Thursday, July 29, 2010

Monkeys & the Housing Bubble

Good news - monkeys would have taken option ARM and pay-as-you go mortgages too:

For more about Human Irrationality, check out Dan Ariely's blog and his book - Predictably Irrational.

Tuesday, July 27, 2010

Equilibrium Economics & DSGE

Many thanks to Greg Mankiw for posting the link on his blog to Robert Solow's prepared statement to the House Committee on Science and Technology Subcommittee on Investigations and Oversight - “Building a Science of Economics for the Real World."

I didn't realize it at the time, but I was introduced to the field of DSGE (Dynamic stochastic general equilibrium modeling) economics in part last year at the "Stimulus SmackDown: Can Deficit Spending Save the Economy?" hosted at the University of California - Davis where Michele Boldrin expressed his view from the vantage point of equilibrium economics, of which DSGE is a branch.

Why is does this matter?

Along with other explicit reasons to mistrust DSGE as a viable economic theory, Solow explains:
The only way that DSGE and related models can cope with unemployment is to make it somehow voluntary, a choice of current leisure or a desire to retain some kind of flexibility for the future or something like that. But this is exactly the sort of explanation that does not pass the smell test.
Much of today's political approach to economic cures focuses on reviving the Keynesian/government intervention approach. Robert Solow developed the Solow Eocnomic Growth Model (yes, that Solow...) and his economic standpoint falls on the opposite end of spectrum from Keynesians and New Keynesians.

It's reasonable to generalize about economic conditions and accept that there will be gaps and holes in describing how economic events and policies affect each individual participant. There's certainly no accounting for taste (as microeconomists often state) and how participants respond or are affected by each new macroeconomic condition may in fact change each time because of amultitude conscious and sub-conscious factors weighing decisions. While noble, the notion that modeling macroeconomic activity as a construct of measured individual decisions emits a certain arrogance that individual human behavior can be predicted and subsequently controlled through economic policy.

Solow, Friedman and scores of other free market economists have long shown the positive effects of less government intervention and empowering individuals to make their own economic decisions. While some will choose poorly and even irrationally, the aggregate optimizes their situation with any set of given constraints. Most importantly, I simply want the liberty to make such decisions. It's just not possible to predict how the individual, on an individual basis, will respond to conditions at any one point in time.

The complexities of individual choice border on infinite and have long been articulated. Nobel prize winner Hebert Simon published his paper "A Behavioral Model of Rational Choice" back in 1955 (and even used the housing market to illustrate his point...).

I'm not suggesting that DSGE economists are seeking to control behavior, but a general Keynesian approach that includes modeling nearly infinite variations for individual players just doesn't seem right.

Wednesday, July 21, 2010

The Social Media Monopoly

Interesting article on Wired today - 5 Thinks That Could Topple Facebook's Empire. It's fun and easy to create this lists - 5 things that..., 10 things that... - but thought-provoking nonetheless.

Terms on a patent are 20 years, but businesses of the Facebook sort are difficult to make patentable, let alone enforce any legal restrictions on design or usability. (Ask Apple how that went with Microsoft a few years back.)

This effect shrinks the window of opportunity for a company like Facebook to capitalize on their monopoly and create an infallible social network medium. But, infallibility is more of a quixotic notion that one borne in reality. Technology companies with enormous market and mind share are constantly getting nipped in the heels by direct competitors or emerging niche players in the very same industries that the Facebook-like companies helped to create - Skype with other VoIP providers or eBay with UBid, ePier, atOncer... Heck, even Facebook took over the social media space created by previous players like MySpace (remember them?).

Facebook has been around a while and still emits a feeling that it's still in start-up stage. Monopoly power is a good thing - that's what drives entrepreneurs to create new products and services because of the clear profit motive. Would be a shame if they missed their profit opportunity but waiting too long to capitalize.

Monday, July 19, 2010

Rational Optimism - Matt Ridley on

How humans' ability to conceptualize and capitalize on gains from trade leads to economic and societal progress:

Ridley references one of my favorite economics lessons from Uncle Milty - The Story of the Pencil - though he fails to cite Milton Friedman on the idea... Found that rather disappointing.

(Thanks to Paul Kedrosky's blog post for pointing out this video presentation.)