Date post: | 12-Apr-2017 |
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Les querelles ne dureraient pas longtemps, si le tort n’était que d’un côté.
– La Rochefoucauld, maxime 496
UsuryDa queste due,* se tu ti rechi a mente lo Genesì dal principio, convene prender sua vita e avanzar la gente; e perché l’usuriere altra via tene,per sé natura e per la sua seguace dispregia, poi ch’in altro pon la spene.
– Inferno XI * (natura e arte)
• Weber: prevalence of debt slavery → Abrahamic prohibition of interest
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Dalí, The Usurers (1951-60)
Interpretations of the Great Depression
• Hayek: monetary expansion induced malinvestment
• Keynes: excessive saving depressed aggregate demand
• Schumpeter: adjustment of the market to technological change and other exogenous shocks
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Great Depression, cont.• Fisher: debt need not be
macroeconomically neutral
• Schumpeter, Friedman, Tobin: “greatest economist the US has ever produced”
• Smith: “A student once asked Leontief why there was no Fisherian school. Leontief said: ‘He wrote too clearly’.”
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Irving Fisher (1867-1947)
Vernon L. Smith (n. 1927)
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Rien ne persuade tant le gens qui ont peu de sens, que ce qu’ils n’entendent pas.
– Retz, Mémoires III
Equilibrium• In microeconomics, efficient outcome is one in
which all possible gains from voluntary exchange are realized
• No one could be better off without making another worse off
• Also Pareto optimality or, in a pricing context, general equilibrium
• Refers only to exchange
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Equilibrium, cont.• Worked out by Fisher,
Samuelson et al. by analogy with thermodynamic equilibrium
• Directly influenced by statistical mechanics of Willard Gibbs (1839 - 1903)
• Arrow-Debreu welfare theorems (1951, 59) assume complete markets & perfect information
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Assets• Consumption market: good or
service exchanged once (e.g., hamburgers, haircuts)
• Asset market: same good exchanged many times (e.g. capital stock, real state)
• Bachelier (1900), Mandelbrot (1963) & Samuelson (1965) showed the efficiency asset prices follow random walks (sub-martingales)
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Assets, cont.• Smith et al. find experimentally
that consumption markets equilibrate very robustly
• Not the case for assets
• Debate on asset market efficiency reflected in 2013 Nobel Prize for Fama, Hansen & Shiller
• In an efficient asset market, risks would be correctly estimated
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Fuente: http://www.uchicago.edu/features/what_makes_nobel_speeches_endure/
Modigliani-Miller (1958)• In equilibrium, firm’s value must be independent of its
capital structure
• Investor could cancel her share of the firm’s debt with money borrowed on her own account, without gaining or losing anything (no arbitrage)
• “In retrospect, it is clear that macroeconomists —both inside and outside central banks— relied too heavily during that period on variants of the so-called Modigliani-Miller theorem, an implication of which is that the details of the structure of the financial system can be ignored when analyzing the behavior of the broader economy.” – Ben Bernanke, 2013
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Monetary paradox• Friedman rule: in equilibrium, private opportunity cost
of holding liquidity should equal social cost of providing it
• Cost to central bank of providing liquidity is negligible
• → optimum would be 0% nominal rate on riskless bond
• → deflation equal to real interest rate
• Not even Friedman took this seriously as policy (cf. his “k-percent rule”)
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My pulse, as yours, doth temperately keep time, And makes as healthful music: it is not madness
That I have utter’d. – Hamlet III, 4
• “If statistical observation leads us to believe that a given magnitude varies periodically, and if we look for the cause of those oscillations, we may suppose that that magnitude executes either
• (a) forced oscillations, or
• (b) self-oscillations, which may be either sinusoidal [weakly nonlinear] (bα) or of relaxation type [strongly nonlinear] (bβ).”
- Econometrica 1, 328 (1933)
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• AJ, “Self-Oscillation”, Phys. Rep. 525, 167 (2013), [arXiv:1109.6640 [physics.class-ph]]
• Micro-dynamics of markets totally different from physical systems
• …but uses & limitations of macroscopic equilibrium have similarities in statistical mechanics and economics
• AJ, “Towards a Microeconomic Theory of the Finance-Driven Business Cycle”, Laissez-Faire 42, 12 (2015) + refs.
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https://arxiv.org/abs/1312.0323
Edward Hopper, The “Martha KcKeen” of Wellfleet, oil on canvas (1943)Museo Thyssen-Bornemisza, Madrid
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Rayleigh - van der Pol
10 20 30 40 50 60 t
-2
-1
1
2V
V (0) = 0.1 , V̇ (0) = 0
10 20 30 40 50 60 t
- 3
-2
-1
1
2
3
4V
V (0) = 4 , V̇ (0) = �4
V̈ � 0.2�1� V 2
�V̇ + V = 0
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Relaxation
5 10 15 20 25 30 t
-2
-1
1
2V
V (0) = 0.1 , V̇ (0) = 0
5 10 15 20 25 30 t
-2
-1
1
2
V
V (0) = 2.2 , V̇ (0) = �12
V̈ � 5�1� V 2
�V̇ + V = 0
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Macro models• Linearly unstable relation between income,
capital & investment introduced in 1930s by Kalecki, Hansen & Samuelson
• Non-linear models with relaxation limit cycles by Goodwin, Kaldor, Hicks, et al.
• Lucas critique: anticipation of a regular cycle would make it go away
• Is business cycle efficient?
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Bubbles• Self-driven, but unsustainable, rise in asset price
• V. Smith et al. easily generate bubbles in controlled experiments, even with experienced traders
• Max Weber on Mississippi & South Sea Co. bubbles (1710s): “can be explained only by the fact that short selling was impracticable, since there was as yet no systematic exchange mechanism” (General Economic History, 1923)
• Incompleteness may persist in finance
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Relaxation oscillations are commonplace not only in physics, but also in physiology (heart beats) and economics (business cycles) as well. In fact, the expression ‘history repeats itself’ is probably a description of a large-scale integrated relaxation oscillation phenomenon.
– Sargent, Scully & Lamb, Laser Physics (1978)
Ingredients1. Leverage cycle
2. Liquidity crisis (financial panic)
3. Debt deflation
4. Debt overhang & flight to quality
5. Household deleveraging & liquidity trap
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Leverage cycle
• John Geanakoplos (2010): market determination of leverage for buying an asset on credit, as in mortgage
• More leverage allows more optimistic investors to set price
• Higher asset price improves collateral, promoting credit
• Positive feedback between leverage and price24
leverage =
(purchase value� down payment)
down payment
Leverage, cont.• Credit default swaps (CDS)
complete market by allowing pessimist to leverage their bets.
• CDS standardized for US secondary housing market towards the end of 2005
• see The Big Short
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Information• Optimism & pessimism wouldn’t exist under perfect
info.
• Hayek, Stigler, et al. stressed that economically relevant info. is not given, but emerges through market process
• Absence of CDS pre-2006 relevant not just as incompleteness per se
• Prevented info. held by pessimist potential investors from being incorporated into asset prices in a timely way
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Liquidity crisis• Bubble followed by rapid fall in asset prices
• Widespread defaults among leveraged buyers
• Losses to banks, which also carry asset in their balances
• Depositors withdraw funds, forcing hasty liquidations (fire sale)
• Asset prices fall further; financial institutions may grow illiquid
• Financial panic: joint defaults, counterparty credit risk, etc.
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Debt overhang• Borrowers end up as owners of depressed asset; lenders end up
as owners of debt
• Wealth transfer from net borrowers (‘households’) to net lenders (‘banks’)
• Fisher: net lenders have lower marginal propensity to consume
• Smith: borrowers may end up with negative equity (‘underwater’)
• → households can’t enjoy most of their new income
• Principal-agent problem between banks and households causes investor’s flight to quality
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Debt deflation• Fractional reserve banking
causes spike in demand for liquidity to contract monetary supply (money’s ‘perverse elasticity’)
• Deflation aggravates debt overhang
• Can be combatted by increased supply of liquidity (quantitative easing)
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(1936)
Keynesianism• Debt overhang and principal-agent problem could
help explain Keynes’s excessive saving
• Underwater households can’t spend or invest at normal levels
• → fall in aggregate demand
• Money paid to households goes quickly to bank
• Bank won’t lend back while household is underwater → liquidity trap
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Keynesianism, cont.• Inflation relieves debt overhang, but has other
undesirable consequences
• Government’s deficit spending even more problematic
cf. Eggertsson & Krugman (2012)
• Wiping out savers harmful in the long run, even if it relieves crisis
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Statistical mechanics• Theoretical physics suffers very analogous blind spot
• ‘Non-equilibrium thermodynamics’ usually focused on stochastic fluctuations about equilibrium
• Mostly fails to describe dynamics of engines (self-oscillators)
• Engines are powered by external gradient of temperature or chemical potential
• e.g., life on Earth maintained by temperature difference between Sun’s surface (6,000 K) & Earth’s surface (300 K)
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Debt dynamics• People save some of their income, even at negative rates
• Banks exist because of info. problems in finding efficient use for these savings
• Fisher & Rothbard’s mistake: Equilibrium yield curve (rate v. term) not determined by deposit contracts alone
• There’s usually scope for arbitrage of terms
• i.e., pay low rate on short-term deposit one expects to be renewed, while lending out that money at higher rates and longer terms
• Why free markets disfavor 100% reserve banking
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Debt dynamics, cont.• Maturity mismatch makes liquidity crises possible,
but it’s partly a free-market phenomenon
• Financial markets probably remain far from equilibrium
• This may explain many macroeconomic paradoxes
• Yield curve doesn’t translate into structure of production (Hayek’s mistake)
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Sustained non-equilibrium• Savings analogous to
reservoir of chemical energy in biological cell
• E. Moreno: “the economy is alive”
• No savings → no business cycle
• but also far lower living standard!
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Outlook• Post-2007 policies have responded only to liquidity
crisis & debt deflation (monetarism)
• Slow deleveraging of households has depressed consumption & investment
• Worsened in Spain by “personal collateral” for residential mortgages
• Uncertainly about regulatory, monetary, and fiscal policies obstructs voluntary debt-relief negotiations
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Outlook, cont.• Bailing out “solvent but illiquid” financial institutions
involves grave risk of corruption
• e.g., deep & long-lasting damage to efficiency of Japanese banking post-1992
• Monetary expansion (zero interest, quantitative easing) meets banks’ elevated liquidity demand
• Inflation & deficit spending weakly focused on problem of underwater households, while involving grave unintended consequences
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Solutions• Regulate leverage? (Geanakoplos)
• Universalize margin requirements? Smith justifies it as defining property rights when betting with others’ money
• Simply completing financial markets?
• Shouldn’t be so much harder to bet against asset
• Smith: Owners of bad debts should face ‘haircuts’
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