reflects an a priori commitment to laissez-faire

TO BE NOTED: From John Quiggan:

"Austrian Business Cycle Theory

By jquiggin | May 3, 2009

I’ve long promised a post on Austrian Business Cycle Theory, and here it is. For those who would rather get straight to the conclusion, it’s one I share in broad terms with most of the mainstream economists who’ve looked at the theory, from Tyler Cowen, Bryan Caplan and Gordon Tullock at the libertarian/Chicago end of the spectrum to Keynesians like Paul Krugman and Brad DeLong.

To sum up, although the Austrian School was at the forefront of business cycle theory in the 1920s, it hasn’t developed in any positive way since then. The central idea of the credit cycle is an important one, particularly as it applies to the business cycle in the presence of a largely unregulated financial system. But the Austrians balked at the interventionist implications of their own position, and failed to engage seriously with Keynesian ideas.

The result (like orthodox Marxism) is a research program that was active and progressive a century or so ago but has now become an ossified dogma. Like all such dogmatic orthodoxies, it provides believers with the illusion of a complete explanation but cease to respond in a progressive way to empirical violations of its predictions or to theoretical objections. To the extent that anything positive remains, it is likely to be developed by non-Austrians such as the post-Keynesian followers of Hyman Minsky.

First, some history and data. Austrian Business Cycle Theory was developed in the first quarter of the 20th century, mostly by Mises and Hayek, with some later contributions by Schumpeter. The data Mises and Hayek had to work on was that of that of the business cycle that emerged with industrial capitalism at the beginning of the 19th century and continued with varying amplitude throughout that century. In particular, it’s important to note that the business cycle they tried to explain predated both central banking in the modern sense of the term and the 20th century growth of the state. The case of the US is of particular interest since the business cycle coincided with a wide range of monetary and banking systems: from national bank to free banking, and including a gold standard, bimetallism and non-convertible paper money.

This NBER data goes back to 1857, but there was nothing new about the business cycle then (Marx, for example, had been writing about it for a decade or more). The US experienced serious “panics”, as they were then called in 1796-97, 1819 and 1837 [1] as well as milder fluctuations associated with the British crises of the 1820s and 1840s.

The typical crisis of the 19th century, like the current crisis, began with bank failures caused by the sudden burst of a speculative boom and then spread to the real economy, with the contraction phase typically lasting from one to five years. By contrast, recessions since 1945 have generally lasted less than a year, and have mostly been produced by real shocks or by contractionary monetary and fiscal policy.

According to the theory, the business cycle unfolds in the following way. The money supply expands either because of an inflow of gold, printing of fiat money or financial innovations that increase the ratio of the effective money supply to the monetary base. The result is lower interest rates. Low interest rates tend to stimulate borrowing from the banking system. This in turn leads to an unsustainable boom during which the artificially stimulated borrowing seeks out diminishing investment opportunities. This boom results in widespread malinvestments, causing capital resources to be misallocated into areas that would not attract investment if price signals were not distorted. A correction or credit crunch occurs when credit creation cannot be sustained. Markets finally clear, causing resources to be reallocated back towards more efficient uses.

At the time it was put forward, the Mises-Hayek business cycle theory was actually a pretty big theoretical advance. The main competitors were the orthodox defenders of Says Law, who denied that a business cycle was possible (unemployment being attributed to unions or government-imposed minumum wages), and the Marxists who offered a model of catastrophic crisis driven by the declining rate of profit.

Both Marxism and classical economics were characterized by the assumption that money is neutral, a ‘veil’ over real transactions. On the classical theory, if the quantity of money suddenly doubled, with no change in the real productive capacity of the economy, prices and wages would rise rapidly. Once the price level had doubled the previous equilibrium would be restored. Says Law (every offer to supply a good service implies a demand to buy some other good or service) which is obviously true in a barter economy, was assumed to hold also for a money economy, and therefore to ensure that equilibrium involved full employment

The Austrians were the first to offer a good reason for the non-neutrality of money. Expansion of the money supply will lower (short-term) interest rates and therefore make investments more attractive.

There’s an obvious implication about the (sub)optimality of market outcomes here, though more obvious to a generation of economists for whom arguments about rational expectations are second nature than it was 100 years ago. If investors correctly anticipate that a decline in interest rates will be temporary, they won’t evaluate long-term investments on the basis of current rates. So, the Austrian story requires either a failure of rational expectations, or a capital market failure that means that individuals rationally choose to make ‘bad’ investments on the assumption that someone else will bear the cost. And if either of these conditions apply, there’s no reason to think that market outcomes will be optimal in general.

A closely related point is that, unless Say’s Law is violated, the Austrian model implies that consumption should be negatively correlated with investment over the business cycle, whereas in fact the opposite is true. To the extent that booms are driven by mistaken beliefs that investments have become more profitable, they are typically characterized by high, not low, consumption.

Finally, the Austrian theory didn’t say much about labour markets, but for most people, unemployment is what makes the business cycle such a problem. It was left to Keynes to produce a theory of how the non-neutrality of money could produce sustained unemployment.

The credit cycle idea can easily be combined with a Keynesian account of under-employment equilibrium, and even more easily with the Keynesian idea of ‘animal spirits’. This was done most prominently by Minsky, and the animsal spirits idea has recently revived by Akerlof and Shiller. I suspect that the macroeconomic model that emerges from the current crisis will have a recognisably Austrian flavour..

Unfortunately, having put taken the first steps in the direction of a serious theory of the business cycle, Hayek and Mises spent the rest of their lives running hard in the opposite direction. As Laidler observes, they took a nihilistic ‘liquidationist’ view in the Great Depression, a position that is not entailed by the theory, but reflects an a priori commitment to laissez-faire. The result was that Hayek lost support even from initial sympathisers like Dennis Robertson. And this mistake has hardened into dogma in the hands of their successors.

The modern Austrian school has tried to argue that the business cycle they describe is caused in some way by government policy, though the choice of policy varies from Austrian to Austrian - some blame paper money and want a gold standard, others blame central banks, some want a strict prohibition on fractional reserve banking while others favour a laissez-faire policy of free banking, where anyone who wants can print money and others still (Hayek for example) a system of competing currencies.

Rothbard (who seems to be the most popular exponent these days) blames central banking for the existence of the business cycle, which is somewhat problematic, since the business cycle predates central banking. In fact, central banking in its modern form was introduced in an attempt to stabilise the business cycle. The US Federal Reserve was only established in 1913, after Mises had published his analysis.

Rothbard gets around this by defining central banking to cover almost any kind of bank that has some sort of government endorsement, such as the (private) Bank of England in the 19th century, and arguing for a system of free banking that would avoid, he asserts, these problems. But, on any plausible definition of the term, the US had free banking from the Jackson Administration to the Civil War and that didn’t stop the business cycle (Rothbard offers some historical revisionism to argue that the Panic of 1837 didn’t really happen, but that wasn’t what US voters thought when they threw the Jacksonians out in 1840). And free banking in late 19th century Australia (our first quasi-central bank was the Commonwealth Bank established in 1915) didn’t prevent a huge boom and subsequent long depression around 1890. Overall, the US was much closer to free banking throughout the 19th century than in the period from 1945 until the development of the largely unregulated ’shadow banking’ system in the 1990s, but the business cycle was worse then (how much worse is a matter of some controversy, but no serious economist claims it was better).

To sum up, the version of the Austrian Business Cycle Theory originally developed by Hayek and Mises gives strong reasons to think that an unregulated financial system will be prone to booms and busts and that this will be true for a wide range of monetary systems, particularly including gold standard systems. But that is only part of what is needed for a complete account of the business cycle, and the theory can only be made coherent with a broadly Keynesian model of equilibrium unemployment. Trying to tie Austrian Business Cycle Theory to Austrian prejudices against government intervention has been a recipe for intellectual and policy disaster and theoretical stagnation."

Whatever you call it, trickle down economics is one of the casualties of the financial crisis.

John Quiggan:

"Refuted economic doctrines #5: Trickle down

By jquiggin | February 1, 2009

The idea that policies favorable to the wealthy, such as financial deregulation and favorable tax treatment of capital income, will ultimately benefit everybody has been described, pejoratively, as ‘trickle down’ economics.

The same idea been summed up, more positively, in the aphorism ‘a rising tide lifts all boats’ attributed to John F Kennedy, and a favorite of Clinton advisers such as Gene Sperling and Robert Rubin. (It should be noted that this phrase is also used in the context of debates over free trade and over the effects of macroeconomic expansion. While it generally implies that we should focus on expanding aggregate income without too much concern over distribution, it is less sharply focused than the ‘trickle down’ pejorative.

Whatever you call it, trickle down economics is one of the casualties of the financial crisis. I’m not the first to point this out, and I’m sure I won’t be the last, but here’s a piece summing up my thoughts.

US experience during the decades of neoliberalism gives little support for this view. In the period since the economic crisis of the early 1970s, US GDP has grown strongly, and the incomes and wealth of the richest Americans has grown spectacularly.

By contrast, the gains to households in the middle of the income distribution have been much more modest. Between 1973 (the last year of the long postwar expansion) and 2007, median household income rose from $44 000 to just over $50 000, an annual rate of increase of 0.4 per cent. (More on this here and here)

Household size has decreased, mainly due to declining birth rates. The most appropriate measure of household size for the purpose of assessing living standards is the number of “equivalent adults” derived from a formula that takes account of the fact that children cost less to feed and clothe than adults and that two or more adults living together can do so more cheaply than adults in separate households. The average household contained 1.86 equivalent adults in 1974 and 1.68 equivalent adults in 2007 (my calculations on US census data). Income per equivalent adult rose at an annual rate of 0.7 per cent over this period.

For those at the bottom of the income distribution, there have been no gains at all. Unlike the situation in Australia and other countries where a poverty line is defined in relative terms, as a proportion of average income, the US has a poverty line fixed in real terms, and based on an assessment of a poverty-line standard of living undertaken in 1963.

The proportion of Americans below this fixed poverty line fell from 25 per cent in the late 1950s to 11 per cent in 1974. Since then it has fluctuated, reaching 12.5 per cent in 2007, a level that is certain to rise as a result of the financial crisis and recession now taking place. Since the poverty line has remained unchanged, this means that the incomes accruing to the poorest 10 per cent of Americans have actually fallen over the last 30 years.

Other measures yield similar conclusions. Median earnings for full-time year-round male workers have not grown since 1974. Women have done a little better, with median earnings for full-time year-round workers rising by about 0.9 per year over this period.

Overall, the main factors sustaining growth in living standards for American households outside the top 20 per cent have been an increase in the labour force participation of women and a decline in household savings. Over the period since 1999, consumption financed by borrowing against home equity has been the main factor offsetting stagnant or declining median household incomes.

Thus, in statistical terms the US offers little support to the trickle down theory. It is equally important, however, to look at how the theory is supposed to work. The general idea is that, the more highly owners of capital and highly-skilled managers are rewarded, the more productive they will be. This will lead both to the provision of goods and services at lower cost and to higher demand for the services of less-skilled workers who will therefore earn higher wages.

The financial sector is the obvious test case for this theory. Incomes in the financial sector have risen more rapidly than in any other part of the economy, and have played a major role in bidding up the incomes of senior managers and professionals in related fields such as law and accounting. According to the trickle-down theory, the growth in income accruing to the financial sector benefitted the US population as a whole in three main ways.

First, the facilitation of takeovers, mergers and buyouts by private equity firms offered the opportunity to increase the efficiency with which capital was used, and the productivity of the economy as a whole.

Second, expanded provision of credit to households allowed higher standards of living to be enjoyed, as households could ride out fluctuations in income, bring forward the benefits of future income growth, and draw on the capital gains associated with rising prices for stocks, real estate and other assets.

Finally, there is the classic ‘trickle-down’ effect in which the wealth of the financial sector generates demands for luxury goods and services of all kinds, thereby benefitting workers in general, or at least those in cities with high concentrations of financial centre activity such as London and New York.

The bubble years from the early 1990s to 2007 gave some support to all of these claims. Measured US productivity grew strongly in the 1990s, and moderately in the years after 2000. Household consumption also grew strongly, and inequality in consumption was much less than inequality in income or wealth. And, although income growth was weak for most households, rates of unemployment were low, at least by post-1970 standards for most of this period.

Very little of this is likely to survive the financial crisis. At its peak, the financial sector (finance, insurance and real estate) accounted for around 18 per cent of GDP and a much larger share of GDP growth. With professional and business services included, the total share was over 30 per cent.[1] The finance and business services sector is now contracting, and it is clear that a significant part of the output measured in the bubble years was illusory. Many investments and financial transactions made during this period have already proved disastrous, and many more seem likely to do so in coming years. In the process, the apparent productivity gains generated through the expansion of the financial sector will be lost.

The failure of the trickle-down approach has been even more severe in relation to consumer finance. The idea that increasing income inequality was unimportant when households could borrow to finance growing consumption was never defensible. The gap between income and consumption had to be filled by a massive increase in debt. With sufficiently optimistic assumptions about social mobility (that low-income households were in that state only temporarily) and asset appreciation (that the stagnation of median incomes would be offset by capital gains on houses and other investments) these increases in debt could be made to appear manageable, but once asset prices stopped rising they were shown to be unsustainable.

In the US context, these contradictions have been resolved for individual households by a massive increase in financial breakdowns. Until 2005, this mainly took the form of a steady increase in bankruptcy, to the point where Americans were more likely to go bankrupt than to get divorced. Restrictive reforms introduced at the behest of the credit card industry produced a dramatic drop in bankruptcy (in part, the lagged counterpart a massive upsurge in 2003 and 2004 as people rushed to get in under the old rules). From 2006, onwards, bankruptcy rates resumed their upward trend, reaching 1.1 million per year in 2008

This trend attracted little attention as bankruptcies were rapidly overshadowed by foreclosures on home mortgages. During the boom, when overstretched householders could normally sell at a profit and repay their debts, foreclosures were rare. From 2007 onwards, however, they increased dramatically, initially among low-income ‘subprime’ borrowers but spreading ever more broadly. 2.3 million houses were affected by foreclosure action in 2008. In hard-hit areas of California, more than 5 per cent of houses went into foreclosure in a single year

As in other respects, the longer-run implications of the crisis have yet to be fully comprehended. Even when economic activity recovers, consumer credit will be far more restricted than in past decades. As a result, there will be no escape from the implications of decades of stagnant wages for workers at the median and below.

Politically, the failure of the trickle-down theory seems likely to produce a resurgence of the class-based politics pronounced dead in the era of economic liberalism. The contrast between the enforced austerity of any recovery period, and the massive, and massively unjustified, excesses of the financial elite during the boom period, will produce a political environment where phrases like “malefactors of great wealth” no longer seem quaint and old fashioned. (Just after writing this, I Googled it, and found it as the title of a piece in Time Magazine’s Swampland by Joe Klein, among the most reliable indicators of the political zeitgeist_

fn1. Here I’m measuring the ratio of gross FBS output to gross domestic product, which is the figure most relevant to the argument. The value-added in FRB (which nets out inputs purchased by the FRB sector) is smaller, around 20 per cent, but still indicates a highly financialised economy."

And me:

1. Don the libertarian Democrat Says:
   February 2nd, 2009 at 7:19 am

   “The general idea is that, the more highly owners of capital and highly-skilled managers are rewarded, the more productive they will be. This will lead both to the provision of goods and services at lower cost and to higher demand for the services of less-skilled workers who will therefore earn higher wages.”

   Like a lot of theories, this one has taken on a much wider meaning. In some sense, it is true that more investment leads to more jobs. Hence, if you encourage investment with tax breaks, that should lead to more jobs. It seems to me that the real question you’re asking, which is a very good one, is why the middle and lower income earners seem stagnant? Shouldn’t the standard of living be going up? As I understand most free market theories, it should.

   Of course, unlike you, I believe that we have a welfare state. Here’s a paper similar to my view:

   http://www.petersoninstitute.org/publications/interstitial.cfm?ResearchID=1096

   Most likely, lobbying accounts for much of the problem. In other words, contrary to what people believe in theory, the Investor Class, say, is simply far more effective at getting policies in their favor adopted. They are not all free market, as tariffs and professional standards will often attest.

   My solution is simple: we need to focus on the problem and try whatever we can to alleviate this problem. Sometimes, lowering government requirements, based on large industries, for example, will encourage competition from smaller businesses. Michael Pollan and Barbara Kingsolver’s recent books both mention this problem, for example.

   In other words, I see the problem as political. You can call my approach class based if you’d like. I prefer to call it an approach that leads to a wealthier and more stable society. When people are wealthy enough, including the middle class and lower class, government will have far less to do. For me, there is no diminution of government power and interference that doesn’t involve the rising economic tide of the middle and lower classes. At some point along this path, we will, as Thoreau said, have the kind of government we deserve. Namely, confined to helping the truly needy, which will hopefully keep getting smaller and smaller.

"seems like doing live electrical work while wearing a blindfold and standing in a pool of water."

John Quiggan:

"In which I disagree with Paul Krugman

By jquiggin | January 21, 2009

As James Surowiecki points out here, my views on what’s entailed in bank nationalisation differ significantly from those of Paul Krugman[1]. Krugman, like quite a few other advocates of nationalisation, has in mind models like the Resolution Trust Corporation and the Swedish nationalizations of the 1990s, where the government took insolvent institutions into temporary public ownership, liquidated the bad assets and returned them to the private sector( THIS IS MY POSITION ). These solutions worked well because the global financial system as a whole was solvent and liquid, even though some sectors (US S&Ls, Swedish banks) were not.

What’s needed in the present case is not only to fix the problems of individual banks, problems on a much bigger scale than have been seen before (even in the leadup to the Great Depression, the financial sector played a smaller role in the economy than in the recent bubble), but to reconstruct a failed global financial system. It’s kind of like rewiring an electrical system in near-meltdown, while keeping the power on (this is possible, but tricky and dangerous). The job is likely to be much slower than the rescues mentioned above, and the institutions that emerge from it will be very different from those that went in.

But, contra Surowiecki this time, this only strengthens the argument for nationalisation. Financial restructuring is going to be a huge challenge, involving both a radical redesign of national regulations and the construction of an almost completely new global financial architecture. To attempt this task while leaving the banks under the control of discredited managers nominally responsible to shareholders whose equity has, in the absence of massive transfers from taxpayers, been wiped out by bad debts, seems like doing live electrical work while wearing a blindfold and standing in a pool of water.

fn1. Krugman is well-known for being right when lots of others have been wrong, so take this into account in assessing the arguments."

I don't agree with Quiggan, but I agree about leaving the current management in place being foolish beyond belief. Where are the shareholders?

"The logical implication is that a mixed economy will outperform both central planning and laissez faire"

John Quiggin reminds me of Jimi Hendrix pronouncing Surfer Music dead:

"Refuted economic doctrines #1: The efficient markets hypothesis

By jquiggin | January 2, 2009

I’m starting my long-promised series of posts on economic doctrines and policy proposals that have been refuted or rendered obsolete by the financial crisis. There will be a bit of repetition of material I’ve already posted and I’ll probably edit the posts in response to points raised in discussion.

Number One on the list is a topic I’ve covered plenty of times before (in fact, I was writing about it fifteen years ago), the efficient (financial) markets hypothesis. It’s going first because it is really the central microeconomic issue in a wide range of policy debates that will (I hope) be covered later in this series. Broadly speaking, the efficient markets hypothesis says that the prices generated by financial markets represent the best possible estimate of the values of the underlying assets."

Here's where I stand. I propound a form of Behavioral Finance:

(((((("Criticism and behavioral finance

Price-Earnings ratios as a predictor of twenty-year returns based upon the plot by Robert Shiller (Figure 10.1,^[11] source). The horizontal axis shows the real price-earnings ratio of the S&P Composite Stock Price Index as computed in Irrational Exuberance (inflation adjusted price divided by the prior ten-year mean of inflation-adjusted earnings). The vertical axis shows the geometric average real annual return on investing in the S&P Composite Stock Price Index, reinvesting dividends, and selling twenty years later. Data from different twenty year periods is color-coded as shown in the key. See also ten-year returns. Shiller states that this plot "confirms that long-term investors—investors who commit their money to an investment for ten full years—did do well when prices were low relative to earnings at the beginning of the ten years. Long-term investors would be well advised, individually, to lower their exposure to the stock market when it is high, as it has been recently, and get into the market when it is low."^[11] This correlation between price to earnings ratios and long-term returns is not explained by the efficient-market hypothesis.

Investors and researchers have disputed the efficient markets hypothesis empirically and theoretically. Behavioral economists attribute the imperfections in financial markets to a combination of cognitive biases such as overconfidence, overreaction, representative bias, information bias, an inability to use configural rather linear reasoning, and various other predictable human errors in reasoning and information processing. These have been researched by psychologists such as Daniel Kahneman, Amos Tversky, Richard Thaler, and Paul Slovic. These errors in reasoning lead most investors to avoid high-value stocks and buy growth stocks at expensive prices, which allow those who reason correctly to profit from bargains in neglected value stocks and the overreacted selling of growth stocks.

Empirical evidence has been mixed, but has generally not supported strong forms of the efficient markets hypothesis^{[3] [2]} low P/E stocks have greater returns. In this paper he also refuted the assertion by Ray Ball that these higher returns could be attributed to higher beta,^[12] whose research had been accepted by efficient market theorists as explaining the anomaly^[13]:151 in neat accordance with modern portfolio theory.

Speculative economic bubbles are an obvious anomaly, in that the market often appears to be driven by buyers operating on irrational exuberance, who take little notice of underlying value. These bubbles are typically followed by an overreaction of frantic selling, allowing shrewd investors to buy stocks at bargain prices. Rational investors have difficulty profiting by shorting irrational bubbles because, as John Maynard Keynes commented, "Markets can remain irrational longer than you can remain solvent." Sudden market crashes as happened on Black Monday in 1987 are mysterious from the perspective of efficient markets.

Another anomaly exists in the form of the investors who beat the market soundly on a long-term basis, including Peter Lynch, Warren Buffett, George Soros, and John Templeton. Warren Buffett has commented that "I'd be a bum on the street with a tin cup if the markets were always efficient".

Burton Malkiel, a well-known proponent of the general validity of EMH, has warned that certain emerging markets such as China are not empirically efficient; that the Shanghai and Shenzhen markets, unlike markets in United States, exhibit considerable serial correlation (price trends), non-random walk, and evidence of manipulation.^[14]

Behavioral psychology approaches to stock market trading are among some of the more promising alternatives to EMH (and some investment strategies seek to exploit exactly such inefficiencies). But Nobel Laureate co-founder of the programme—Daniel Kahneman—announced his skepticism of investors beating the market: "They're [investors] just not going to do it [beat the market]. It's just not going to happen."^[15] Richard Thaler has started a fund based on his research on cognitive biases. In a 2008 report he identified complexity and the herd behavior as central to the global financial crisis of 2008.^[16]"))))))

Back to Quiggan:

"The hypothesis comes in three forms.

The weak version (which stands up well, though not perfectly, to empirical testing) says that it is impossible to predict future movements in asset prices on the basis of past movements, in the manner supposedly done by sharemarket chartists. While most of what is described by chartists as ‘technical analysis’ is mere mumbo-jumbo, there is some evidence of longer-term reversion to mean values that may violate the weak form of the EMH.

The strong version, which gained some credence during the financial bubble era says that asset prices represent the best possible estimate taking account of all information, both public and private. It was this claim that lay behind the proposal for ‘terrorism futures’ put forward, and quickly abandoned a couple of years ago. It seems unlikely that strong-form EMH is going to be taken seriously in the foreseeable future, given the magnitude of asset pricing failures revealed by the crisis.

For most policy issues, the important issue is the “semi-strong” version which says that asset prices are at least as good as any estimate that can be made on the basis of publicly available information. It follows, in the absence of distorting taxes or other market failures that the best way to allocate scarce capital and other resources is to seek to maximise the market value of the associated assets. Another way of presenting the semi-strong EMH is to say whether or not markets are perfectly efficient, they’re better than any other possible capital allocation method, or at least, better than any practically feasible alternative."

Here's a similar list and explanation:

(((((("There are three common forms in which the efficient-market hypothesis is commonly stated — weak-form efficiency, semi-strong-form efficiency and strong-form efficiency, each of which have different implications for how markets work.

[edit] Weak-form efficiency

• Excess returns cannot be earned by using investment strategies based on historical share prices.
• Technical analysis techniques will not be able to consistently produce excess returns, though some forms of fundamental analysis may still provide excess returns.
• Share prices exhibit no serial dependencies, meaning that there are no "patterns" to asset prices. This implies that future price movements are determined entirely by information not contained in the price series. Hence, prices must follow a random walk.

[edit] Semi-strong-form efficiency

• Semi-strong-form efficiency implies that share prices adjust to publicly available new information very rapidly and in an unbiased fashion, such that no excess returns can be earned by trading on that information.
• Semi-strong-form efficiency implies that neither fundamental analysis nor technical analysis techniques will be able to reliably produce excess returns.
• To test for semi-strong-form efficiency, the adjustments to previously unknown news must be of a reasonable size and must be instantaneous. To test for this, consistent upward or downward adjustments after the initial change must be looked for. If there are any such adjustments it would suggest that investors had interpreted the information in a biased fashion and hence in an inefficient manner.

[edit] Strong-form efficiency

• Share prices reflect all information, public and private, and no one can earn excess returns.
• If there are legal barriers to private information becoming public, as with insider trading laws, strong-form efficiency is impossible, except in the case where the laws are universally ignored.
• To test for strong-form efficiency, a market needs to exist where investors cannot consistently earn excess returns over a long period of time. Even if some money managers are consistently observed to beat the market, no refutation even of strong-form efficiency follows: with hundreds of thousands of fund managers worldwide, even a normal distribution of returns (as efficiency predicts) should be expected to produce a few dozen "star" performers."))))))

Back to Quiggan:

"As it has become evident that the financial crisis is comparable, in important ways, to the early stages of the Great Depression,"

I'm not much interested in these lessons from the 30s discussions, but here's John Quiggin's take:

"As it has become evident that the financial crisis is comparable, in important ways, to the early stages of the Great Depression, there has been a lot of debate about the lessons to be learned from the responses to the Depression in the US, most notably the various policies that made up the New Deal. There’s a lot to be learned there, but it’s also important to remember that the Depression, in the US and elsewhere, continued throughout the 1930s before being brought to an abrupt end by the outbreak of World War II.[1]

Not only did the slump end when the war began, it did not return when the war ended - a huge difference from previous major wars.[2] Instead the three decades beginning in 1940 were a period of unparalleled prosperity for developed countries, with economic growth higher and unemployment lower than at any time before or since.

What lessons can we learn from this experience?

In the immediate aftermath of the war, the lesson seemed obvious. Planning had succeeded where capitalism had failed, and more planning was needed to maintain that success. As the White Paper on Full Employment (Commonwealth of Australia 1945) put it

Despite the need for more houses, food, equipment and every other type of product, before the war not all those available for work were able to find employment or to feel a sense of security in their future. On the average during the twenty years between 1919 and 1939 more than one-tenth of the men and women desiring work were unemployed. In the worst period of the depression well over 25 per cent were left in unproductive idleness. By contrast, during the war no financial or other obstacles have been allowed to prevent the need for extra production being satisfied to the limit of our resources.

Over time, as the difficulties of planning became apparent, emphasis shifted to the idea that the war had provided a Keynesian stimulus to aggregate demand, and that, with careful management, unemployment (or inflation) due to inadequate (excessive) aggregate demand could be avoided. Thirty years of success seemed to confirm that view.

After the failure of Keynesian economic management in the 1970s, this explanation appeared less adequate, but no adequate alternative was proposed. Given the apparent success of monetary policy in stabilising output and inflation, and reducing unemployment, from 1990 onwards, the issue seemed largely academic, and given the focus of US economists on the New Deal, even academic attention to the question has been limited.

Perhaps stimulatory fiscal policy will produce a rapid and complete recovery from the current crisis, and a restoration of the postwar Keynesian orthodoxy. But given the damage that has already been done to the global financial system, and the prospect of much more to come, this is far from certain. The experience of Japan in the 1990s is not encouraging, and this crisis is far worse in important respects. Perhaps when the collapse of financial intermediation is as near-complete as it was in the Depression, a large element of central direction is needed to restore trade and ensure necessary flows of credit. In the absence of a rapid recovery, questions like this will assume increased urgency over the next year or two."

I don't agree with him on various points, but here was my main response:

1. Don the libertarian Democrat Says:
   December 8th, 2008 at 3:17 am

   I’m on record favoring a very grand stimulus, tax cuts, and even printing money. I also love Keynes, but more for his writing style, which means a lot to me.

   Anyway, I feel differently about the knowledge we can gain from the 30s. Abstracting out the economic data can be of some slight use, but not much. The reason I believe this is that the decisions people made in the 30s were made in the context of the 30s, and that was a very different context than ours.

   I’ll give you one example. I once read a bunch of books by Wyndham Lewis. I don’t remember much about them, except that he seemed to truly believe that the only choice available was between Communism or Fascism. In other words, some form of Totalitarianism. This shocked me, but, after reading his books, I was surprised to find that many people writing in the 30s made that same assumption.

   Fortunately, there were wiser and better people around, millions and millions of them it turned out,including Keynes and Hayek, who understood the world better, and so we weren’t left with only those choices. But I continue to believe that the existential situation of the times people live in are more important than other people do. So that, the choices and decisions made in the 30s really can’t help us much.

   Instead, what’s happening is that we’re lurching and veering in a pragmatic way towards a path that leads us out of this mess. It turns out that we’re doing so in a way more reminiscent of Keynes, so, in order to feel like we really know what we’re doing, and since Keynes helped get us out of the 30s, we’re calling upon his spirit for solace and guidance.

   That’s fine with me because, as I’ve said, I love Keynes. But we’re going to get out of this mess in our own way and in our own time, and part of the process will be reading great books that help us get through these kind's of times. But there’s one thing that makes me more hopeful about this crisis, and, maybe I’m different than everybody else, but I really wouldn’t want to have been in the existential crisis of the 30s. I’ll take this one any day.

"The War brought nothing but evil, and its evil has persisted through almost a century since it began."

John Quiggan on Armistice Day:

"It’s 90 years today since the Armistice that brought a temporary halt to fighting on the Western Front of the Great War. The War had already brought forth the horrors of Bolshevism and fighting in Russia continued well beyond the Armistice. Within a few years, Fascism and Nazism were also on the march. Full-scale war resumed in the 1930s, first in Spain, Abyssinia and the Far East and then throughout the world. The War brought nothing but evil, and its evil has persisted through almost a century since it began."

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