Stiglitz: Six harsh lessons we failed to learn

ritholtz.com/blog/2009/12/st … -to-learn/

I have some quibble with them…
4. It is too soon to say with Australia. Just because a bubble hasn’t burst, doesn’t mean it isn’t there. If the Australian property bubble bursts, the fallout for the country will be the same as the fallout from bubbles everywhere else.

  1. Excessive focus on inflation is not the problem. Excessive focus on deflation is the problem. We were living in times when deflation (as a result of technological change and globalisation) should have been a good thing, arising as it did from productivity improvements. But nationalised inflation numbers don’t measure imported deflation except in terms of price (they make no allowance for productivity). Central Banks erred by trying to stave off this ‘natural’ deflation through cheapening money, prompting asset bubbles. So while it is right to say that there’s more to life than interest rates, the logical conclusion of this is that you shouldn’t use interest rates to fight what they do not control. Interest rates in Europe or the US do not affect the cost of production in China.

Point 6

Similar to the point made by Simon Carswell in his book about the banking scandals re how more inventive AIB took more risks and caused more chaos (that we know of), than the more conservative BoI. It would also apply to the mess that PMPA and PMPS turned into - lots of new ideas, little or no regulation - certainly nothing effective and in the latter case - could the same be said for the Fingleton Fiasco? - too much power in the hands of the Great Innovator…

I could argue with a couple of those points, but I will only mention the biggest one of all - 5) Inflation.

This is where things went very wrong, as they calculated inflation in a very skewed and one-sided manner in that they completely ignored asset-price inflation.

Take a house that is bought for €100,000 on an interest rate of 10%.
The annual interest is €10,000.

As interest rates slip to 5%, the house price increases to €200,000.
But the annual interest stays at €10,000.

The manner in which inflation is calculated ignores the €100,000 to €200,000 jump in asset price and simply focuses on the interest element.
The annual interest has remained constant at €10,000 - hence no inflation.
Mad !

Point number 1 is plainly wrong, market is self regulating itself - all bubbles are subject to correction, current bubble is no exception.

Second point does not deal with root of the problem, which is mixing public services(money supply) with private business(investment). Imagine water supply company that decides to maximize income by growing some plants in water resevoir, one failure could mean whole region without water. It is all about strict separation of public services from risk, and size is not matter. One big failure is no different to plenty of small banks failing.

Regarding third point. central planning is much more prone to imperfect information and takes much more time for corrections. It is like democracy, terrible system but probably best known.

I agree with number 4 as long as policy is also used in good times to cut expenditure. Otherwise it is just irresponsible.

Fifth point is quite interesting, as it kind of contradicts pro regulation and pro intervention policies. Governments could intervene and stop the bubble earlier, I think there was Bacon report in Ireland that contained some suggestions how to prevent bubble, few years before it peak. Using monetary policy to solve asset bubbles is like shooting fly with cannon. Voter empowered governments around the world were capable to deal with dot-com bubble, property bubble and others. Yet they have failed to do so! It was market forces that brought corrections.

Six point is a truly good lesson. Some things are wrong and some people could do evil stuff for private benefit. Did this guy really needed a great economical crisis to find it out?

Not only that, the 100% inflation in the price of the house is lauded as a good thing! Yeehaa!

Government regulation and policy was the main factor behind the housing bubble in Ireland, planning permission is regulation on where housing can be built and what height and size and how many there can be. The government also tried to regulate the market using stamp duty as a tool to regulate the price. The government introduced taxation policies that led to a lot of housing stock being built to satisfy the demand from developers and specuvestors for tax breaks rather than long term living space. The regulators are also lazy and ignorant of how central bank monetary policy causes the business cycle, how can someone who does not care or understand the consequences of their actions regulate a market? A free market is made up of people voluntarily exchanging goods and services, the regulator (or central planner) simply intervenes and provides misinformation to market participants that leads to a cluster of errors being made and the subsequent bust when the bad information is discovered.

All paths to the root cause of the financial crisis lead to the central banks (i.e. the regulator).

Yes, it is the deception by the central banks that leads to the errors, when the error is discovered the market participants will try to resolve this, this means a loss has to be incurred by some parties. But rather than take a loss, some participants will appeal to government for new regulations to protect them from loss at the expense of the taxpayer. Since Central banking rests on fraud then the regulators only function is to maintain the deception and their continued employment.

No. China implemented a big fuck-off stimulus package internally and this requires raw materials (low order goods) that a country like Australia supplies, when China crashes (and it will) Australia will also. The United States government can hardly be accused of being stingy with it’s stimulus programs and bailouts, can it?
Maybe we could do like Japan did and build a road to nowhere, that worked great for them.

I quibble with listening to Stiglitz in the first instance.

I don’t get his point no. 5 either. Surely a monetary policy which is designed to prevent asset bubbles would have high interest rates? High interest rates dampens inflation as it discourages people from borrowing (to buy assets). The problem wasn’t that interest rates were set to fight inflation - quite the opposite, they were not set high enough to discourage inflation and the asset bubbles that come with them.

I don’t recall talk of the asset bubbles in Germany. No point in arguing the unsuitability of the ECB’s monetary policy for the Irish economy. The points are well known. What would an independent Irish CB have done.

We had the benefits of a government fiscal policy which would undermine any monetary policy. When house prices got too high, we reduced stamp duty and increased mortgage interest relief. If we’d had our own central bank, they might have thrown their hands in the air.

In the US they do anyway

BTW China is not the deflationary driver, that would be demand, in our bipolar world of collapsing demand in some areas and exploding demand in others

Unfortnately when so much economic activity occurs in the tertiary economy, the laws of supply and demand do not work very well. Increasing asset (such as house) prices inflate demand, not quell it. This makes a mockery of the traditional laws of supply and demand. The result is self destruction, not self correction. We have not received back a functional market, and it is getting more dysfunctional all the time

In the US, they do worser things - they apply a ‘productivity’ deflator to domestic prices - so your pc is faster, but more expensive = the same price as far as the Fed is concerned. Never mind that the bloatware on it eats up the extra capacity and costs more, it does more things, so hedonics reduce that price too.

This is not a productivity improvement, it is at best no change, at worst increased obsolescence of existing product.

Hedonics allow an understatement of inflation in the same way as lumping together imported goods price declines with domestic goods and services price increases allows a false overall benign inflation picture to emerge.

So without planning permission and tax breaks there would have been no property bubble? Are you for real? Everything is the governments fault, yeah let’s just abolish the government and we’ll all be free, man. Deluded hippy utopian nonsense.

Stiglitz on Iceland, they were right. From last year.

imf.org/external/mmedia/view … 4323638001

I can’t remember who had as their sig but I believe this is apt: “It’s impossible to design a system so perfect that nobody needs to be good”. In the end all systems rely on all individuals.