Scott Sumner  

Larry Summers and asset prices

PRINT
Hire Locally... Kling and Johnson review The M...

I frequently argue that anti-EMH theories are not useful. That is, theories of irrational market behavior, such as "bubbles", are simply not useful to policymakers, academics and ordinary investors. If they are useful to anyone (it's hard to know either way) it would only be to the tiny, tiny, number of lucky individuals who are smarter than the markets. I'm certainly not one of them.

I thought of this when I read a recent interview with Larry Summers:

The essence of democratic governmental institutions is that they're supposed to distill the conventional wisdom and act on it, and the essence of bubbles is that the conventional wisdom is dead wrong. To expect democratically accountable institutions to be good at recognizing and puncturing bubbles is unrealistic.
I don't know how Summers feels about academics and investors, but he certainly agrees with me that bubble theories are not useful to policymakers.

And speaking of Larry Summers, TravisV directed me to this article:

Jeffrey Gundlach and Larry Summers are joining derivatives traders in saying the Federal Reserve is too ambitious in its plans to raise interest rates against a backdrop of slowing global economic growth.

Gundlach, the co-founder of DoubleLine Capital LP, said moves by the central bank to raise rates are fighting non-existent inflation and hurting gross domestic product growth. Summers, the former Treasury secretary, said the economy can't withstand the four rate increases that policy makers project this year.

Turbulence in global financial markets emanating from China has fueled concern of a global slowdown as oil prices dropped to a 12-year low. That has traders and investors questioning the Fed's stance that domestic inflation will rebound gradually as U.S. wages pick up. Derivatives traders are pricing in fewer than two quarter-point rate increases in 2016.

"I'd be surprised if the world economy can comfortably withstand four hikes," Summers said Wednesday in an interview with Bloomberg TV. "Markets agree with me and that's why, despite the statements that are being made, markets aren't expecting four hikes."


If Summers keeps this up he'll soon be considered a market monetarist. Although I suppose that his saying "markets agree with me" is a bit different from my tendency to simply accept the market forecast. But then Summers has a bigger . . . um . . . amount of self confidence than I do.

PS. If there is a recession this year then I'll have to issue a mea culpa, as I advocated Yellen over Summers a couple of years ago.


Comments and Sharing


CATEGORIES: Finance , Monetary Policy




COMMENTS (15 to date)
marcus nunes writes:

Scott, two/three years ago, Summers sounded a bit worse than Yellen!
https://thefaintofheart.wordpress.com/2013/08/02/the-pretenders-an-outsider/

marcus nunes writes:

Gillian Tett had the right profile for the new Fed Chairperson in August 2013!
https://thefaintofheart.wordpress.com/2013/08/23/the-art-of-storytelling/

Brian Donohue writes:

Gundlach is great. He was virtually alone in predicting lower long-term rates during 2014. Compare with bond king Bill Gross.

Philo writes:

"Mea culpa" is excessive: your advocacy probably had no influence on the appointment, so you are not to blame.

Gordon writes:

"If there is a recession this year then I'll have to issue a mea culpa, as I advocated Yellen over Summers a couple of years ago."

Summers' views on monetary policy appear to have changed significantly over the last couple of years so there's no need for regret. I would simply give him a lot of credit for being open minded enough to change his views.

bill writes:

But if Paul Krugman or Dean Baker saw the bubble, then we're all idiots. And democracy should be ended. ;-)

A writes:

Unfortunately, Bernanke showed that pre-Fed beliefs don't necessarily survive the Borg, I mean Fed culture. Except for Kocherlakota, no one seems to revise their models to new information. It's really easy to critize someone who beat you in a competition that dredged up past controversies.

John Wake writes:

Possible translation of Summers, "I didn't see the Great Real Estate Bubble or Recession, therefore no one could have and nothing could have been to prevent or lessen them. I'm blameless on all counts. Always. Everywhere."

ThomasH writes:

Lots of people made the same mistake, starting with the President.

So derivative traders now know that raising interest rates was an error? Anyone who looks at the CPI can see it is still below its pre-crisis trend. The Fed should be moving toward easier money. Returning ST interest rates to zero will not be enough. They'll probable need to do some more QE to persuade markets that they intend to raise inflation enough to get the PL back on track,

Philip George writes:

Are you saying there will be no recession this year even if the Fed implements four rate hikes?

Scott Sumner writes:

Philip, Oddly, a recession is less likely if they raise rates 4 times rather than zero. But that's because causation would be reversed---they'd only raise rates 4 times if we were clearly avoiding a recession.

The real danger would be if they raised rates 4 times despite a tanking economy.

TravisV writes:

Prof. Sumner,

Thanks for mentioning me. I've been quiet lately due to health issues. Anyway.....

- David Glasner has a great new post

- Re: your fantastic new Trump post, Morgan Warstler's responses in the comments section were fun to read. However, I think his theory for "modern" trade is dubious.

- How The Hell can the ECB be outperforming the Fed, what the hell is going on, Bernie, Trump, deflation Aaaaaaaahhh!!

Roger McKinney writes:

EMH is a theory of the very long run. Keynes was right that knowing the ocean will be calm after the storm does no one any good. In the long run we're all dead.

Behavioral econ with its bubbles and irrational behavior is all about the very short run.

Both see recessions as random events: crap happens!

Investors need a medium-term theory, like the ABCT: monetary policy causes the boom but the real economy ends it.

Stock prices follow profits and profits track the business cycle. Profits have declined YOY the past three quarters. The market is responding to that and anticipating the next six months.

It is said that the market has predicted 10 of the last 8 recessions. But that is a far better record than mainstream economists have.

isomorphismes writes:
I frequently argue that anti-EMH theories are not useful. That is, theories of irrational market behavior, such as "bubbles", are simply not useful to policymakers, academics and ordinary investors. If they are useful to anyone (it's hard to know either way) it would only be to the tiny, tiny, number of lucky individuals who are smarter than the markets. I'm certainly not one of them.

It's not like the only way for "a theory" to be useful is to predict prices better. Knowing not to lean too heavily on the metaphysics of the most predictive theory is useful too.

In economics it's useful to know not to take every price (let's say one that didn't cross many times) as too meaningful of a signal. It's useful to know that not everything that happens is a step toward perfect efficiency, even lacking a specific theory of eg what makes people buy things or exactly how incomplete information works or exactly what market failures cause this or that.

(In physics I wouldn't lean too heavily on the metaphysics of the theory either. The billiard-ball model was once the best predictor, but QM had totally different metaphysics / philosophy. So maybe the next more accurate theory will also have a different metaphysics.)

In other words, only those who quest for a better theory should really make this criticism. For practical purposes it's very useful to know "Economic theory isn't very good yet" ---- even lacking a better grand theory. You can then down-weight the well-specified academically rigorous theory, and up-weight whatever else you would have used to figure things out if you'd never heard of the EMH theory.

isomorphismes writes:

Let me be a little more concrete with an example. Browsers (like Firefox) make money from selling the default search position. SEO's show much higher click-through rates to the first SERP's. The milliseconds / attention arguments you would have to make to call this "efficient" are, in my opinion, the unhelpful distraction. Why even debate it? Why try to make a theory? It's useful to know that the default is sticky --- so sticky that a business model can be built on it. By weak, non-rigorous analogies of "ienrtia" or "stickiness" or something, I could try to extend that observation to other domains and that, I think, is more likely to be useful.

As a counterexample think about Eric Falkenstein's book where he takes Keynes down for saying that "smelly" occupations should compensate more. (No. That reminds me of a 22-year-old who thought big corporations pay more because he would have to put up with bureaucracy.)

Comments for this entry have been closed
Return to top