While catching up on some reading, this Op-ed in the WSJ rang so true with me that I wanted to share. In the article Holman W. Jenkins, Jr relates a recent sit down he had with Nobel-winning economist Robert Lucas of the University of Chicago.
Some insights from the article:
- When modelling an economy you need to make some assumptions
- Scrutiny of these assumptions is extremely important to the outcome of your model
- Personal biases can affect your assumptions and skew your results
The University of Chicago has put some famous assumptions into our investing vernacular. Terms like “efficient markets” the notion of “rational expectations.”
This piece about rational expectations may seem inconsequential or at least predictable, but this is not the case. Economic models are used to determine policy for the economy. The models produce outcomes based on the modeler’s own opinion of how a bank, consumer, and business owner etc. is likely to act. These market participants act with rational expectations of the future, based on current conditions. The reality is: “rational expectations” is not an axiomatic truth. The insinuation in the article is that neither President Obama nor the likes of Paul Krugman have scrutinized this concept. Current personalities with input into policy seem baffled, perhaps they have omitted this piece of consideration.
“By now, the Krugmanites are having aneurysms. Our stunted recovery, they insist, is due to government’s failure to borrow and spend enough to soak up idle capacity as households and businesses “deleverage.” In a Keynesian world, when government gooses demand with a burst of deficit spending, the stick figures are supposed to get busy. Businesses are supposed to hire more and invest more. Consumers are supposed to consume more.
But what if the stick figures don’t respond as the model prescribes? What if businesses react to what they see as a temporary and artificial burst in demand by working their existing workers and equipment harder—or by raising prices? What if businesses and consumers respond to a public-sector borrowing binge by becoming fearful about the financial stability of government itself? What if they run out and join the tea party—the tea party being a real-world manifestation of consumers and employers not behaving in the presence of stimulus the way the Keynesian model says they should?”
An Obama supporter in 2008, Dr. Lucas is genuinely disappointed in the policy of this administration.
This article is a very intuitive, common-sense, macro view of the world today.
Click here to read: http://online.wsj.com/article/SB10001424053111904194604576583382550849232.html
For information on Alhambra Investment Partners’ money management services and global portfolio approach to capital preservation, Douglas R. Terry is reachable at dterry@alhambrapartners.com
