'Psychologist Daniel Kahneman won the Nobel Prize in economics in 2002 for his work on decision making. While I've discussed some of this work previously, Kahneman's insights seem particularly useful in thinking about the economy and financial markets here. The key issue is how investors, central bankers, journalists and policy makers should go about evaluating "evidence" in making judgments.
In his book, Thinking, Fast and Slow, Kahneman suggested that people normally form judgments by defaulting to a rapid, associative sort of intuitive thinking that immediately gets to work with whatever information it is given. Only when that "System 1" runs into trouble do we call on the slower, effortful System 2 to gather evidence and go through orderly, detailed processing and analysis.
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The way to avoid systematic error and form better predictions, Kahneman observes, is to temper your intuition by considering the actual
correlation between the data you are given and what you are trying to predict..
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The real problem isn’t what the Fed may do, but the ultimately unavoidable consequences of what the Fed has already done. The cost of reckless Fed-induced yield seeking will likely be felt first in the financial markets as previous paper gains evaporate, while defaults on excessive low-quality covenant-lite credit will emerge over the course of the economic cycle, and the impact of malinvestment will be to limit productivity and economic growth over the longer run. This is all rather inevitable except in the eyes of those who haven’t watched and memorized a dozen adaptations of the same movie.As the Austrian School economist Ludwig von Mises wrote in Monetary Stabilization and Cyclical Policy (1928), just a year before the Great Depression began:
"Every deviation from the prices, wage rates and interest rates which would prevail on the unhampered market must lead to disturbances of the economic equilibrium. This disturbance, brought about by attempts to depress the interest rate artificially, is precisely the cause of the crisis. The ultimate cause, therefore, of the phenomenon of wave after wave of economic ups and downs is ideological in character. The cycles will not disappear so long as people believe that the rate of interest may be reduced, not through the accumulation of capital [i.e. savings made available for productive investment], but by banking policy.
“If banks emerge from the crisis unscathed, or only slightly weakened, what remains to restrain them from embarking once more on an attempt to reduce artificially the interest rate on loans and expand circulation credit? The fact that each crisis, with its unpleasant consequences, is followed once more by a new ‘boom,’ which must eventually expend itself as another crisis, is due only to the circumstances that the ideology which dominates all influential groups - political economists, politicians, statesmen, the press and the business world - not only sanctions, but also demands, the expansion of circulation credit." '
- John P. Hussman,
The Beauty of Truth and the Beast of Dogma, September 14, 2015
'..In its essentials, Keynes’s doctrine harked back to John Law and the so-called “monetary cranks” of the nineteenth century.
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..monetarism was nothing more than Fisher’s stable money principle supported by a seemingly more sophisticated version of the quantity theory of money restated in Keynesian terminology.
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By the early 1990s, a new theoretical consensus in macroeconomics had emerged known as New Keynesian economics, which synthesized elements of Keynesianism, monetarism, and New Classical economics, an offshoot of monetarism.'
- Joseph T. Salerno (
Money, Sound and unsound) (Acting Man, Hawks,
Doves and Chickens, September 18, 2015)
'..human beings are not “predictable”. They continually soak up new knowledge as it emerges, their value scales are in no way “fixed” and their actions are based on future states of knowledge that are simply not known yet. A physicist can tell us precisely where a rock we have thrown will land, provided he is made aware of all the necessary data – all of which can be precisely measured. He doesn’t have to worry that the rock will change his mind in mid-flight, mainly because the rock has no mind. Human beings – most of them, anyway – do have minds.
The premise that economics should be based on some variant of positivism – i.e., that it should employ “data” and “statistics” and use them to make “predictions” is fundamentally erroneous. Not only is this simply impossible, it is not even the task of economics. As Mises noted, economics is essentially the best elaborated part of the broader science of human action – which used to be called “sociology” before Mises renamed it
praxeology (he didn’t do this lightly) due to the anti-economics stance embraced by most sociologists in his time.
As such, the task of economics is to elaborate economic laws. This is done by logical deduction based on the action axiom. Within reason, it is not only legitimate, but necessary to employ models in economic theorizing. These allow economists to create a simple world with numerous so-called “ceteris paribus” conditions, to which new conditions are then added in a step-by-step process. For instance, the model of the evenly rotating economy (an economy in “equilibrium” that can never exist in the real world) is extremely useful in explaining how savings, investment and interest rates affect the economy’s structure of production.
Economic theory, i.e. the body of economic laws, can be used to explain economic history – but the reverse cannot be done, i.e., economic history cannot possibly serve to construct economic theory. Economic predictions are in a way akin to the task of a
historian rather than that of an economist. The study of history requires that the historian employ the known data, as well as the knowledge provided by other scientific theories, but it ultimately goes beyond that.
Mises referred to this as the
“understanding” of the historian. When e.g. discussing important historical personalities such as Julius Cesar, it won’t be enough to merely consider the documentary evidence from Cesar’s time. What were Cesar’s motives? Why did he act the way he did? This is where
understanding comes in. When economists make predictions, they are no longer wearing the hat of the economist – instead, similar to speculators in the stock market – they become “historians of the future” as Mises put it.'
- Acting Man,
Institutional Aggression, Superfluous Planners and Predictions, September 4, 2015
ContextImpractical Pragmatism, September 8, 2015
Why nobody believes the Federal Reserve’s forecasts, June 15, 2015
H.R.2912 - Centennial Monetary Commission Act of 2015, June 25, 2015
How Keynes Almost Prevented the Keynesian Revolution, August 15, 2015
Fed Apologist Ritholtz Interviews Fed Apologist McCulley, September 2, 2015
Now What? September 19, 2015 (
Tracking the Implosion of Brazil.., September 25, 2015)
(Praxeology) - '..the behaviorist and the experimentalists versus the praxeologists and the philosophers..'(Haptopraxeology) - Humans Are Underrated '..the skills of deeply human interaction .. Learning to be more socially sensitive..'