Economics Bashing Wrong, Lucas

Does the financial crisis represent a failure of economics, both of macroeconomics and of financial economics? This criticism is widespread and fashionable nowadays, but wrong. Nobel laureate and Chicago economist Robert Lucas explains very convincingly why in an article published by The Economist here . The efficient market hypothesis is not disproved, on the one hand, and mainstream macroeconomic modelling has been mostly useful and not off the mark, on the other hand, contrary to what critics and journalists have claimed. A must read.

The Dollar Carry Trade and the Next Bubble

Nouriel Roubini, the New York University professor that correctly predicted the recent banking crisis, notes that investors worldwide are borrowing dollars to buy assets including equities and commodities, and he fears that they are again at it, fueling “huge” bubbles that may spark another financial crisis, reports Bloomerg’s Michael Patterson here.

Goodhart vs. Kay

“Narrow banking is not the answer to systemic fragility” writes Charles Goodhart who develops some good arguments against the narrow banking proposal in his October 28 Financial Times column here .

He is wrong however on one point at least: being in favor of smaller, more specialized banks, as an objective for the future, after a reform of the system, is not the same thing as claiming that financial authorities should not have helped large diversified banks avoid bankruptcy in the recent past. The impact on the economy would have been devastating given their sheer size, and it is precisely for that reason that banks should be compelled to downsize and re-specialize in the future. The failure of one or a few smaller investment banks would then not jeopardize the whole economy, which is the main point of the "too big to fail" reform proposal.

He then argues that in a narrow banking system, depositors would shift their funds towards risky financial institutions during relatively safe periods, only to return to safer institutions when risks increase, and thus would exacerbate the cyclical instability of the economy. But that would not be the case if investment banks were not allowed to manage current payments for depositors, just as corporations in general are not allowed to manage the payments needs of their shareholders.

Soros vs Markets

George Soros launches a $50 million onslaught on free market economics. Read the Newsweek story here .

Imperfect Financial Information

Most people, and commentators, do not understand what the efficient market hypothesis means. As I claimed in past posts on this blog, the big crash (especially in stock markets around the world) and the financial crisis (essentially a banking crisis) do not refute the hypothesis. As Jeremy J. Siegel (author of Stocks for the Long Run, McGraw Hill, now in its fourth edition) writes in the Wall Street Journal here , “neither the ratings agencies’ mistakes nor the overleveraging by financial firms was the fault of an academic hypothesis".

Market prices can reflect all the available information, and nevertheless change drastically from one period to another. We should not forget that information about the environment is constantly changing too.

So, after all, the market for information is imperfect indeed since most people who write in the field do not get the basics right.

Hat tip to Greg Mankiw.

British Schadenfreude

Follow my advice, not my policy. The Financial Times rejoices about the strength of the euro here, relative to the dollar and to the pound which have been plunging lately.

According to the City’s newspaper: “A strong common currency is better than none at all. Before, dollar strength would set off currency chaos by creating incentives for beggar-thy-neighbour attempts at weakening national currencies. Not only was this self-defeating: it also softened exporter’s market discipline, since relying on policy action became easier than raising productivity.”

Now indeed the pleasures of currency depreciation are reserved for the happy few: the US and the UK. And of course, currency depreciations are all the more effective when the partners in exchange do not retaliate. That’s exactly what has strengthened the German economy competitive position within Europe since the 1990s. Could it be that the Financial Times advice is slightly biased towards British self interest?

Health Insurance Transatlantic Differences

Tyler Cowen (Marginal Revolution) has some good arguments against universal mandatory health insurance here .

I do favor such a system for European countries where universal health insurance already exists, but is tax financed. The US case is different since health insurance is optional there. The debate thus is mostly about the desirability (or not) of universal coverage.