there something cultural going on as well? The more capitalist a country is, the worse it seems to be at saving. I lived in China, where people might be earning RMB 1,000 a month, and yet somehow they managed to have RMB 30,000 in their savings account.

It’s an interesting phenomenon, and it may not be permanent. I think it may reflect the stage that China is going through. It used to be that the Japanese had a higher saving rate. In China, they have a sense of epic transformation right now. It’s a kind of patriotic feeling, as well as a sense of uncertainty, that encourages saving. It’s not the capitalist difference, I don’t think. You’re suggesting that China saves more because of some cultural values that are at odds with capitalism?

I think culture plays a big role in our attitude to money. I’m originally from Holland, where we like being thrifty.

That’s a stereotype of the Dutch, isn’t it? That they’re stingy?

It’s true. You may have a million dollars in the bank, but you’ll still take a bus rather than a taxi.

I bet it’s not true. Because if the Dutch had been conspicuous savers for centuries, they would be vastly richer than any of us. It would accumulate over centuries. I like to use another example from Holland, which is that home prices in Amsterdam, according to Piet Eichholtz at Maastricht University, haven’t gone up – they’re no higher in real terms today than they were 300 years ago. So, I’m sorry, but you can’t be right.

The amazing thing about saving is that if you really save a lot and you do it for a hundred years, reinvesting interest, you will get awfully rich, and that’s a fact. The best example of that is not Holland, it’s Singapore, which has had a government imposed saving plan. In Singapore, they have a mandatory saving plan that has propelled that nation up rapidly. It’s just arithmetic. If you save and invest, it adds up, because of the power of compound interest.

Next one he picks up Rajan’s “Faultlines” and he says inequality is a major problem.  In the end he says:

We have to understand human psychology; we have to accept an impulse towards selfishness, which is the reality. We cannot change that: it’s through millions of years of evolution that this has come. And yet, we do have an engineered environment. Our economy is an invention, a reaction to past crises and depressions, and we can try to coordinate it. We can’t change people’s emotions, so part of what we do is we tolerate greedy behaviour, within limits. If it follows certain rules, and if there’s a certain integrity that underlies it, we tolerate it.

Nice short read.

In a unrlelated post, FinanceClippings blog points that Shiller says that EMH predicts financial crisis can’t happen. Whatever little I have read EMH is both right and wrong. It is right as one cannot predict markets. It is wrong saying that markets are always correct and any mispriced asset will get corrected in quicktime. The mispricing may not correct immediately and may take years to correct as we saw recently. If there is a belief that assets are fairly prices by large number of investors, herd mentality takes the price further away from fundamentals.

The problem with EMH has been its interpretation (or misinterpretation). FinClip blog says the same. EMH is quite narrow and has been expanded to interpret all kinds of things. What is even more ironical is that there is a huge finance industry who is paid to predict markets and asset prices. Most miss predictions every year, but salaries/bonuses keep rising.

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