Scott Sumner  


Venezuela's Tiger... Altruism, No Regard for Some O...

People like to think in terms of stories:

It's a movie classic. The lovers are out for a walk when a villain dashes out of his house and starts fighting the man. The woman takes refuge in the house; having seen off his rival, the villain re-enters and chases after her. Yet the hero returns, pulling open the door so that the heroine can escape. The villain chases the lovers, until they finally flee, and he smashes his own home apart in fury.

Who are these characters? None of them ever made another movie, and you won't find them in any directories of famous actors. They are, in order of appearance, a large triangle (villain), a small triangle (hero), and a circle (heroine). The animated film was made in 1944 by the psychologists Fritz Heider and Marianne Simmel of Smith College in Massachusetts, whose paper 'An Experimental Study of Apparent Behaviour' is a milestone in understanding the human impulse to construct narratives.

At one level, their movie is just a series of geometric shapes moving around on a white background. It appears to lack any formal elements of story at all. Yet study groups (of undergraduate women) who saw the film in 1944 were remarkably consistent in their judgment of what it was 'about'. Thirty-five out of 36 decided that the big triangle was a mean, irritable bully, and half identified the small triangle as valiant and spirited.

That's a striking result: near unanimity on the emotional journey of a bunch of shapes. Then again, how surprising were these findings? Abstract animation existed as early as the 1920s, and experimental animators such as the Hungarian Jules Engel had already shown in sequences such as the Mushroom Dance in Walt Disney's Fantasia (1940) that very little visual information is needed to create characters and story. So perhaps research was just catching up with what the empiricism of art had already discovered.

I've found that stories get in the way of logical thinking in economics. When I try to explain that a tight money policy led to the recession of 2008, I have to contend with the fact that people have already interpreted the events of 2008 through a very different set of stories, ones much more consistent with Hollywood. (Indeed there is a new example in the theaters right now.)

People don't like my claim that the Fed needed a more expansionary policy because:

1. It would "bail out" foolish borrowers (or foolish lenders?)
2. I would simply be "papering over" deeper structural problems (or perhaps the failures of the Obama administration.)
3. It would be taking the "easy way out", not making the hard decision to endure a period of austerity.
4. "There's a price to be paid" for the reckless excesses of the housing bubble.
5. It would just be "kicking the can" down the road.

These metaphors do more to obfuscate than enlighten, but they appeal to our sense that society can be understood through stories. Trump and Sanders have cleverly exploited this human weakness, in their current campaigns.

At times it seems like the press is so enamored with stories that they don't even need any facts. Consider this assertion in a recent WSJ "story".

After substantially revaluing the yuan over a decade in response to protectionist threats, China now finds the strong dollar has left its currency grossly uncompetitive with the euro, the yen and all the rest. The alarming recent devaluation of the yuan, while a sensible response for China, is creating strains throughout emerging economies and deep uncertainty through all global supply chains.

When you look at the numbers this comment literally makes no sense. The Chinese yuan has been very strong in the last few years, and has strongly appreciated against the other emerging market currencies. But it seems to fit a deeply held narrative, which people cling to because it makes a good story. China's a "big triangle", trampling all over the "smaller triangles" like Brazil and Indonesia and Vietnam.

Banking is another example. In the recent crisis, the biggest problems were in the small and mid-sized banks. FDIC (i.e. we taxpayers) spent tens of billions of dollars paying off the depositors of the smaller banks, who made lots of reckless subprime mortgages. But it makes a better story to blame the biggest banks, so that's become the standard narrative.

Then there was the orgy of predatory borrowing. People lying about their incomes to get mortgages. But that doesn't make a good story, so let's make it "predatory lending." Sometimes their are competing stories, as when the right claims the police are a "thin blue line" protecting civilization from barbarism, whereas the left sees the police as powerful bullies, picking on the most downtrodden members of society.

Bernie Sanders sees a financial system where Grandma (Jimmy Stewart banks) was replaced by the wolf (Goldman Sachs).

Screen Shot 2016-01-09 at 12.02.28 PM.png
In my view, Alice in Wonderland best captures the counterintuitive nature of monetary economics.

PS. I'm sure I stole part of this from the very first TED talk I ever saw, by Tyler Cowen.

HT: Caroline Baum

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COMMENTS (13 to date)
Foxhuntingman writes:

You and the WSJ say the same thing about the yuan.

Kevin Erdmann writes:

It's interesting how so many of the books about the crisis support mortgage renegotiations, cram downs, etc. The easiest way to have helped them would have been to support home prices. But, that would have helped the banks, too, and that would be unacceptable. When it comes down to it, even after all the damage it caused, almost everyone supports the housing collapse, even in hindsight, even if they agree that home prices could have been nominally supported. "Liar loans" have become a cynical reference to no-doc loans, but has anyone actually looked at the data? Because the macro data says it didn't happen. This is story-telling by attribution error.

In fact, real home prices in the 2000s didn't fall that much farther than they had in the 1980s and the 1990s, but inflation was high enough in those periods to avoid the nominal collapse that caused all the defaults. In fact, those episodes are commonly referred to as the problem, for which the housing bust was the cure. Because banks and borrowers needed to know that something which had not occurred since the Great Depression could occur. We explicitly imposed this anomaly on ourselves in order to teach ourselves that it could indeed happen.

Forget about debates over which Fed policy regime is more optimal. This century's regime has literally been a regime that explicitly imposes instability, as a goal. Even today, Bernanke refers to the housing collapse as a correction that was fated to happen. Even today, with equity risk premiums near all-time highs, William Dudley sees maintaining a high risk premium as a policy goal.

Even you have bought part of the story here, Scott. There is substantial evidence that there was little or no degradation in the characteristics of borrowers during the boom. Here is a measure by the urban institute. Note that default risk from borrower characteristics was level during the boom. This is the typical finding. New homeowners during the boom were typically from the top income quintiles.

This whole episode is no different than burning witches after a bad harvest. This is a story as old as time. Look, even I made it a story - it's a witch hunt story! The appropriate response isn't to parse blame and say, "Hey there are non-witches in town who have been sinning, too. We should blame them for the harvest, too." The appropriate response, and the most difficult response, is to stand athwart the pitchfork wielding mob and yell, "Witches can't ruin the harvest!"

Kevin Erdmann writes:

Oops. Last 3 sentences of first paragraph were supposed to be in the 2nd to last paragraph.

Njnnja writes:

Obligatory xkcd

Also note the rollover text.

Isn't an economic model something like a story?

You mention "logical thinking", Scott, but what is logical thinking if not thinking delimited by the assumptions of a model, thinking delimited by what makes sense as a continuation of a story supposed to be in progress?

The nervous system of an organism has this purpose, I would claim: To direct the actions of the organism so as to take advantage of some fact or process external to the organism. This direction of actions requires the nervous system to build a model (or a story) of what is going on external to the organism.

You cannot act thoughtfully without having an interior story of what is going on outside of you. But perhaps I will soon learn better.

E. Harding writes:

Foxhuntingman, seconded.

And, Erdmann, using possibly fraudulent data to respond to allegations that the data is possibly fraudulent is clueless at best.

"Witches can't ruin the harvest!"

-You sure? Maybe not in this case, but the concept of predatory borrowers resulting in housing bubbles isn't an impossible one.

Kevin Erdmann writes:

Well, if census data and Survey of Consumer Finance data are so fraudulent that they show no sign whatsoever of the supposedly largest story of the decade, then we might as well pack up and go home.

It only seems possible in the same way that it seems possible that witches can ruin the harvest or that excesses of the 20s caused the Great Depression or that Native Americans were dying from pandemics because God favored the new European settlers. This error is so huge in history that we should demand extra evidence when our stories look like this. Has anyone put forward real evidence making the connection? It looks to me like causality has been universally assumed, to the point that factually incorrect assertions are core parts of the story.

Predatory borrowers making prices skyrocket along with rent inflation, while real housing expenditures stagnate would be quite a trick.

Jeff writes:


Economic models are indeed story-telling devices. They're more sophisticated stories, but they're still stories. The virtue of an economic model is that it helps you understand what your story actually is. The most useful models also cast the story in a form in which you can use statistics and data to evaluate how plausible the story is. Unfortunately, not many models do this very well.

But stories without at least an implicit model are even worse. How do you evaluate them?

ThomasH writes:

These "objections" are just right-wing excuses for not letting a crisis go to waste.

As I understand the physics of life, we living things survive by conjuring theories, stories about what lies outside us. The fact that we continue to live proves (well enough for me at least) that our stories are true enough often enough that we overcome the transactions costs, the second law of thermodynamics.

Our human quest for knowledge quite naturally prefers exact, perfect prediction. But life on our higher level does not require perfection. With a layer of fat, or a family, or an insurance industry, we only need to be right often enough, as I just said. Evidently we can grope ahead with only hunches and be right often enough to survive.

We like to think our natural-language descriptions are capable of being exact, mathematical even, but the communication of hunches with fuzzy terms proves useful to survival. Science advances from "Duh! What was that?!", to econometrics, to far beyond that I hope. But I suppose the interesting levels of social science will remain between Tyler's "mess" and "Yes, I saw something too! I think."

The above will be clarified, I hope, in my Perceived Order project.

Scott Sumner writes:

Kevin, OK, but surely there was SOME predatory lending.

Njnnja, Cute.

Richard, Yes, perhaps it´s stories all the way down. But surely some stories are more seductive than others. Like the big bullying the small.

Kevin Erdmann writes:

Yes, there was Scott. Maybe even a lot. There were surely SOME stocks being traded on margin in the 1920s, too. Should that be central to a Great Depression story?

Here, I think the distinction is even more sharp than the Great Depression issue, though. In Dallas, during the boom credit was generous, there were higher than normal default rates, homes were cheap, rent was low, and they were building like crazy. That could be called predatory lending, but there was no bubble, only a small bust in prices, and defaults didn't shoot up in 2007. If the US were Dallas, none of this would be newsworthy.

In San Francisco, when your family became the next in line to leave because of the economic stress of rising rents, you could do nothing and slowly succumb to volatile and rising cost of living, try to salvage life where you were by hedging those costs and buying a glorified closet that you couldn't afford, move to Modesto and try to commute with a slightly larger home that you could maybe afford if things go well for a couple of years, or move to Las Vegas where you can afford a house but you have to pick up and move which creates its own economic risks. The predatory nature of this story isn't excess, it's deprivation.

Maybe there is a parallel to the Great Depression here. Maybe real estate in places like California is like when people were starving and sharecroppers were pushed off the land when FDR ordered farmers to burn crops and leave land fallow in order to raise prices. The difference is that FDR was trying to raise prices, and we were appalled by the rising prices. In the GD, the deflation came first and deprivation was an unwise attempt at reversing it. In the GR, we imposed deprivation first, which led to high prices, then we imposed deflation in an unwise attempt at reversing it.

The margin traders in the 1920s weren't the cause of the GD and predation experienced by displaced sharecroppers certainly wasn't the cause. We re-ordered the GR as if the sharecroppers and the margin traders both happened in the 1920s, and this has fooled us into thinking the sharecroppers' poor set of choices and the traders' optimism were part of the same category.

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