Bryan Caplan  

Cry Panic!

Barry Eichengreen's Theya Culp... Mueller's Theory, Wilkinson's ...
Yesterday I quoted Scott Sumner: "I believe that the depression was caused by events that took place in September and October, when the markets actually crashed," and replied:
I'm strongly tempted to second Scott.  My main proviso: He's got to let me count the public's panic as an "event that occured in those two fateful months."  How about it, Scott?
In the comments, Scott graciously replied:
As long as you define "panic" as "correctly ascertaining that the monetary authority was about to embark on a dramatically lower NGDP growth trajectory that would plunge the world into depression" then I am completely with you.
I'm afraid I've got more in mind.  Why can't we think of the public's mood as an independent - and highly volatile - causal variable? 

I didn't expect a panic in October, 2008.  But when it happened, it sure didn't seem to be due to news about nominal GDP.  It seemed to be due to news about the public's mood.  A week before, the natives were calm.  Then they suddenly got amazingly restless. 

As long as this restlessness is unpredictable, it's perfectly consistent with EMH.  So this account seems to meet Scott's objections to distant "root cause" theories.  And it seems to fit our experience of actually living through those days, doesn't it?  So what's wrong with blaming an exogenous panic attack?

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COMMENTS (6 to date)
Jesse writes:

All economic models would be well-served to include an incredibly volatile and unpredictable exogenous shock factor. This is bound to be fruitful.

8 writes:

Why don't you look up socionomics. The change in mood was predicted too.

winterspeak writes:

Arnold: I agree with you, public mood should be an independent causal variable. In particular, the private sector desire to save (income minus spending shrinks) critically, and unexpectedly, impacts aggregate demand.

Sumner's fixation with monetary policy makes it difficult for him to see when it turns into fiscal policy (which it surely is now). And he does not understand how private sector savings balances Federal deficits, and drives aggregate demand.

Lord writes:

The problem with EMH is eventually proponents have to assume it and whatever happens becomes its confirmation. This makes it unprovable and useless, but better that than wrong.

I would call this the markets are efficient except when they are not theory. Was the market failure the failure to anticipate such a change, to anticipate the effects of such a change, or in the reaction to such a change? Were prices too high before, too low now, both, or neither? Are prices anything other than the whims of participants? Will they fall by half or double tomorrow? What are markets failing to anticipate next? What are they overreacting to now? There is nothing wrong with treating psychology as exogenous other than making a mockery of EMH. It is notable how the same reasons are used at times like these, psychology, technology, .. and there may well be some truth in them, but such truth would be far more significant than the meaninglessness of EMH.

Matthew C. writes:

EMH is completely bogus, see here for an example refutation.

Steve Roth writes:

It strikes me that trying to define the cause of the recession is like trying to define the cause of a river--this tributary or that one (or those others)?

Yeah, you could say that rain is the cause (or the downward-sloping terrain?), but that's about as useful as saying that the economy is the cause of the recession.

Likewise, what's the "cause" of (a case of) schizophrenia?

Or the symptoms of phenylketonuria--are they caused by the gene mutation making its possessor incapable of digesting phenylalanine? Or by phenylalanine in the diet? Not a useful question.

Useful answers to the above: implement measures to detect and prevent infant hypoxia during childbirth, and for those infants for whom it is prevented, reduce the chance of schizophrenia when adult by 80-90%.

Test for phenylketonuria at birth, and prescribe phenylalanine-free diets for those so afflicted.

Or: implement measures to detect and prevent the emergence of financial enterprises that are a systemic threat to the economy.

Yes, I realize that looking back might help determine what those measures should be. But looking back and saying "shit just happens sometimes" probably won't.

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