My new podcast episode is out.

Diane Coyle — Markets, states and humans

I was eager to read Paul De Grauwe’s The Limits of the Market because I profoundly agree with its premise that the false dichotomy between ‘the state’ and ‘the market’ has led to bad public policies and lower social welfare. The book is a short overview of the flaws of this dichotomous view of the world. It organises its discussion around two sets of reasons why a ‘free market’ is a meaningless abstraction: externalities and ‘internalities’…

Short and important. Deals with economic and non-economic factors that influence economic behavior that are not taken into account as information in market behavior.

The Enlightened Economist
Markets, states and humans
Diane Coyle | freelance economist and a former advisor to the UK Treasury. She is a member of the UK Competition Commission and is acting Chairman of the BBC Trust, the governing body of the British Broadcasting Corporation

Chris Dillow — Capitalism vs markets

One thing that irritates me is the tendency of many on the right to conflate capitalism and markets. 

They are, in fact, two different things: capitalism is a system of ownership; markets a method of exchange. Although the two have sometimes gone together, this need not be so. Crony capitalism in which a few monopolies or cartels run much of the economy gives us capitalism without markets. And market socialism would give us markets without capitalism*.…

Stumbling and Mumbling
Capitalism vs markets
Chris Dillow | Investors Chronicle

What Can We Really Know About the Future of Stock Prices? — Lynn Parramore interviews Roman Frydman

Lynn Parramore interviews Roman Frydman.

The Huffington Post
What Can We Really Know About the Future of Stock Prices?
Lynn Parramore
ht Neil Wilson

Steve Keen — Economists Prove That Capitalism Is Unnecessary

Actually they’ve done no such thing. But they do effectively assume that it’s unnecessary all the time...

Hayek’s main target here were socialists who believed that a complex economy could be centrally planned—thus doing away with markets institutionally. But he also criticized his mainstream rivals for assuming the existence of all-seeing, all-knowing “economic agents” to overcome mathematical problems in their equilibrium-obsessed models of the economy. Here he was actually in agreement with his great rival Keynes, since they both said that the only way equilibrium could be achieved would be if people’s expectations about the future were both shared and correct.…

Forbes
Economists Prove That Capitalism Is Unnecessary

Steve Keen | 

Chris Dillow — Markets need Marxism

All this poses the question. Why, then, haven't we seen state help to create what Robert Shiller has called financial democracy?

It's certainly not because of a commitment to laissez-faire: the massive implicit subsidy to banks tells us that the state is very happy to intervene in the financial system.

Instead, the answer was pointed out by Marx: the state serves the interests of capitalists, not the people. And financial capital would rather financial markets consisted of rent-seeking than of enhancing aggregate welfare. Crony capitalism has encouraged financialization (pdf), not financial democracy. 

In this sense, a well-functioning market economy requires that the state be freed from the grip of capitalists. In some respects it is capitalism that is the enemy of a market economy, and Marxism that is its friend.

Stumbling and Mumbling
Markets need MarxismChris Dillow | Investors Chronicle

John Carney — Financial Stress Index Hits Scary Level

Assuming this [previous Fed action] isn't a completely spurious correlation, the recent rise in financial stress may mean that we should expect something new from the Federal Reserve soon.

CNBC NetNet

Financial Stress Index Hits Scary Level

John Carney | Senior Editor

How's that monetary policy working for ya?

John Aziz — What Could Possibly Go Wrong?

John doesn't mention Tepper, but the profile fits. That's three in agreement, Mike, John, and me. Is Tepper talking his book, or does he know something we don't?

Azizonomics
What Could Possibly Go Wrong?
John Aziz

Lars P. Syll — Robert Lucas and the intellectual collapse of freshwater economics

Robert Lucas is at is again. The invisible hand will return the economy to equilibrium at full employment to the degree that it is allowed to operate by eliminating government interference. And as Lars points out, without a shred of evidence in the face of massive failure of that paradigm to foresee the crisis, which it explains as either resulting from governmental intervention or an unforeseeable shock.

The presumption of equilibrium in neoclassical economics is derived from a 195y century view of physics that contemporary economists have attempted to save using DSGE. That is is say, the assumption is that equilibrium is the guiding principle in analysis of "free" markets and distribution by price discovery.

This is reminiscent of past presumptions that affected thought in the West. The Greeks had that cosmos (order) is imposed on the original chaos (randomness) by logos (rational principle or cause – Greek αἰτία). The Greek term logos is the root of English "logic." The ancient Greeks held that the universe (cosmos) is rational. Logic is the rational structure underlying human cognition of invariant principles that order change iaw law (causality). Mathematics is an aspect of logic. The lintel of Plato's Academy was inscribed with the words, "Let no one ignorant of geometry come under my roof." Given this presupposition the discovery of irrational numbers was an earth-shaking event that initially concealed from the uninitiated lest they lose faith. Subsequently, it led to a bifurcation between arithmetic and geometry that persisted until the beginning of the modern period.

The discovery of irrational numbers caused a break in Greek mathematics between arithmetic and geometry. The Greeks could not accept the fact that some lengths were incommensurable with rational numbers. Therefore, they decided that numbers could not be associated with lengths. Unfortunately, this decision led to a division between arithmetic and geometry that was not reconciled until the time of Descartes. (Math Lair)

Similarly, Aristotle had posited that the motion of heavenly objects must be circular because of the perfect form of the circle. This presupposition was at the root of the resistance to change in astronomy from a Ptolemaic system of epicycles to the simpler heliocentric Copernican system, later explained by Kepler, who was the first to use elliptical orbits.

Modern physics also presents a parallel. Classical physics presents the universe as realistic and deterministic. The discovery of quantum mechanics shook that foundation by suggesting the bedrock on which classical physics is built is probabilistic. Einstein famously objected to this interpretation with "God does not play dice," and engaged in a running debate with Bohr for decades over this. The debate was finally resolved by time, and now a majority of physicists accept that "reality" is probabilistic at ground.

The discipline of economics is affected by a similar presumption — equilibrium. Keynes rejected the neoclassical view, but Keynesians were not able to hold the fort. Samuelson capitulated and "bastardized" Keynesianism with his neoclassical synthesis. Now mainstream economists, who call themselves "orthodox" and everyone else "heterodox," which is a euphemism for "heretical," have largely prevailed and imposed equilibrium as the "normal" paradigm in Kuhn's sense.

Until this lock on the discipline is broken, economics will be theology and lag its sister science in adherence to a dogma that has been widely discredited.

As Robert Vienneau wrote recently:

If you want to argue against mainstream economics, a mainstream economist can dismiss you as ignorant of some model variation and as attacking a strawperson. Furthermore, this dismissal could be "justified" by just checking whether you have a degree from a small number of schools, and, if you do, just mocking you as not having fully learned what they are teaching. Thus, your time can be taken up with argument about whether you know what you are talking about. The mainstream economist never need get to the point of engaging a critique.

The economics profession is broken and it cannot be fixed without replacing those who adhere religiously to discredited dogma, which looks suspiciously like a conservative preference for government as an adjunct to business rather than the ordering mechanism of society as a complex system in which emergence presents challenges that markets alone are not suited to address.

Lars P. Syll's Blog
Robert Lucas and the intellectual collapse of freshwater economics
Lars P. Syll | Professor, Malmo University

Miles Kimball — Steven Pinker on How the Free Market Makes Us Uneasy

As far as I can see, this takes Market Pricing out of the realm of human nature, and there seem to be no naturally developing thoughts or emotions tailored to it.

Confessions of a Supply-Side Liberal
Steven Pinker on How the Free Market Makes Us Uneasy
Miles Kimball | Professor of Economics and Survey Research at the University of Michigan

People inherently know that there is a difference between price and value, although most economists presume that they are the same. Price discovery in markets is based on the assumption that price is identical with value. 

If that were true, Consumer Reports would not exist, for example. Markets are not equipped to discover actual value, only perceived value, and as all successful sellers realize, perception can be manipulated. In fact, that is what the field of advertising & marketing is essentially about — cognitive bias.

"Invasion of the Straw Men"

commentary by Roger Erickson

Italian Economy Contracts for Fourth Straight Quarter

This is just sad. Markets are already pricing in continued asset transfers? No questions are being asked, and we're calling it "recovery?"  A few brave people uncover what is happening and try to stop them (to no avail, in the first version;  later retelling twists the plot to declare that the good guys actually win).

Look for another movie: "Invasion of the Straw Men"

"They Came From Another Paradigm!"

"They're Everywhere You Look!"

"They're Insatiable!!!"

"They're in YOUR Bank Account!!!" 

"Only a Secret Weapon Called [TARP/euro .. whatever] can defeat them." 

(but will the latest version work this time?)

Aka, the wolves who keep crying wolf for every newly invented, nameless fear at the door.

Nothing like shamelessly inventing a ridiculous "crisis," and then profiting off it before "solving it."

Under "emergency conditions" theft becomes an incidental asset transfer.

Foolish electorates and their real assets are continually parted? Especially if they worship straw men, boogie financiers and wolves - and are Controlled by that fear?  Since we worship what we hope will protect us from our fears, we essentially worship what we fear, and hence fear itself.  Is that a convoluted way of worshiping whatever can effectively motivate our growing numbers?  The God of sociology may indeed work in strange, lumbering ways ... but not necessarily in very impressive ways.

The Library of Congress will even preserve the current strawman story as being "culturally, historically, or aesthetically significant," but won't do anything to preserve the will to resist the recurring cycle.

There is a better way. We could continually reallocate resources more gracefully, by organizing on a larger scale - since we must continue to explore our emerging options anyway. Continually turning those options over to crooks, and then trying to recover them is a strange way to keep ourselves motivated. With a little coordinated, statistical process control, we could graft all the efficient steps of Maneuver Warfare between crooks and citizens into Maneuver Context Management of ourselves?

Maneuver Warfare between an organized electorate and it's emerging options?  If we can have "Total Soccer," why not total national alignment to a fully organized adaptive rate?

Just saying it's possible. If we only had a brain. And if we actually wanted to use it.

A group intelligence is a terrible thing to waste.

Brenda Rosser — The assumption that markets are 'natural'

On David Graeber's Debt: The First 5000 Years and its implications for economics. It speaks to some the recent controversy in the comments, too.

There is no evidence of markets before the introduction of money. Exchanges between individuals informally? Yes. Through markets? No.

Graeber: ....Call this the final apotheosis of economics as common sense.  Money is unimportant.  Economies - "real economies" - are really vast barter systems.  The problem is that history shows that without money, such vast barter systems do not occur....


"Apotheosis" def= exalting someone or something to divine status.

Do not worship at the altar of false gods.

Read it at Econospeak (very short)
The assumption that markets are 'natural'

by Brenda Rosser
(h/t Angry Bear)

Markets — On the good, the bad, and the ugly

...Markets are tools that, relative to the alternatives, happen to have great strengths with respect to incentives, efficiency, and innovation. But they are not perfect; they underperform in the presence of externalities (the un-priced consequences – for example, air pollution – of individual actions), informational gaps and asymmetries, and coordination problems when there are multiple equilibria, some superior to others.

But markets have more fundamental weaknesses. Or, rather, most societies have important economic and social objectives that markets and competition are not designed to achieve. In today’s rapidly globalizing world, the most important of these objectives – expressed in various ways through the political and policymaking process in a wide range of countries – are stability, distributional equity, and sustainability.

Read it at Project Syndicate

Mind over Market
by Michael Spence

((h/t Mark Thoma)

Overall good marks on this, but he needs to study up on MMT here:

Attention is increasingly – and, in my view, rightly – being focused on the role of the state, and in particular on the state’s balance sheet. Experience in developing and advanced countries alike suggests that states with substantial and healthy balance sheets are better positioned to deal with today’s stability, distributional, and sustainability challenges. The benefits are several, including an ability to withstand shocks and mount countercyclical responses, as well as a capacity to recycle income to households during periods like the present, when the share of income that goes to capital is rising (with adverse distributional consequences).

Peter Cooper — On the Market Evaluation of Productiveness

This is a brief follow-up to a couple of previous posts (here and here) that concern the market evaluation of social productiveness. In particular, it relates to frequent assertions, for example in the debate over the job guarantee, that private markets are better at evaluating social productiveness than alternative (e.g. democratic) mechanisms.

Read it at heteconomist.com
On the Market Evaluation of Productiveness
by peterc

Noah Smith — Harrison & Kreps 1978: The power of irrational expectations

So what does that say about macro? Since the late 70s, nearly all of the models used by macroeconomists have been "rational expectations" models. "Rational expectations" is the idea that people don't make systematic mistakes when predicting the future. If you think that sounds a bit silly, you're not alone, but I kid you not when I say that rational expectations absolutely dominates modern macro.

But if expectations aren't rational in financial markets, why should they be rational in the economy as a whole? The answer is that they shouldn't. This is why Thomas Sargent, who won the Nobel Prize this year and who helped develop the theory of rational expectations, calls himself a "Harrison-Kreps Keynesian." Keynes, though he is usually associated with the idea of fiscal stimulus, was a professional stock speculator, and perceived clearly the irrationality of the markets in which he participated; Sargent is merely recognizing that financial market irrationality, which was formalized by Harrison and Kreps, is a huge hint that rational expectations is not going to get the job done in macro either. 

Read the whole post at Noahpinion

Harrison & Kreps 1978: The power of irrational expectations

by Noah Smith

(h/t Keven Fathi via email)

Some good comments too.

Smith points out that Keynes was a trader. Unlike many academic economists he was familiar with how financial markets actually operate based on trader psychology. He understood "uncertainty" based on personal experience with skin in the game. He also was aware of the many factors that affect traders in addition to those studied by academics when they consider markets. This shaped his views on macro that make the Keynesian approach to macro different from the approach based on rational expectations modeling.

I would suggest to traders and those interested in the cognitive-affective aspects of trading, along with the biases involves, that they take a look at Behavioral Finance and Wealth Management: How to Build Optimal Portfolios That Account for Investor Biases by Michael M. Pompian ((Wiley Finance, 2006).