Sharpening my knife
This post and then this post passed by in succession in my rss reader this afternoon. Since its hard work to make real connections between things, I’ll let this random pairing do the work for me.
First reaction to Mike’s post on financial education: education is paternalism. To wit, Mankiw’s views of economics education are exactly like a Marxist’s need to raise his students’ consciousnesses. We have views we think our students should have. There are “good” views and there are “bad” views. I think we’re going to have to live with this sort of paternalism.
Second, financial education, and personal finance in particular, IS NOT economic education. Personal finance is about individuals making decisions about particular goods and services. Economics is about how many people’s decisions aggregate up into market behavior. Like waaay different.
Third — and here’s the lazy connection with the Robin Hanson post — financial education is just an instance of rationality education. If students could learn to be more rational (and they use that reason), they would be better consumers of finance when they get out in the world. Because some students aren’t smart enough and most aren’t so inclined, they can’t be taught to be more rational in general. So, financial education needs be a set of rules of thumb with a sprinkling of general principles.
Example: everything you need to know about interest rate calculations is taught to you in 6th grade math class. Because students are too dumb or disinclined to care, they don’t make the connection. So we need to teach them specifically how to calculate the interest payments on credit cards and point out to them how many big screen tv’s they won’t get to buy if they rack up their credit card balances.
The guiding principle would be to teach rules of thumb that, if followed, would lead to people making the least bad mistakes, e.g. its better to scare the bejeezus out of students about credit cards even if it leads them to forgo getting them. That said, people learn from mistakes so we shouldn’t aim to prevent all mistake making.
Aside: I consider myself a pretty staunch anti-paternalist… the big fight with the Real Scientist right now is over whether we should cut checks to poor people or buy health care for them. She says, and I’m paraphrasing only a little, “they’re too dumb to buy health insurance themselves so we have to do it for them.” I say that I’d hate to be treated that way, like a child, and so we should just give income subsidies to the poor and let them figure out what goods and services they need to buy.
Anyway, I’m an anti-paternalist EXCEPT when it comes to education and specifically when it comes to teaching people how to think. To me, it better for people to learn to think for themselves than for others to think for them. A second best: people should at least act like they’re thinking for themselves (i.e. following rules of thumb). At least in this case, there’s at least a chance that people will learn to think for themselves and become more rational.
In all three cases, though, paternalism is involved.
… every time I run into a statement like this: “But all interesting models involve unrealistic simplifications, which is why they must be tested against data.”
We can know things a priori, but we can’t know how important those things are a priori. A model can tell us how a particular mechanism operates, but it can’t tell us how important that mechanism is. Effect size can only be determined by looking at the data.
I’m sure there’s something wrong with my brain that can’t internalize this fact. I just read Landsburg’s Big Questions and this was his major theme. (BTW, I liked the book and here’s a review at /.)
Sumner writes his manifesto.
In the 70’s they discovered expectations mattered. Since then “expectations are important” has been muttered towards the end of macro lectures but the idea hasn’t sunk in. Sumner wants to make expectations the central concept of the discipline.
Expected future outcomes (like inflation and output) determine today’s outcomes via the capital markets. His big insight is that the capital markets are the best measure of those expectations. The only expectations that matter are the ones that market participants have. They’re the ones setting wage contracts and prices. If market participants have the “wrong” expectations, prices and wage contracts will be “wrong” too and outcomes will be “wrong” anyway.
This means the solution to the business cycle — at least the part caused by nominal shocks — is to change policy so expectations and the target line up. First, the Fed has to convince itself that it can control the nominal level of output. Once they’re convinced, we’ll be convinced by them successfully moving policy to align expectations to their target. Once we’re convinced that policy will always be such that expected outcomes are the Feds target, then it’ll be so and nominal outcomes will be more or less constantly growing.
Good stuff. But what’s next?
…
This makes me wonder if the Fed has time varying credibility. If real output moves a little bit, the Fed can be expected to do the little that needs to be done to keep nominal output constant. But what happens when there’s a large shock to real output? Will the public believe the Fed will take the extraordinary actions needed to keep nominal output constant? Credibility is earned by the public observing the Fed follow-up on what it says it will do. The extraordinary actions have never been observed before by definition.
Is this what happened last Fall? Perhaps no Fed policy would have been credible under those extraordinary conditions.
“Let’s look at several of the problems that happened over the past few years in the financial sector, and see how legislative efforts have attempted to address them. (Spoiler alert: not very well.)”
Mike tells this story:
Our regulator’s goal isn’t to make a system in which there are never failures but a system in which failures are cleaned up in an orderly and nondisruptive fashion. Like an elaborate game of Jenga, even removing the smallest piece can collapse the entire structure, and regulators need to be able to remove any piece without having the entire real economy collapse.
This is a great story. Can it be rationalized? What objective function of regulators would lead them to aim to prevent “disruption”? A disruption now and again might be good by standard measures of welfare. Does Mike have a public choice model in mind? Do bailouts improve the chances of re-election?
Is the system as precarious as Mike suggests? Bailouts are sold to the public using a counterfactual that is rarely, if ever, observed. Namely, if the bailed out institutions were allowed to fail, it would have produced an undesirable level of systematic risk. When have failed banks caused systematic risk? The Great Depression had bank runs which caused a bad situation to get worse. But bank runs weren’t, by far, leading the causal chain. You need deflationary expectations, no deposit insurance and no branch banking to get those sorts of bank runs.
Besides, is the recent banking crisis evidence of the system’s precariousness or evidence against it? A long time transpired between banking crises in the US.
UPDATE: What is systemic risk?
