I was shocked, shocked! to learn that Canadians cannot get 30-year mortgages. I was even more shocked, shocked! to learn that the typical mortgage is 5-years. Who can afford to live in Canada? I shrieked!
The average house price as of January 2010 in Toronto - $409K, and in Ottawa - $324K. Other sources for prices are here and here (which reports a national average as of 05/2010 of $346K, Toronto $446K, Ottawa $334K.)
A 5-year mortgage at 6% for a loan amount of $300,000 is about $5,000 per month. The average montly income of a computer programmer is about $3,000 per month (not so different from a carpenter!) in 2005 dollars (and I'm assuming before tax). Even with 2 incomes so that the montly household income reaches $8000K before tax, I find it hard to believe that Canadians can afford to own a home in Canada. (Assuming a 30% tax rate, that would he a HH income of $4,200.)
Tuesday, July 13, 2010
Sticky price models
I've been trying to make some sense out of the arguments for and against sticky price models. First, Stephen Williamson rants about how he was betrayed by Kocherlakota:
... the Narayana I knew would have thought the worldview represented in standard Keynesian economics was hopelessly naive. ... Woodford's view of the world is not coherent, and it certainly isn't a normative theory - the Taylor rule has never been shown to be an optimal response to anything. Also forget the "positive analysis." One would think that New Keynesians would be thoroughly embarrassed by the financial crisis, which obviously has nothing to do with sticky prices, and left them at a loss for policy prescriptions. ...
... First, there is nothing new in New Keynesian economics, which is successful in good part because it is completely unobjectionable to (i.e. the same as) Old Keynesian economics. Some people might tell you that it's forward looking price-setting that makes the difference, but I don't buy it. Second, New Keynesian economics leaves me empty. There is nothing "important" going on there.
A more reasoned argument is made by David Andolfatto:
... the data show sticky prices and the NK [New Keynesian] model has sticky prices. So what is there to argue? In fact, something very important: Do not confuse measurement with theory. The sticky price hypothesis is a theory; i.e., a proposed mechanism designed to interpret the data. And while the theory arguably has some empirical support, it is not as strong as one is generally led to believe. Sticky price models calibrated to match the observed average duration of price changes (just over one quarter) imply relatively benign consequences. Things get uglier when trying to match model predictions to microdata; see Klenow 2003. These considerations have led some economist to explore other avenues of "stickiness;" e.g., the "sticky information" models posited by Mankiw and Reis (QJE 2002).
...What accounts for the enduring popularity of sticky price models? I'm not sure, but here are some possibilities. First, they do the least violence to the comfort of Walras and Marshall. Second, they imply that money is non-neutral; something that central bankers are particularly fond of believing in. And third, they appear to rationalize (legitimize) interest rate policies like the Taylor rule.
... I have a hard time taking the sticky price hypothesis seriously. The theory literally implies that if prices were fully flexible, many of the worst properties of recessions would be avoided. There would be no liquidity traps, no financial crises, and no lost decades. Conversely, if prices are sticky (in the theoretical sense), simple government policies, like raising the long-run inflation rate or expanding government spending, can evidently restore something close to economic nirvana when the economy is in a liquidity trap. More than one prominent econblogger appears wedded to this view. I remain skeptical of such easy fixes.
Nick Rowe responds:
One of the jobs that economists are supposed to be doing, and have been doing for the last couple of centuries, is to explain prices. To assume prices are fixed is not to explain them; it's to refuse to explain them. We aren't doing our job. It is only a little better to assume prices are "sticky", which means imperfectly flexible, so they adjust only slowly from one equilibrium to another. We don't explain why they are sticky; we just assume it. For example, the Calvo model of the Phillips curve, that underlies most New Keynesian macroeconomic models, simply assumes that firms face a fixed probability d per period of being "allowed" to change price.
... if I hate the assumption so much, why am I still a sticky price macroeconomist?
First, because when I go to the supermarket, what I see and what I do seems to fit my macroeconomic model pretty well.
... A Marshallian economy has many markets, one for each of the non-money goods, where that good is exchanged for money. A Walrasian economy has one big centralised market, where all goods are exchanged simultaneously for all other goods. Sticky-price macroeconomics is Marshallian, in that sense, and definitely not Walrasian. By ignoring the possibility of a market in which labour is exchanged directly for output, sticky-price macroeconomists are implicitly assuming a monetary exchange economy. Barter is ruled out. Recessions are inherently a monetary exchange phenomenon in these models. Recessions are caused by a shortage of money - an excess demand for the medium of exchange. ...
A model of recessions that says they are caused by an excess demand for the medium of exchange seems right to me. I think I see more resort to home production, barter, and private monies during a recession, and I do see more incentive for people to do so. We see proxies for excess supply generally increase: sellers need more effort to sell; buyers need less effort to buy. The prices that do seem more flexible, because we see them rise and fall daily, tend to fall. It looks right.
Unfortunately for me, I am not familiar with the literature and the discussion pretty much left me flummoxed especially the part where Nick Rowe introduced me to the literature that states that if output is demand determined then wage stickiness does not matter but price stickiness does.
To me, all the action is in the labor market. RBC models had problems with it (matching the moments of hours) and it is the labor market where economists tend to focus on in terms of gauging the health of the economy. The key assumption as the post points out is if output is demand determined and I don't really know how crucial this assumption is. Firms produce what they produce and then 'let the markets decide'. There is constant labor reallocation within and between industries as demand for differentiated products fluctuate.
Suppose I start a new firm to crank out some new cereal and start by producing 500,000 units and set the price at $10. I hire some labor to do the job and pay them $5 per hour. If the product is not selling well I may lower the price and either cut back on number of workers or pay them less. If the product does well then I may hold the price constant and either hire more workers or have them work more hours. If a recession hits and I'm in the first situation where the product is not doing so well then whether prices or wages are sticky or not really doesn't matter - I will just shut down and all the workers are out of a job. If I am in the second situation I may cut back on labor or lower the price of the product. If wages were not sticky I may pay them less. If prices were not sticky I may lower the price. It's not clear to me what firms would do. Sticky prices need to be explained in this situation. And I do see that it is more plausible that workers and firms can come to some agreement so that wages are flexible. So perhaps, Nick Rowe is right after all - that it is the product market that matters which in turn affects the labor market.
The question of whether monetary or fiscal policy works better in the situation where the firm continues operation is to ask the question what does the policy maker want to achieve? Is it that the firm does not lay off workers or cut back on production hours? If this is the case then perhaps there is a role for fiscal policy by stimulating demand for my product. What about monetary policy? Does lower interest rates help the firm or the worker? Yes, if we can borrow to smooth production or consumption (at least to tide us over) until the recession is over but this sounds less effective somehow.
Mark Thoma summarizes some evidence which I have yet to digest.
... the Narayana I knew would have thought the worldview represented in standard Keynesian economics was hopelessly naive. ... Woodford's view of the world is not coherent, and it certainly isn't a normative theory - the Taylor rule has never been shown to be an optimal response to anything. Also forget the "positive analysis." One would think that New Keynesians would be thoroughly embarrassed by the financial crisis, which obviously has nothing to do with sticky prices, and left them at a loss for policy prescriptions. ...
... First, there is nothing new in New Keynesian economics, which is successful in good part because it is completely unobjectionable to (i.e. the same as) Old Keynesian economics. Some people might tell you that it's forward looking price-setting that makes the difference, but I don't buy it. Second, New Keynesian economics leaves me empty. There is nothing "important" going on there.
A more reasoned argument is made by David Andolfatto:
... the data show sticky prices and the NK [New Keynesian] model has sticky prices. So what is there to argue? In fact, something very important: Do not confuse measurement with theory. The sticky price hypothesis is a theory; i.e., a proposed mechanism designed to interpret the data. And while the theory arguably has some empirical support, it is not as strong as one is generally led to believe. Sticky price models calibrated to match the observed average duration of price changes (just over one quarter) imply relatively benign consequences. Things get uglier when trying to match model predictions to microdata; see Klenow 2003. These considerations have led some economist to explore other avenues of "stickiness;" e.g., the "sticky information" models posited by Mankiw and Reis (QJE 2002).
...What accounts for the enduring popularity of sticky price models? I'm not sure, but here are some possibilities. First, they do the least violence to the comfort of Walras and Marshall. Second, they imply that money is non-neutral; something that central bankers are particularly fond of believing in. And third, they appear to rationalize (legitimize) interest rate policies like the Taylor rule.
... I have a hard time taking the sticky price hypothesis seriously. The theory literally implies that if prices were fully flexible, many of the worst properties of recessions would be avoided. There would be no liquidity traps, no financial crises, and no lost decades. Conversely, if prices are sticky (in the theoretical sense), simple government policies, like raising the long-run inflation rate or expanding government spending, can evidently restore something close to economic nirvana when the economy is in a liquidity trap. More than one prominent econblogger appears wedded to this view. I remain skeptical of such easy fixes.
Nick Rowe responds:
One of the jobs that economists are supposed to be doing, and have been doing for the last couple of centuries, is to explain prices. To assume prices are fixed is not to explain them; it's to refuse to explain them. We aren't doing our job. It is only a little better to assume prices are "sticky", which means imperfectly flexible, so they adjust only slowly from one equilibrium to another. We don't explain why they are sticky; we just assume it. For example, the Calvo model of the Phillips curve, that underlies most New Keynesian macroeconomic models, simply assumes that firms face a fixed probability d per period of being "allowed" to change price.
... if I hate the assumption so much, why am I still a sticky price macroeconomist?
First, because when I go to the supermarket, what I see and what I do seems to fit my macroeconomic model pretty well.
... A Marshallian economy has many markets, one for each of the non-money goods, where that good is exchanged for money. A Walrasian economy has one big centralised market, where all goods are exchanged simultaneously for all other goods. Sticky-price macroeconomics is Marshallian, in that sense, and definitely not Walrasian. By ignoring the possibility of a market in which labour is exchanged directly for output, sticky-price macroeconomists are implicitly assuming a monetary exchange economy. Barter is ruled out. Recessions are inherently a monetary exchange phenomenon in these models. Recessions are caused by a shortage of money - an excess demand for the medium of exchange. ...
A model of recessions that says they are caused by an excess demand for the medium of exchange seems right to me. I think I see more resort to home production, barter, and private monies during a recession, and I do see more incentive for people to do so. We see proxies for excess supply generally increase: sellers need more effort to sell; buyers need less effort to buy. The prices that do seem more flexible, because we see them rise and fall daily, tend to fall. It looks right.
Unfortunately for me, I am not familiar with the literature and the discussion pretty much left me flummoxed especially the part where Nick Rowe introduced me to the literature that states that if output is demand determined then wage stickiness does not matter but price stickiness does.
To me, all the action is in the labor market. RBC models had problems with it (matching the moments of hours) and it is the labor market where economists tend to focus on in terms of gauging the health of the economy. The key assumption as the post points out is if output is demand determined and I don't really know how crucial this assumption is. Firms produce what they produce and then 'let the markets decide'. There is constant labor reallocation within and between industries as demand for differentiated products fluctuate.
Suppose I start a new firm to crank out some new cereal and start by producing 500,000 units and set the price at $10. I hire some labor to do the job and pay them $5 per hour. If the product is not selling well I may lower the price and either cut back on number of workers or pay them less. If the product does well then I may hold the price constant and either hire more workers or have them work more hours. If a recession hits and I'm in the first situation where the product is not doing so well then whether prices or wages are sticky or not really doesn't matter - I will just shut down and all the workers are out of a job. If I am in the second situation I may cut back on labor or lower the price of the product. If wages were not sticky I may pay them less. If prices were not sticky I may lower the price. It's not clear to me what firms would do. Sticky prices need to be explained in this situation. And I do see that it is more plausible that workers and firms can come to some agreement so that wages are flexible. So perhaps, Nick Rowe is right after all - that it is the product market that matters which in turn affects the labor market.
The question of whether monetary or fiscal policy works better in the situation where the firm continues operation is to ask the question what does the policy maker want to achieve? Is it that the firm does not lay off workers or cut back on production hours? If this is the case then perhaps there is a role for fiscal policy by stimulating demand for my product. What about monetary policy? Does lower interest rates help the firm or the worker? Yes, if we can borrow to smooth production or consumption (at least to tide us over) until the recession is over but this sounds less effective somehow.
Mark Thoma summarizes some evidence which I have yet to digest.
What's unsatisfying about e-books
At least what I find unsatisfying:
1. The feel of pages, the smell of the paper.
2. I can't share it (or can I?) without breaking DRM laws.
3. I can't resell it.
4. I can't give it away.
1. The feel of pages, the smell of the paper.
2. I can't share it (or can I?) without breaking DRM laws.
3. I can't resell it.
4. I can't give it away.
Monday, July 12, 2010
Future of American jobs
Are we looking here at A Future of Lousy Jobs? The current recession its effect on employment has economists looking harder at this question. In a previous post, Raghu Rajan speculated that labor reallocation would not be easy. The future of jobs has also been in recent blog posts due to an essay by Andy Grove and is also discussed by Rajiv Sethi.
I am mainly reacting Economists View and welcome Tim Duy to the heretics club:
... very right minded economist and policymaker knows unequivocally that free trade is good, and to even question that assumption makes one an ignorant heretic who has never heard of Smoot-Hawley. ...I grow increasingly convinced that the disappointing economic outcomes of the last decade are the culmination of decades of industrial neglect. That economists have dismissed industrial decline with a story of high value knowledge-based workers, a story with specific relevance to the tech boom of the 1990s but that is now defunct. And I am increasingly convinced that these trends have been largely dismissed by the economics community because acknowledging them would cast doubt on value of free trade, failing to recognize that currency manipulation was turning free trade into a zero-sum game. In short, I have become a heretic.
I would point out only that the size effect of Smoot-Hawley on the Great Depression is not a settled question. (MR doesn't share Andy Grove's concerns however.)
But how can we take a bad job and make it better? What we are really concerned about is the possibility that the hollowing out of blue-collar manufacturing jobs and the stagnant wages associated with these jobs and in the service sector are leading to a future where workers are trapped in the lower rungs with little mobility. As the previous link mentions:
... the blue-collar jobs we pine for were not always good jobs: we made them good jobs. ... Some of this was due to the power of unions. Most of it was because of the enormous improvements in productivity wrought by improved technologies and management techniques.
However, as Tim Duy points out, the growth in wages has lagged behind the growth in productivity:
... productivity growth is supposed to yield improved economic outcomes via higher real wages. Yet ... labor's share of output has been steadily decreasing since the early 1980s. This downward trend was interrupted by gains evident during the tech bubble of the mid-1990s. Apparently, only during that brief, shining moment of generational technological change did the productivity story work as we believe it should, at least since the early 1980's.
Here are some more heretical views:
1. Turn the government into the union by raising the minumum wage and or making health benefits mandatory. (I realize that this is indeed HERETICAL! that should drive most economists into a hair tearing frenzy!)
2. Mandate that "low-wage jobs" e.g. hamburger flippers, cashiers, grocery baggers, etc. be reserved solely for part-timers i.e. those who are looking to supplement their income such as students, retirees or home-makers with some time on their hands. These jobs will be exempt from the minimum wage. (I also realize the incentives that are inherent in the regulation of job categories, i.e. the pressure to make one job category exempt will also lead to pressures to make other jobs exempt).
In the best possible world, the invisible hand works best but we don't often know very well how long it takes to work and how it distributes the gains and losses as it goes to its phase of creative destruction.
I am mainly reacting Economists View and welcome Tim Duy to the heretics club:
... very right minded economist and policymaker knows unequivocally that free trade is good, and to even question that assumption makes one an ignorant heretic who has never heard of Smoot-Hawley. ...I grow increasingly convinced that the disappointing economic outcomes of the last decade are the culmination of decades of industrial neglect. That economists have dismissed industrial decline with a story of high value knowledge-based workers, a story with specific relevance to the tech boom of the 1990s but that is now defunct. And I am increasingly convinced that these trends have been largely dismissed by the economics community because acknowledging them would cast doubt on value of free trade, failing to recognize that currency manipulation was turning free trade into a zero-sum game. In short, I have become a heretic.
I would point out only that the size effect of Smoot-Hawley on the Great Depression is not a settled question. (MR doesn't share Andy Grove's concerns however.)
But how can we take a bad job and make it better? What we are really concerned about is the possibility that the hollowing out of blue-collar manufacturing jobs and the stagnant wages associated with these jobs and in the service sector are leading to a future where workers are trapped in the lower rungs with little mobility. As the previous link mentions:
... the blue-collar jobs we pine for were not always good jobs: we made them good jobs. ... Some of this was due to the power of unions. Most of it was because of the enormous improvements in productivity wrought by improved technologies and management techniques.
However, as Tim Duy points out, the growth in wages has lagged behind the growth in productivity:
... productivity growth is supposed to yield improved economic outcomes via higher real wages. Yet ... labor's share of output has been steadily decreasing since the early 1980s. This downward trend was interrupted by gains evident during the tech bubble of the mid-1990s. Apparently, only during that brief, shining moment of generational technological change did the productivity story work as we believe it should, at least since the early 1980's.
Here are some more heretical views:
1. Turn the government into the union by raising the minumum wage and or making health benefits mandatory. (I realize that this is indeed HERETICAL! that should drive most economists into a hair tearing frenzy!)
2. Mandate that "low-wage jobs" e.g. hamburger flippers, cashiers, grocery baggers, etc. be reserved solely for part-timers i.e. those who are looking to supplement their income such as students, retirees or home-makers with some time on their hands. These jobs will be exempt from the minimum wage. (I also realize the incentives that are inherent in the regulation of job categories, i.e. the pressure to make one job category exempt will also lead to pressures to make other jobs exempt).
In the best possible world, the invisible hand works best but we don't often know very well how long it takes to work and how it distributes the gains and losses as it goes to its phase of creative destruction.
Parsing monetary vs fiscal policy
In this well-written post, Raghu Rajan argues that this is not the time to raise interest rates but at the same time argues that interest rates should also rise lest they result in speculative growth. However, I had a hard time parsing his arguments without resorting to some cutting and pasting to link together his argument.
Of course, some who are convinced that the Fed contributed to the recent crisis by keeping real interest rates negative too long in the period 2002 to 2004 would wonder if stimulus “consistent with the past” is appropriate. Has the Fed, like the Bourbons, learnt nothing and forgotten nothing?
... What many people forget is that interest rates are also a price, and shape not only the level of economic activity but also the allocation of resources and the relative wealth of buyers and sellers of financial savings. A sustained period of ultra-low interest rates will favor the segments of the economy that took us into the crisis – housing, durable goods like cars, and finance. And it will encourage households to borrow and spend rather than save.
... None of this is to say that the Fed should jack up interest rates quickly without adequate warning, or to extremely high levels. There are trade-offs here, between short-term growth and long-term misallocation of resources, between reducing risk aversion and inducing excessive risk taking, between reviving hard-hit sectors and encouraging repeated bad behavior. On balance though, if and when the jitters about Europe recede, it would be prudent for the Federal Reserve to start paving the way towards positive real interest rates.
Aha! So he is arguing that interest rates should rise. But what about fiscal policy?
Even while I think monetary policy is too a blunt tool, there may well be some role for fiscal policy. There is a humanitarian need to extend benefits to the unemployed.
Yes, but no.
I don't disagree with what he is saying but it doesn't say a heck of a lot about what we should do NOW. His arguments about labor reallocation however may point to some painful adjustments ahead:
If households are going to want fewer houses, industries such as construction will have to shrink (as should the financial sector that channeled the easy credit). A significant number of jobs will disappear permanently, and workers who know how to build houses or to sell them will have to learn new skills if they can. Put differently, the productive capacity of the economy has shrunk. Resources have to be reallocated into new sectors so that any recovery is robust, and not simply a resumption of the old unsustainable binge. The United States economy has to find new pathways for growth. And this will not necessarily be facilitated by ultra-low interest rates.
Of course, some who are convinced that the Fed contributed to the recent crisis by keeping real interest rates negative too long in the period 2002 to 2004 would wonder if stimulus “consistent with the past” is appropriate. Has the Fed, like the Bourbons, learnt nothing and forgotten nothing?
... What many people forget is that interest rates are also a price, and shape not only the level of economic activity but also the allocation of resources and the relative wealth of buyers and sellers of financial savings. A sustained period of ultra-low interest rates will favor the segments of the economy that took us into the crisis – housing, durable goods like cars, and finance. And it will encourage households to borrow and spend rather than save.
... None of this is to say that the Fed should jack up interest rates quickly without adequate warning, or to extremely high levels. There are trade-offs here, between short-term growth and long-term misallocation of resources, between reducing risk aversion and inducing excessive risk taking, between reviving hard-hit sectors and encouraging repeated bad behavior. On balance though, if and when the jitters about Europe recede, it would be prudent for the Federal Reserve to start paving the way towards positive real interest rates.
Aha! So he is arguing that interest rates should rise. But what about fiscal policy?
Even while I think monetary policy is too a blunt tool, there may well be some role for fiscal policy. There is a humanitarian need to extend benefits to the unemployed.
Yes, but no.
I don't disagree with what he is saying but it doesn't say a heck of a lot about what we should do NOW. His arguments about labor reallocation however may point to some painful adjustments ahead:
If households are going to want fewer houses, industries such as construction will have to shrink (as should the financial sector that channeled the easy credit). A significant number of jobs will disappear permanently, and workers who know how to build houses or to sell them will have to learn new skills if they can. Put differently, the productive capacity of the economy has shrunk. Resources have to be reallocated into new sectors so that any recovery is robust, and not simply a resumption of the old unsustainable binge. The United States economy has to find new pathways for growth. And this will not necessarily be facilitated by ultra-low interest rates.
Behavior and rationality
In a very interesting post on the winners curse, Rajiv Sethi describes the following based on Thaler:
The winner's curse is a concept that was first discussed in the literature by three Atlantic Richfield engineers, Capen, Clapp, and Campbell (1971). The idea is simple. Suppose many oil companies are interested in purchasing the drilling rights to a particular parcel of land. Let's assume that the rights are worth the same amount to all bidders, that is, the auction is what is called a common value auction. Further, suppose that each bidding firm obtains an estimate of the value of the rights from its experts. Assume that the estimates are unbiased, so the mean of the estimates is equal to the common value of the tract. What is likely to happen in the auction? Given the difficulty of estimating the amount of oil in a given location, the estimates of the experts will vary substantially, some far too high and some too low. Even if companies bid somewhat less than the estimate their expert provided, the firms whose experts provided high estimates will tend to bid more than the firms whose experts guessed lower... If this happens, the winner of the auction is likely to be a loser.
In Thaler's description, the winner's curse arises despite the fact that bidder estimates are unbiased: their valuations are correct on average, even though the winning bid happens to come from someone with excessively optimistic expectations. Someone familiar with this phenomenon would therefore never conclude that all bidders are excessively optimistic simply by observing the fact that winning bidders tend to wish that they had lost.
Sethi then goes on to argue that the reason for the crisis is not so much behavioral but can be seen as a rational response to ecological factors. He claims that there is herding due to what other firms/actors are doing rather than interdependent preferences (or cognitive limitations) as quoted by Kindleberger:
Overestimation of profits comes from euphoria, affects firms engaged in the production and distributive processes, and requires no explanation. Excessive gearing arises from cash requirements that are low relative both to the prevailing price of a good or asset and to possible changes in its price. It means buying on margin, or by installments, under circumstances in which one can sell the asset and transfer with it the obligation to make future payments. As firms or households see others making profits from speculative purchases and resales, they tend to follow: "Monkey see, monkey do." In my talks about financial crisis over the last decades, I have polished one line that always gets a nervous laugh: "There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich."
My only thought to all this was: If agents are rational can they also be optimistic (or pessimistic)? I would tend to argue that optimism is a cognitive or behavioral trait rather than part of rationality. Some previous thoughts here.
The winner's curse is a concept that was first discussed in the literature by three Atlantic Richfield engineers, Capen, Clapp, and Campbell (1971). The idea is simple. Suppose many oil companies are interested in purchasing the drilling rights to a particular parcel of land. Let's assume that the rights are worth the same amount to all bidders, that is, the auction is what is called a common value auction. Further, suppose that each bidding firm obtains an estimate of the value of the rights from its experts. Assume that the estimates are unbiased, so the mean of the estimates is equal to the common value of the tract. What is likely to happen in the auction? Given the difficulty of estimating the amount of oil in a given location, the estimates of the experts will vary substantially, some far too high and some too low. Even if companies bid somewhat less than the estimate their expert provided, the firms whose experts provided high estimates will tend to bid more than the firms whose experts guessed lower... If this happens, the winner of the auction is likely to be a loser.
In Thaler's description, the winner's curse arises despite the fact that bidder estimates are unbiased: their valuations are correct on average, even though the winning bid happens to come from someone with excessively optimistic expectations. Someone familiar with this phenomenon would therefore never conclude that all bidders are excessively optimistic simply by observing the fact that winning bidders tend to wish that they had lost.
Sethi then goes on to argue that the reason for the crisis is not so much behavioral but can be seen as a rational response to ecological factors. He claims that there is herding due to what other firms/actors are doing rather than interdependent preferences (or cognitive limitations) as quoted by Kindleberger:
Overestimation of profits comes from euphoria, affects firms engaged in the production and distributive processes, and requires no explanation. Excessive gearing arises from cash requirements that are low relative both to the prevailing price of a good or asset and to possible changes in its price. It means buying on margin, or by installments, under circumstances in which one can sell the asset and transfer with it the obligation to make future payments. As firms or households see others making profits from speculative purchases and resales, they tend to follow: "Monkey see, monkey do." In my talks about financial crisis over the last decades, I have polished one line that always gets a nervous laugh: "There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich."
My only thought to all this was: If agents are rational can they also be optimistic (or pessimistic)? I would tend to argue that optimism is a cognitive or behavioral trait rather than part of rationality. Some previous thoughts here.
Assessment gap
K1 got her results from a standardized test over the summer. She did pretty well. One thing that surprised me about the report was the following:
In one sub-test she was in the 72 percentile when normed against "Independent schools" which I read as private schools. But when normed against the national norm (which I read as including public schools) she was in the 95 percentile. This tells me that the gap between the achievement of private and public school students is pretty large - larger than I had expected - which was no more than 10 percent at the 50-75 percentile range.
In one sub-test she was in the 72 percentile when normed against "Independent schools" which I read as private schools. But when normed against the national norm (which I read as including public schools) she was in the 95 percentile. This tells me that the gap between the achievement of private and public school students is pretty large - larger than I had expected - which was no more than 10 percent at the 50-75 percentile range.
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