Some Economics of Housing _Policy_

|Peter Boettke|

Whenever I did something stupid -- on the playing field or in life -- my father would often grab me by the shoulders with both hands, stand me up, and stare me in the face and say simply: "Peter, this isn't rocket science." And then give me the straightforward explanation of what I should have done instead that would not be so stupid and would have resulted in the outcome I desired.

I have adopted many of my father's sayings as I have grown older, and this particular phrase "ain't rocket science" I tend to use all the time about economics.  Yesterday the report came out that housing sales were down, and the stock market fell.  I woke up this morning to emails from a very good friend in the investment business with dire predictions from Morgan Stanley and even Goldman Sachs that the US economy is going to tailspin into a deeper recession.

I don't possess a crystal ball, so I cannot forecast the economic future. But I do know that it is not good to expand the monetary base 140% or to run deficits the size we have, or accumulate public debt as we have. See Laurence Kotlikoff in The Economist.  This "ain't rocket science"!  There will be a day of reckoning due to the monetary mischief and fiscal irresponsibility.

I also know that the problems we are facing are not "market problems" --- it is not that actors are all of a sudden 'irrational', and it is not that markets are inherently 'unstable'.  Everything we are seeing in market behavior is a rational response to the environment created by public policy.  This is not a psychological problem we are dealing with, it is a public policy problem.  Bad public policy produce bad incentives which in turn produce bad results.  Ultimately, this is a problem of bad ideas which result in bad public policies.  Again, this ain't rocket science.  The role of the economists in all of this should be like my Dad when I was a teenager (and truth be told an adult), and grab policy makers by the shoulders star them squarely in the face and state clearly "this isn't rocket science" and explain clearly the Econ 101 basics of why the decisions we have made so far have not been correct.

Gerald O'Driscoll over at ThinkMarkets does precisely this today.  Nothing that has gone on so far with the housing market would be unpredictable with a little return to the lessons of Econ 101 about incentives and information, and how markets work to coordinate plans through time via relative price adjustments and profit and loss accounting.  Policies produce incentives, when individuals in the system follow the path those incentives lead them to pursue, we should not be surprised (and certainly not disappointed). The policies adopted produced the results we see, not individuals behaving badly or behaving 'irrationally'.  Unfortunately, in our efforts to be 'sophisticated' we often confuse simple economics with simple-minded economics.  But there is nothing simple-minded about returning to simple basics of economic science.  This ain't rocket science, but individuals respond rationally to incentives and demand curves slope downward and supply curves slope upward.

Comments

[Daniel Kuehn]

Should we worry at all when both sides of the same issue each say "it's ain't rocket science" - because clearly you're not the only one befuddled with the other side's position right now.

It seems to me when one side is caught off guard and the other side isn't surprised, then that's a good time to say "it ain't rocket science". When both sides are saying it, thoguh, that's a good indication that the answer isn't as easy as either side suggests.

btw - the comments were closed but I agree with and appreciate your history of thought post. I live a couple blocks away from the Arlington campus - if you were teaching it there I might have signed up for the class.

[Jasper]

"it is not that actors are all of a sudden 'irrational', and it is not that markets are inherently 'unstable'. Everything we are seeing in market behavior is a rational response to the environment created by public policy."

Over generalization - but I'll go with it.

[Jerry O'Driscoll]

I have been rereading Hayek's Monetary Theory and the Trade Cycle. He doubted that any monetary system can be designed to avoid economic fluctuations.

Henry Simons, whom Hayek greatly admired, advocated 100% reserve banking and limits on all forms of short-term credit. I think Simons could be credited with anticipating the problem of shadow banking.

Simons ideas were incorporated in the Chicago Plan for Banking. Fisher had his own plan. Milton Friedman advocated narrow banking and updated the Chicago Plan in 1960.

More recently, Nicole Gelinas of the Manhattan Institute has argued in "After the Fall" that free markets can be saved only by regulation and restircting what banks and Wall Street do. That is in line with Simons and the early Chicago School.

And, of course, we have Laurence Kotlikoff's plan for radically restrucuring all forms of financial services -- defined very broadly -- as mutual funds. Excess leverage is bad, so eliminate all leverage.

I think Hayek would have thought the solutions constructivist and overkill. But what are classical liberals to say? Free banking, narrow banking or no banking (effectively Kotlikoff's solution)?

Footnote: Sam Houston was a Jacksonian, and saw to it that the Texas constitution forbade banking in the Texas Republic.

[Richard Ebeling]

If I may mention, the 19th century American free market economist, George Gouge, wrote a book on "The Fiscal History of Texas" in 1852.

He details the monetary and fiscal mischief followed by the provisional government of Texas during its war for independence from Mexico, and then the period of its full independence until its incorporation into the United States.

In reference to the period of their war for independence, Gouge say that the leaders of the revolution,

"finding that other nations in their periods of exigency had resorted to taxing, borrowing, begging, selling, robbing, and cheating, they were determined to try all six."

Both before and during Texas' ten years of independence they imposed restrictive tariffs. (Exempt from import duties were billiard tables, liquors, and nine-pin alleys, and "games of that kind." You have to have your priorities, clearly, to assure a supply of "essentials.")

To attract volunteers to find in the war for independence and induce lenders to finance the war, they "sold" or promised land grants far in excess of the amount available. In other words, they "sold" or "pledged" the same lands multiple times over.

The leaders of Texas during its years of independence often referred to a national debt as a "blessing." And they practiced what they preached. So much so, that when Texas was annexed by the U.S., the Congress appropriated $10 million to fund redemption of Texas' outstanding government debt. (That was "big bucks" back then.)

Under "robbing," the Texas revolutionary authorities authorized basically seizing beef heads of Mexicans to feed the troops.

Under "cheating," Gouge explains the recourse to the issuance of paper money to fund the war and other expenses.

History offers many examples of fiscal and monetary irresponsibility from which we can learn.

(If you have difficulty finding a copy of Gouge's book, 19th century American economist, David Ames Wells, offers an excellent summary exposition of Gouge's analysis in his own book, "Practical Economics: A Collection of Essays Respecting Certain of the Recent Economic Experiences of the United States" [1888], in the first chapter entitled, 'A Modern Financial Utopia: How It Grew Up, and What Became of It.')

Richard Ebeling

[Troy Camplin]

After I took university physics and had rocket science taught to me in literally half an hour, I have always found the saying "it ain't rocket science" to be absolutely hilarious. Rocket science is in fact one of the simplest forms of knowledge one could imagine. Economics, on the other hand, is one of the most complex.

[Richard Ebeling]

John Maynard Keynes recounts in his memorial essay for Alfred Marshall that he once asked Ernst Mach if he had ever thought of studying economics.

Mach replied that, indeed, he had, but found that it was too complex a subject with so many variables interacting all at once, and decided to give it up.

So I think, as Machlup once pointed out, we should have no inferiority complex about economics compared to physics any other of the "complex" natural sciences.

Richard Ebeling

[Peter Boettke]

Daniel,

I have to say that in this entire time period, I am not drawn constantly to Hayek or Keynes, but to the letters between Say and Malthus and their debate over the possibility of a general glut. I take the Say position.

And among bloggers, I think Mario and Jerry have done fantastic, as has Richard Ebeling (in terms of putting things in historical perspective), but I am also drawn often to the perspective that Casey Mulligan offers at Supply and Demand.

[Jasper]

Troy,

It is all a matter of how in depth the material goes: for instance did your intro to physiics class talk about the fluid dynamics of how liquid feul breaks apart in zero gravity? Somehow I doubt it.

-J

[Greg Ransom]

"Rocket science" in fact was part of the problem which created the current crisis. E.g.

-- the "Quants" on Wall Street with their "no fat tails" statistical models

-- the ratex thinking of folks at the Fed. (like Greenspan) who believed asset bubbles were impossible.

-- the prestige via the "rocket science" mathematization of old ideas that such work gives to money cranks like Paul Krugman, who has cheer leaded for horrible policies in the NY Times for a decade.

Well, that's the short list.

[Greg Ransom]

The irony is that Samuelson and Schumpeter and Neurath and others thought that Mach's bogus picture of "science" was a perfect fit for mathematical economics.

Not so much, alas.

Richard wrote,

"John Maynard Keynes recounts in his memorial essay for Alfred Marshall that he once asked Ernst Mach if he had ever thought of studying economics.

Mach replied that, indeed, he had, but found that it was too complex a subject with so many variables interacting all at once, and decided to give it up.

So I think, as Machlup once pointed out, we should have no inferiority complex about economics compared to physics any other of the "complex" natural sciences."

[Troy Camplin]

J. --

First, it wasn't intro to physics, it was university physics -- the first class for physics majors. Second, what you described isn't actually rocket science, but fluid dynamics. Rocket science per se involves equations about how much thrust one needs to get a ship off the earth and into orbit. Beyond that, we are talking about engineering problems -- which are also in fact pretty simple for the most part. The fluid dynamics problem is probably the most complex problem in all of rocket science, and that's still about 3 magnitudes less complex than economics.

For difficulty in respect of complexity, one has to ask oneself how many variables one has to keep up with, as Ebeling observed in his anecdote.

Let me give an anecdote of my own:

I have an acquaintance who was working on his Ph.D. in engineering. He believed that I have gotten my Ph.D. in the humanities because it was easier than the sciences, and he didn't believe me when I told him I had dropped out of my Master's program in molecular biology because I had gotten bored with it, and that I had gotten into the humanities because it was sufficiently complex to prevent me from getting bored. Needless to say, he also didn't believe me when I told him that the humanities was harder than math and engineering. At least, he didn't, until one day he came into the Starbucks where I like to work and saw me working on a paper on Aeschylus' play "The Suppliants." He asked me what I was working on, and I proceeded to tell him how I was explaining how one could understand the action of the play better by looking at the historical situation, the social changes going on (which included expanding notions of who was properly "Greek" and also expanding notions of what constitutes incest, bringing in a discussion of the Westermarck effect), the motivations of the characters by using evolutionary psychology, and the role of tragedy in ancient Greek society. When I finished, he looked at me in silence for a few seconds, then said, "How on earth do you keep track of so many variables at once!" "I told you this was more difficult than engineering," I said. He nodded, and never argued with me on that issue again.

[Daniel Kuehn]

"The irony is that Samuelson and Schumpeter and Neurath and others thought that Mach's bogus picture of "science" was a perfect fit for mathematical economics.

Not so much, alas."

Ya... that whole comparative statics thing... terrible idea! That has never done anything for us!

I think these critiques are kind of silly. He borrowed some math, but math is math. Darwin was inspired by Malthus - do we throw out evolutionary biology because we're terrified of disciplinary miscegeny? These critiques start to get a little silly.

Most of Samuelson worked out great and that, ulimately, is the only test.

[The Cuttlefish of Cthulu]

Anybody who thinks that quants were (and are) anything more than window dressing on Wall Street obviously has never worked there.

[Greg Ransom]

Daniel, what are you talking about?

"Ya... that whole comparative statics thing... terrible idea! That has never done anything for us!"

This has nothing to do with "borrowing some math".

This is about adopting wholesale a deeply false picture of science (and knowledge)l

[Greg Ransom]

In providing a completely bogus explanatory strategy / "scientific" program for economics, Samuelson and Schumpeter lead the profession into a massive FAIL which the profession has still not dug itself out from under.

[Greg Ransom]

Daniel, once more you venture out into fields you don't know a thing about, with self confidence that is humorous.

[Greg Ransom]

People made billions betting against quant models.

The money says you are wrong.

"Anybody who thinks that quants were (and are) anything more than window dressing on Wall Street obviously has never worked there."

[The Cuttlefish of Cthulu]

"The money says you are wrong."

My experience in the actual industry says you are a clown who is commenting on things he's clueless about.

[Greg Ransom]

This is why the "assembly of reminders" is so crucial in economics.

"When I finished, he looked at me in silence for a few seconds, then said, "How on earth do you keep track of so many variables at once!""

To dismiss "the assembly of reminders" (e.g. the history of economic ideas )is to fundamentally misunderstand the complexity of the science (not as math, but as an explanatory complex).

[Greg Ransom]

There's no evidence you have any experience in any industry, "Cuttlefish".

Michael Lewis tells the story of betting against quant models in his "The Big Short".

Outsiders took the Wall Street boys to school.

Scott Patterson's _The Quants_ is good on the history.

If you know so much, write your own book, "Cuttlefish".

[The Cuttlefish of Cthulu]

"There's no evidence you have any experience in any industry, "Cuttlefish"."

No need to take my word for it, Greg (btw still waiting for you to write a book, or anything else for that matter). Simply ask yourself: do you really believe the self-serving stories Wall Street management is feeding intellectually lazy journalists (is there any other kind?) about quant models blowing up the economy? What kind of "experience" do you need to recognize a snow job when you see it?

And appealing to Michael Lewis? LOL, what a tool (you and him).

[Steve Horwitz]

Gentlemen,

I think it's time to ratchet down the rhetoric. I have deleted two of Greg's comments that were, shall we say, non-responsive. I've left CofC's in only because the first part is substantive, though the charges of being a "tool" need to stop.

I'll also note, to Cuttlefish, that this is the downside of choosing a pseudonym. Greg is perfectly justified for asking for substantiation for your claims of "industry experience." Your pseudonymity gives him, and us, every reason to not believe that claim until some concrete evidence is on the table.

Hiding behind a codpiece makes it tough to put your cuttlefish on the table when your bluff is called.

So let's behave ourselves and stay on topic and avoid the namecalling. Demands for substantiation, however, are fair game.

[Jasper]

Troy,

Point taken. I don't have any PHDs, so can't say what's more complex. The fluid problem however remains unsolved.

On Quants: There are a lot of different types of 'quants' and there is a big difference between high frequency automated traders and the quants who hedge insurance company portfolios.

While I'm sure no magic formula like in the movie "Pi" exists, a lot of quant ideas (especially the ones backed up by non-quant reasoning) make a lot of sense --- the risk of course is that these trades get crowded out (and that you don't know it).

Here's one example of a quant variable that makes sense: when research analysts raise (or lower) their estimates they generally won't go way out of line ahead of the street, they'll go just a little above the street. The next analyst will go slightly above the new highest numbers. Therefore you often see a walking up of earnings estimate as various shops issue reports.

-J

[Troy Camplin]

It is much more likely the fluid problem will be solved before any of our social problems are.

[Current]

I agree with Daniel Kuehn that the questions surrounding the 140% increase in the monetary base certainly are akin to rocket science.

[Troy Camplin]

Yeah. It's pretty straightforward: 140% increase in money supply = 140% inflation (unless, through some miracle, the Fed can actually get all the money back -- I'm as confident they can do that as that they can manipulate interest rates with no economic consequences).

[Current]

Troy,

It isn't that simple because we can't be sure that there is a constant demand for money. Friedman suggested that there was, but the evidence doesn't really back him up, especially for recessions.

I agree that the Fed could have difficulty getting the money back. I think that's why the current interest rate is so low. Investors are worried that when price inflation rises they will be burnt if they've tied down their capital.

All that said, it's *not* a simple problem.

[Troy Camplin]

Of course there's not a constant demand for money. When the inflation starts, it will be ehterogeneously spread through the economy. On average, it will end up being the same percentage as the money created, though.

As for interest rates, there's no evidence to support your claim. Interest rates were held artificially low leading into this crisis (and causing it), and these low interest rates are merely a continuation of tht policy.

To the extent that this is complex, it most certainly isn't rocket science -- rocket science is much simpler than this problem. But the outcome is as predictable. If you know what's really going on.

[Lorenzo from Oz]

So, is the burden of this comment (and that linked to) that the putative future inflation/hyperinflation is a monetary phenomenon but the current disinflation is not?