"Applied Rationality Training Regime" #2: Searching for Bugs

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January 2, so I go on to Training Regime Day 2: Searching for bugs where the idea is to look for problems, presumably problems to be rational about but at any rate problems large or small: "In CFAR terminology, a bug is something that systematically goes wrong in your life." And this turns out to be a useful exercise, at least useful in that I hadn't thought enough about how the bugs in my life tend to group together. (And I'd always thought the term started with the dead moth that Hopper's group found after WWII, but it seems Edison was using it in the 1870s.)

  I look over at the kitchen sinks: two of them, small, at right angles to each other in a corner; one tap swivels over either sink and we usually have a dishcloth set on the tap so it can dry out. A long list of things that bug me, just a little bit each day, starts to pour out and then I just think "kitchen layout not well-suited for the current users' workflow." (Most of the time we've lived here has been pandemic time, or we'd have remodelled it already.) So I can list things individually, and I do (not here), but I prefer to think of that as one bug; our use is not the designed-for use and the usability of the kitchen therefore declined when we moved here eighteen months ago, even apart from a couple of physical points of deterioration (knobs, trash bin holder, a couple of hinges.) And yes, it bugs me. (It's possible that the kitchen was badly designed in the first place, but I prefer to think of it as a deterioration; the designer was thinking of something, after all.)

 I look at the messy desk where this laptop mostly sits (except that right now it's on a laptop stand in the hearth-room near the gas-insert fire, which is on) and I realize that the disorganization I see has been a major bug since childhood.... but I can at least see this as an infestation of same-species bugs in workroom (including shelves), garage, entryway, basement, shed, and back to the kitchen. Bug genus entropicus, species itemsOutOfOrderii, and a variety of varieties within that species.

The disorder bug becomes a productivity-failure bug, when I can't (easily) find the items I was going to write about, or when I can't (easily) find the tools or even the glue I was about to use, and so on. My T-shirt saying "organized people are just too lazy to look for things" is a reminder, but I've never fixed this. Aging has not made me more disorganized but it has made it harder to compensate; I can't hold as many items in my head at once as I could forty years ago, and I have less energy to waste. Are those separate bugs? I'd say that I'm getting symbiotic bug-pairs: entropy/mess critters are now coordinating more with entropy/decrepitude critters. It's still all about entropy.

Then there are other bugs of aging, for me and my wife and our little doggie too; my joints ache the way you'd expect for someone who has lost more than two inches in height.  Things work pretty well, except when they don't. I try to compensate with an hour's exercise each morning and with dietary adaptations and supplements and so forth, and this brings out other bugs that live on within the processes of compensation. I have multi-focal glasses, but mostly I do better with one fairly strong pair that I'm using now and an even stronger pair that I pull out for small print, but things don't get better and eventually they get worse. It's all about entropy, and it bugs me many times a day.

 There are items that would be bugs for other people; I'm a geek, and I think of myself as lacking in executive function, social awareness, and so on. Most of the time, for me these are features rather than bugs; it's just the way I always have been, and I like me just fine most of the time. Not always. But I guess things don't qualify as bugs for me unless I'm aware of them crawling around and getting in the way of my current goals.

  But the main bugs for this past year would be misjudgment bugs. For example, I did not expect the disruption of toilet paper supply, and I still don't really understand it: why didn't the businesses which suddenly couldn't use toilet paper, and had people who couldn't go to work, try to make a very little bit of money by redistributing their supply? I assume there's a good reason, but maybe not: maybe it was a regulatory barrier that just stayed up. I don't think I was sufficiently cynical about the WHO, FDA, CDC, Dr. Fauci etc. I suppose I was cynical enough about Trump, since I didn't believe his statements had truth-value to begin with, but back in early March when the Official Word was that masks don't work and you shouldn't be wearing them, I assumed there was a good evidentiary basis for that Word. And so on through the year. As Megan McArdle put it in the Washington Post,

The World Health Organization told us travel bans don’t work, apparently because they harm tourist economies; then we were told masks don’t work, apparently because experts worried that hoarding them would leave health-care workers without personal protective equipment; the public health community fell suddenly silent about the dangers of large gatherings during the George Floyd protests; a presentation to a government advisory committee actually described thousands of potential additional deaths as “minimal” compared with pursuing racial and economic equity; Anthony S. Fauci admitted he’d been lowballing his estimates of the point at which we’ll reach herd immunity.

Well I hadn't been believing Fauci for a while at that point; he does not seem to have credibility as a value, so he has none with me....but I don't understand him. I would like to understand him. There's a sort of model that Scott Alexander proposes, that I want to believe and do partly believe, in A Failure, But Not Of Prediction. Speaking of masks:

Common sense said that they worked. But there weren’t many good RCTs.
We couldn’t do more, because it would have been unethical to deliberately
expose face-mask-less people to disease. In the end, all we had were
some mediocre trials of slightly different things that we had to extrapolate
out of range.

Just like the legal term for “not proven guilty beyond a reasonable
doubt” is “not guilty”, the medical term for “not proven to work in
several gold-standard randomized controlled trials” is “it doesn’t
work” (and don’t get me started on “no evidence”). So the CDC said
masks didn’t work.

 I want to believe that, but it doesn't quite work for me, apart from the challenge-trial rejection which I reject (and I want to understand that mindset). The CDC was saying simultaneously that mask wearing doesn't work, and that health care workers need the masks. That bugs me quite a bit.

 More generally, I still don't have a good model of the "Very Serious People" who assure us that challenge trials are unethical -- it's ethical to forbid people to volunteer to save lives (on net) by risking their own? Since when? I don't even know how to think about that. I was just reading Scott Aaronson's "Distribute the vaccines NOW!" post, which lists the objection and gives the obvious-to-me reply:

5. Human challenge trials wouldn’t have provided much information, because you can’t do challenge trials with old or sick people, and because covid spread so widely that normal Phase III trials were perfectly informative. Actually, 1DaySooner had plenty of elderly volunteers  and volunteers with preexisting conditions. It bothers me how the impossibility of using those volunteers is treated like a law of physics, rather than what it is: another non-obvious moral tradeoff. Also, compared to Phase III trials, it looks like challenge trials would’ve bought us at least a couple months and maybe a half-million lives.

And that bugs me. It bugs me a lot, because I'm just not understanding. I'd have started with setting up challenge trials back in January (Wuhan closed down on Jan 23, and we'd already seen that it was present in the US....and we already had a vaccine, though that's far from the only thing to test. I wanted variolation trials, to begin with, back when I didn't know we already had a vaccine, and I'd have advocated for them anyway: if we know that variolation cases tend to be very mild, then we can be much happier to test vaccines. But I'd have said right off that "here's an alpha test, if it works out we'll have a beta test and then a gamma test and then announce public distribution, but anybody can sign up even for the alpha test if they want to and pass a quiz to show informed consent and can find a spot (i.e., a shot, and a room where you can get gradually increasing variolation exposures) available." If this is irrational, then I admit I'm still irrational; I still think that most of the pandemic so far, and all of it that may follow with a possibly-much-more-contagious strain, was avoidable from the beginning. And this bugs me a lot. (I described my own (fragment of a) healthcare plan way back when... I'd change some things, of course, and I wasn't thinking about the sort of crash Project that would be justified by a pandemic, but I think the principles are the same.)

Well, maybe this just shows the degeneration of an aging geek's brain; maybe it's all entropy after all. Today should surely be recognized generally as Entropy Day: it's the birthday of Rudolf Clausius who came up with the idea, and noted:

1. The energy of the universe is constant.
2. The entropy of the universe tends to a maximum. 

 It's also the birthday (as he celebrated it) of Isaac Asimov, who in his own favorite story (and mine, back when my ABCs were Asimov, Bradbury, Clarke, Delany, Ellison... ... ... Zelazny) asked The Last Question: "How can the net amount of entropy of the universe be massively decreased?" And perhaps it's worthy of note that it's the 118th birthday of Kane Tanaka, who has been fighting entropy longer than anybody else currently on this planet. And spends every afternoon studying math.

Hmm...I'm not sure I did very well on day#2, but it doesn't bug me very much. I think I've learned a bit, and I guess I've identified some things that will presumably come up in later days, if I get that far. So it goes.

Health Care and the Experts: Financial Analogy?

Some co-author or other saw the Myers (fragment-of-a-) Health Care Plan which I put up last Easter, which started with

1. Allow unlicensed health care, wherever it's clearly labeled as such; it won't get public support but people can choose to spend their money on it. The argument against this is apparently that people will make bad choices. Yeah, some will, probably including me and you. So? I've never understood the way some people believe that they (or those they select) can make good choices for others; in fact I'm moderately cynical about licensure requirements as they are now structured, whether for medics or morticians or cosmetologists.

His comment says

I came to look at Chelyuskin but chanced upon healthcare. Your item 1 is the only time I can remember when I totally disagree with you. You say: Some people will make bad choices including you and me. This equates mistakes by poor slobs who lost their houses and livelihoods in 2008 with "mistakes by TJM," that same TJM who, I suspect, belongs to that tiny minority who made money in 2008, because he has both sharp analytical mind and enough money to hire a top-notch money manager. Besides, this just won't work politically: as soon as a poor slob somewhere takes her child to an unlicensed healer, and the child ends up with an amputated limb, the outcry for regulation will be irresistible and, IMHO, justified.

I wasn't sure how to respond to this money-management analogy, and I let it go; I'll give it a try now...

I'm astonished -- and encouraged, because I would not have expected item 1 to be the only total disagreement even in this post, much less in general. And of course it's possible that I'm totally wrong...but I haven't changed my mind yet. Let's take it one step at a time.

The first point of disagreement, a very big one: No, I didn't make money in 2008. In fact in September 2009 I said

I haven't posted for a long time, but it's not that I haven't made any mistakes. Indeed, I've participated to some extent in one of the biggest mistakes of my lifetime -- the market crash of 2008.

Personally, I did see the bubble as such, earlier than some...

In fact I lost much less than I might have because (like my "top-notch money manager" -- I must remember to tell him about that description) I was expecting a downturn at some unpredictable point Real Soon, a small-to-middling wealth-effect recession whenever the bubble popped, and also of course because I avoided real estate. But I did lose, because we weren't expecting what happened. Was this an issue of expertise, in any useful sense of that term? People with far greater expertise than mine, including both the then-current and currently current heads of the Federal Reserve, were denying the problem -- even denying the limited problem that I saw then. (Indeed, since a big part of the problem was excessive risk-taking -- i.e. excessive confidence -- I think those public statements contributed to our still-continuing doldrums in addition to the policy errors I believe they made.) There were indeed a very few people who actually made money by understanding a part of what was going on: a short-seller named Eisman was quoted in late 2008 in The End Of Wall Streets Boom

“We always asked the same question,” says Eisman. “Where are the rating agencies in all of this? And I’d always get the same reaction. It was a smirk.” He called Standard & Poor’s and asked what would happen to default rates if real estate prices fell. The man at S&P couldn’t say; its model for home prices had no ability to accept a negative number. “They were just assuming home prices would keep going up,” Eisman says.

S&P denies that; I haven't heard any coherent excuses for the way they performed as the Supreme Appointed Financial Experts of the American economy (co-equal with Fitch and Moody's, of course). I dunno. Still it's my understanding that Eisman made money whereas on the average, people with more to lose (them with money managers) lost more, disproportionately more, than those with less. That's a Good Thing, as far as it goes -- it didn't go as far as it should because of Too-Big-To-Fail, i.e. some high-income people had their losses made good at the average guy's expense -- but it doesn't fit well with a belief that experts protect us from making disastrous mistakes. As I said in that Sept 2009 post, "To a disturbing extent, I think expertise in (macro)economics has been discredited. I don't believe this is adequately answered by Greg Mankiw's [remarks about economics being non-predictive]". I agree with parts of Brad DeLong's remarks a few days ago in What To Do About Jobs? that

given that most of what we macroeconomists were saying in 2007 was wrong, what, if anything, do we have to say today? Bear in mind that what turns out to have been wrong was pretty much everything that had been done since 1950....

Well, with part of it. As the the Economist (Ryan Avent) said last week,

The narrow point to focus on, however, is that the story in which the housing bust gave us the recession, because America suddenly had lots of houses and workers it couldn't use doesn't appear to fit the data. The economy muddled on despite the housing bust for two years, at which point, for some reason, all sectors suddenly decided that the outlook for growth was much worse than they'd previously believed.

As he says, that fits the Scott Sumner story I've blogged about before, which can be read as very conventional textbook macro and which blames most of the recession on the experts of the Federal Reserve, who simply did the wrong thing in a big way. (There's still room for other blames, of course.) On a more micro-economic level, I'd say that expert stock-picking advice is also of dubious value: I'm a moderate believer in a very weak form of the efficient-market hypothesis, and if this country were to adopt a deduction-free progressive consumption tax system (which it should do on grounds of efficiency/fairness/sanity) I would almost certainly stop using a money manager -- the money-manager's value is rather strongly dependent on his understanding of a complex system that really shouldn't exist. (Also dependent on the fact that his services are mostly deductible, i.e. you're helping to pay. Thanks!) What would I do then? I would switch to a passive management pattern, which in pure investment terms is at least as good and likely better:

In the United States, indexed funds have outperformed the majority of active managers, especially as the fees they charge are very much lower than active managers. They are also able to have significantly greater after-tax returns.

Most of my decisions would then have to do with asset allocation:

The conclusion of the study was that replacing active choices with simple asset classes worked just as well as, if not even better than, professional pension managers. Also, a small number of asset classes was sufficient for financial planning.

Hooray for Malkiel! And for Samuelson and Bogle!. This doesn't prove that financial expertise is worthless, but I don't think it has the kind of value you're suggesting.

Let me put it this way:

• Failure to consult such an expert now and then is really stupid. There are a lot of things a financial specialist knows that are not intuitive; important things.
• Many of these are routine things, how to file this-and-that.
• Many of these are simple things you really ought to learn yourself (why it probably makes sense to own more bonds and fewer stocks as you get older, etc. etc. etc.)
• Some of the others are simply not true, and we don't know which until it's too late (why the top tranche of a pile of mortgage-backed securities deserves its AAA rating, etc. etc.)
• Unlimited trust for your expert is not wise.
• Compulsory obedience to your expert is a really really bad idea, which fortunately is not employed except for the way that S&P and the other experts are embedded in the laws about risk ratings, which effectively required banks to invest in disastrous mortgage-backed securities...
• Perhaps the most important financial skill you can have is that by which you evaluate an expert; nobody else can do this for you, but certification and track-record-checking and recommendations are all important.

Your analogy between medical and financial services is not one that would have occurred to me, but it may have merit. Failure to consult an actual medical expert now and then is really stupid. Medical specialists do indeed know a lot of unintuitive things. Many of these are routine. Many are things you should learn for yourself. Many are false. Trust is a good thing, unlimited trust is a bad thing, compulsory obedience is a really bad thing. Certification and track-record and recommendations...yup. Okay, I'll take the analogy. :-)

Seriously, I think you're saying, effectively, that

If there's one seriously bad (but non-fatal) outcome from an unlicensed healer, public outcry will correctly push us back to requiring licensure

It seems to me you're forgetting something: the licensed doctors we have now are responsible for some 100,000 fatal errors per year (perhaps a little less, perhaps a lot more; see Wikipedia.) Those deaths are on top of a death-toll which I believe to be very much larger: deaths caused by the FDA's prevention of innovation. I'd suggest reading one article, Theory, Evidence and Examples of FDA Harm by Tabarrok and Klein:

Three bodies of evidence indicate that the costs of FDA requirements exceed the benefits. In other words, three bodies of evidence suggest that the FDA kills and harms, on net...

Or you might prefer The FDA: Neither Safe nor Effective ending with a Friedman quote:

“‘The FDA has already done enormous harm to the health of the American public by greatly increasing the costs of pharmaceutical research, thereby reducing the supply of new and effective drugs, and by delaying the approval of such drugs as survive the tortuous FDA process.’ When asked, if you could do anything to improve health in America, what would you do? Friedman replied: ‘No more licensing of doctors. No more regulation of drugs. Not of any kind. Period.’”

Actually, I don't quite agree, but my position is a whole lot closer to Friedman's than to anything that's likely to happen, and I'd accept his as being substantially better than what we have now. (And if we magically went to his, I like you and most others would go right on consulting a conventional MD -- but the MD I consulted might not be in the US. It might depend on what happened to the insurance industry, which would now be free to sell the sort of insurance policy that I'd want to buy.)

Or then again, maybe not.

Update:Stiglitz, Nobel Prize-Winning Economist, Says Federal Reserve System 'Corrupt' according to the Puffington Host:

To Stiglitz, the core issue is that regional Fed banks, such as the New York Fed, have clear conflicts of interest -- a result of the banks being partly governed by a board of directors that includes officers of the very banks they're supposed to be overseeing.

The New York Fed, which was led by current Treasury Secretary Timothy Geithner during the time leading Wall Street firms like Citigroup, JPMorgan Chase, AIG, and Goldman Sachs were given hundreds of billions of dollars in taxpayer bailouts, presently has on its board of directors Jamie Dimon, the head of JPMorgan Chase. He's been there for three years. He replaced former Citigroup chairman Sanford "Sandy" Weill.

"So, these are the guys who appointed the guy who bailed them out," Stiglitz said. "Is that a conflict of interest?" he asked rhetorically.

That really might explain the Fed's behavior... in finance as in medicine, the incentives of regulatory capture and crony capitalism apply. People who exert government's influence are always going to be pushed towards exerting it in favor of those who can exert influence on their behalf, and regulation -- especially licensure, as the power to say who can't compete with you -- is always going to be a Very Good Thing from the point of view of those who have a seat at the table. They may even sincerely believe that they are the only true experts, and that those who do things differently are simply not good for the public. (Or then again, maybe not.)

Update, June 13: In the end, the wealthiest did lose proportionately less from the recession: CONVERSABLE ECONOMIST: Wealth by Distribution, Region, and Age says:

Those in the 90-100th percentiles of the wealth distribution have median wealth of $1,864,000, and mean wealth of $3,716,000 in 2010. That's also the part of the wealth distribution that had the smallest percentage decline in the median and the mean from 2007 to 2010.

I believe that, and I suppose it might have something to do with financial advice, but my current reaction is simply that housing was the most overvalued part of the economy, and those below the top 90% had more of their wealth in housing--and were more likely to have to use up their savings due to job losses in the family. I don't think it has any implications for the health-care analogy.

It's all about healthcare. Well, and signaling.

This afternoon I was sitting in the third row, right behind the woman who placed the winning bid -- $13,000 -- on the auction of Harry Potter's bow tie. Well, of J. Pierpont Finch's bow tie, Finch being the lead character of How to Succeed in Business Without Really Trying; Finch is played by Daniel Radcliffe, a talented young actor/singer/dancer (well, a bit weaker as a dancer, I thought, but I'm no judge) who will probably be plagued for the rest of his life by people who can't help but think of him as Harry Potter. And he and his co-star were trying to raise money for a Good Cause, namely healthcare, after the performance. (Okay, a specific healthcare cause, but I'm still fussing about healthcare in general.) So....

So I would call the winning bid rather impressive; I think most people would. Radcliffe commented that we were "well over the record", some time before the auction closed---I presume he does this with a fresh bow tie for each performance. But I couldn't help but be reminded of the cost of my own appendectomy, not quite a year ago: it was in fact a little over the bow tie's price. Consider what that audience pays for healthcare each year...the auction was a Good Thing to Do, an Exercise in Nobility, a demonstration of the Brotherhood of Man (that being the last song&dance) but as a contribution to healthcare it was a teaspoonful in a lake.

Yes, I understand that's not the point. It's not really about healthcare, even healthcare is not really about healthcare. Robin Hanson put it rather well, some time ago, in his argument that it's about Showing That You Care:

I can explain these puzzles moderately well by assuming that humans evolved deep medical habits long ago in an environment where people gained higher status by having more allies, honestly cared about those who remained allies, were unsure ... These ancient habits would induce modern humans to treat medical care as a way to show that you care. Medical care provided by our allies would reassure us of their concern, and allies would want you and other allies to see that they had pay enough to distinguish themselves from posers who didn’t care as much as they.

That makes sense to me as the beginning of a model, and it certainly isn't a criticism of the woman who paid so much for the bow tie. She evidently does care, and presumably cares that it's evident that she cares, and that's a good thing.

Nonetheless, if you want to use healthcare provision to show you care, I think it would be a good idea to spend some time looking for actual ways to provide actual healthcare; a few more teaspoons of water in the lake won't do it. So I'd like to go back over my proposal of a bit more than a year ago. I'd organize it a bit differently now, but I don't seem to have moved all that far.

If I were (heaven forfend) In Charge, I would crowd-source as much as possible of the decision-making by pushing it into a market, with participants being given as much data for decision-making as possible, and being simultaneously milked for as much data as possible. I want incentives for innovation, to reduce the death-rate for billions yet unborn; I also want incentives for good performance now, not for the sort of regulatory capture our current system maximizes. Specifically I would:

1. Allow unlicensed health care, wherever it's clearly labeled as such; it won't get public support but people can choose to spend their money on it. The argument against this is apparently that people will make bad choices. Yeah, some will, probably including me and you. So? I've never understood the way some people believe that they (or those they select) can make good choices for others; in fact I'm moderately cynical about licensure requirements as they are now structured, whether for medics or morticians or cosmetologists.
2. Require transparent pricing, uniform no-bargaining pricing, from all providers of licensed health care. (The services producing my appendectomy really don't do this.)
3. Require that "licensing" be independent of geography; if the best/cheapest supplier of a particular treatment is two states over or on another continent, that's fine. As I've said before, I believe that telepresence medicine can enable the specialization and trade that has made markets work in other contexts since before Adam Smith wrote about it, so I expect this as the usual case, not an exception.
4. Take away the employer-based tax exemption; health care shouldn't be an employment issue.
5. Add a universal tax-funded "insurance" policy (insulation, actually): if your expenditures for "proven procedures" from licensed health care providers exceed the overall 16% (of GDP) average, then the taxpayers contribute some. Maybe if your cost is 30% of your income, then the taxpayers kick in (30-16)/2=7%, half of the overage, and the maximum you can pay is 50% of your income whether that's $0/year or $10M/year. Is that too generous? Not enough? I dunno. The point is to combine protection from catastrophe (but not from serious pain) with making sure that market prices are set by people or groups who are actually bargaining in that market, i.e. the better-off people for whom procedure X will not be covered. I want to do that combination with some simple, less-than-perfect-but-better-than-nothing rule with which I can trust a government. (Democrats and Republicans trust government on different things; just figure you want a better-than-nothing rule with which you'd trust a politician of the party you despise.)
6. If you want "unproven procedures" and you can pay for them, that's fine too; the licensed health care providers should have a strong motive to come up with new stuff and document/publish that it works. The FDA should not be able to keep you from paying for these likely-to-fail treatments, but it should keep you from charging it to the rest of us. If procedure X has no accepted studies supporting it, then it's up to you to pay for it.
7. Whatever additional insurance/insulation you want to buy for proven or unproven procedures is just fine, and can be bought across state lines. It's your problem. You want to save your money in a special bank account? Feel free.
8. Any care that has been paid or partly paid by public funds goes into an anonymized public database, so that we learn more about which treatments have what effects on which conditions. Organizations promoting not-yet-approved treatments will be encouraged to contribute data.

And that's really it, for me. I'm even less confident of this than I was when I wrote the first version, but I still don't see anything else I like as well. I think that the market I'm describing would probably evolve rather quickly into a market in which people choose and buy packaged health plans from "insurance" agents, and web sites build up crowd-sourced ratings of those health plans; there would be quite a bit of overlap with the better parts of what we have now. I hope. And I care, and I suppose I'd like to signal that I care.

Or then again, maybe not.

update:I never actually mentioned that this post was prompted by thinking about Mark Thoma's Economist's View: Discussion Question: How Can We Reduce the Growth of Health Care Costs?

there is far too much discussion of cutting services, and not enough about how to control costs without affecting services (e.g., using the government's purchasing power to reduce the amount the government pays for drugs, reducing the cost of insurance companies fighting over who pays bills, etc.)

You see, I doubt the premise: if you use government power as I believe Thoma wants, you are increasing the incentives for regulatory capture, crony capitalism, rent-seeking... you are putting yourself on a path where you have signaled your concern but healthcare is not what you're rewarding. Of course government power needs to be used -- to collect the money for treatments which research results say are crucial and which markets say are expensive. And government power needs to be used to maintain a context for innovation (rather than squelch it, as I believe our recent trends in "intellectual property" law tend to do.) But if bargaining-on-prices-with-the-government is the multi-billion$ activity you focus on, then that's what companies will have to invest in. That's a bad bad bad bad thing. I commented here.

Well, it's Easter morning. Maybe we're all saved?

Or then again, maybe not.

Yeah, the Fed Did It.

(More precisely, the Fed aggravated it; the Fed could have prevented most of it; the extent to which we depend on the Fed's good judgment should shrink, not grow.)

I believe we've been having a three-component economic crisis, each component building on and worse than the one before it, with overambitious or overconfident regulators/legislators making each component far worse than it needed to be. The three components I see are

• the trend-following housing (and financial services) bubble, which the Fed worsened slightly by false reassurances;
• the security-seeking, trend-breaking cash crunch which the Fed worsened greatly by too-tight monetary policy;
• the longer-run tech-based employment recalculation. (All right, the Fed is not guilty here but it mostly hasn't happened yet, and our sensitivity to the mistakes the Fed made this time is growing with time. Cheer up, the worst is yet to come.)

bubble: I've commented on the housing bubble before, and how I think it was worsened by regulators and legislators (and raters) who denied the problem. Investor irrationality was real, but part of that irrationality was the willingness of investors to trust pronouncements by Greenspan and Bernanke, by Barney Frank and others on both sides of the aisle, and of course their willingness to believe that AAA meant "safe". I'm not arguing that interest rates were or weren't too low. (I do not believe that was the problem.) I'm not saying that the regulators were (or are, or will be) stupid or malevolent. I am saying that they were, quite obviously, wrong, and that those who relied on their assurances did very badly. (Those who simply said "prices are rising, I'll bet everything I can borrow that the trend will continue" did exactly as badly; there are always some of those.) I'd fix that (following Arnold Kling) mainly by going back to a world of high down payments. You could still give 100% financing if you wanted, but any federal support (including FDIC guarantees for a bank that offers mortgages) should depend on at least 20% down payment. Leverage would shrink generally, and underwater mortgages would be extremely rare. This would reduce homeownership rates, of course, and that may be regrettable, but it's not obvious that people are helped by encouraging them to make commitments they are likely to break, or be broken by. Of course this version of Kling's reform won't happen; what we're getting instead is expanded trust in that which failed before, to which we add taxpayers having to guarantee more than 95% of mortages, still being pushed on those who can't afford them.

cash crunch: As I've said before, I've become a semi-Sumnerite:

the real problem right now is not a “real” problem. The real problem is a nominal problem. When the growth rate of nominal GDP falls sharply there is always a severe recession. We have a severe nominal shock, a problem which has been understood by economists at least as far back as Hume. At the time, it always looks like the “real problem” was some symptom of the monetary shock, such as financial panic. Thus in the 1930s people thought the collapsing financial system caused the Great Depression, only later did we discover it was too little money.

Investors' efforts to minimize individual risk ended up adding to systemic risk. Actually it seems to me that we knew by February 2008, when Roubini said,

"Cash is king in 2008,"... the U.S. went into recession in December and will stay there for at least a year.

The Federal Reserve under Bernanke ignored what Bernanke had written academically; it brought down interest rates and then declared a "liquidity trap". It did expand the monetary base, but not nearly enough to satisfy demand -- and they neutralized part of their monetary expansion in fall 2008, by paying interest on excess reserves, encouraging hoarding by banks. Cash remained king, mostly because people were worried about too much risk in their portfolios. Here I would agree with Sumner that we should target NGDP (nominal GDP, aggregate cash flow) but I worry that buying Treasury bonds with cash, exchanging one low-risk item for another, might not succeed; we need to cope with people trying to shed risk. The Fed's purchases of mortgage-backed securities seems like a really bad idea: this is not absorbing risk in the sense of variability, it's buying a bet that already failed and attempting to prop up a market that should go downwards because there are too many houses out there for a while. So,

• I'd make NGDP measures tradable in the form of Shiller's trills, creating a permanent market growing to perhaps a billion trills, paying one-tenth of one percent of our GDP, owned by citizens or foreigners but not by our own government.
• Like Sumner, I would announce that we're targeting a 5% growth trend in trill yield (i.e., in NGDP), based on the pre-2008 trend so that if it rises too fast or too slow in one year we compensate the next; this is "level targeting".
• I would give the Fed a stock-bonds-cash portfolio to be rebalanced daily, where the cash can be effectively imaginary (set it at last year's NGDP, most will never be printed) and all stocks are treated equally via a Wilshire Index fund; this rebalancing portfolio is the key difference between me and everybody else, hence probably totally wrong, but it makes sense to me. If investors starts selling stocks, the Fed will automatically buy, or sell if everyone else is buying, so this couple-of-trillion portfolio would automatically tend to stabilize the market. It would probably make money for taxpayers, too.
• How would it stabilize the NGDP trend? When trills (next year's trills; buy them now!) start to fall, the Fed would change the portfolio proportions, giving cash for stocks and perhaps bonds, absorbing risk and satisfying the demand for cash. When trills start to rise above the price level target, the Fed portfolio proportions would change back.
• Actually, I might make this last item more indirect: I might start a prediction market on the proportions required to achieve the actual NGDP target. In effect, I'd be giving knowledgeable parties something to bet on, so that they'd make money by getting it right. I don't want them able to make money by betting on the actual cash value of a trill's annual yield: that's (2008 yield)*(1.05^N), so the "right answer" is known in advance. Bet on the unknown path to that, instead. The Fed would use this prediction market to guide the proportions.

Instead of this, of course, we're giving the Fed a more complex mission as if its people had enhanced credibility. Since their credibility with me has gone way down, I don't find this reassuring.

employment recalculation: Kling talks about recalculation, reallocation of resources including labor in the constant search for "sustainable patterns of specialization and trade", and the unemployment this causes. Sumner acknowledges that some recalculation was required at the beginning, but mostly he just means the structural issues of too big a housing sector (and finance.) Delong and Krugman point to aggregate-demand-based unemployment and say that structural unemployment is on the way, but not yet a big deal. (Of course current unemployment is made worse by underwater mortgages which keep people from moving where the jobs are, and therefore by low-down-payment policies. And it's made directly worse by the cash crunch which motivates companies to sit on their cash, and it's made worse by regulatory uncertainty (and especially health care) and inflation uncertainty. But this is talking about aggregate demand v. structural, with recalculation as part of a slightly different story.)

I'd agree with them all, mostly, but add that recalculation is growing as an issue in a way they haven't (to my knowledge) discussed. My feeling is that overall technological productivity will gradually become the biggest factor in continuing unemployment, in the sensitivity of unemployment rates to (failures in) NGDP trends. I think that our increasing wealth and productivity means that a sharply decreasing fraction of the population is generating stuff we actually need, and a less-sharply decreasing fraction of the population is generating stuff we think we need. When money-trends continue, this doesn't matter because people buy whatever they were planning to buy. When money-trends fail and people want to hide their money, only the essentials keep going and that's a shrinking part of the economy. In the long run, (almost?) all production of goods and services is optional. In the short-to-medium run it would be enough to have the Fed do its job, making sure money-trends continue so people are comfortable buying stuff they want, not just what they think they need. In the long run, we will also need a negative income tax.

My approach to this stuff would be even more drastic, and therefore more unlikely, than my approaches to the preceding problems. So I won't finish this part of this post.

Footnote, since this is stuff that wasn't part of the way I thought through 2008: Aggregate cash flow is NGDP, Nominal Gross Domestic Product, the sum of all the money we pay (or get paid) for all the goods and services we use (and produce). You can divide that by your best guess at an inflation multiplier to get "Real GDP", the theoretical "constant-dollar" value of all those goods and services, but your paycheck and mortgage payment and grocery bill are paid in actual nominal cash flowing around and around, keeping our individual financial plans going by fulfilling the promises that we need to make economics ("sustainable patterns of specialization and trade", as per Arnold Kling) work. If expected NGDP drops, then you're already in a recession. I didn't really follow this argument when Tyler Cowen first recommended Sumner's blog. In the end, it's not that complicated. Think of a zillion spreadsheets carrying business plans and personal plans forward a few years, each projecting current trends. Aggregate cash flow -- that's "Nominal GDP". NGDP. Money. Some of those spreadsheets, some of those plans, will fail and others do better than expected, but generally the aggregate cash flow rises each year as population goes up, as productivity goes up, and as inflation goes on. If it falls or rises a little away from the expected trend implicit in all those individual plans, we adapt. If it falls sharply below trend, then cash isn't going around as expected and plans start failing simply because cash isn't going around: businesses fail and it's not their fault. Things are broken. We have a recession, a bad one.

In fact, people act by plans and promises, betting on their projections, so we get a recession as soon as the expected NGDP growth fails so that people stop buying and employers stop hiring.

Q: That sort of sounds almost convincing. Very odd. But isn't the future causing the present here?

A: Gee, thank you. It's actually close to tautological: expected NGDP is the aggregate of expected cash flow, and your belief that you're no longer going to be able to buy the goods and services you expected to buy will immediately change your behavior, the recession hits as soon as you expect it. So it's your beliefs about the future causing your behavior in the present.

In the current case we had a small recession because a whole lot of investors had believed our regulators and legislators who downplayed the risks of the bubble. They -- the investors -- had believed in the AAA ratings. When they hit reality they bounced, and needed more cash.

Q: But is this the Fed's fault? I mean, apart from Greenspan and then Bernanke denying the bubble?

A: The Fed has a dual mandate: they are supposed to manage inflation and unemployment, by managing the money supply. I'm saying that I mostly believe Sumner: the Fed did expand money somewhat, but they could have avoided most of the pain we've felt if they'd done more. So yeah, it's their fault.

Q: Done more? Done what? Lowered interest rates below zero?

A: Well, first by not paying interest on (excess) reserves, which was and is contractionary. Second, by announcing an inflation target or better an NGDP level-targeting sequence. Third, by expanding their open market purchases; preferably by starting the kind of automatically daily-rebalancing portfolio I described above.

Q: I understand why paying interest on reserves is contractionary; why are they doing it?

A: I don't really understand, but I think it's simply a way to give the banks money so they don't fail, while pretending that it's not Main Street bailing out Wall Street. I'm getting very cynical in my old age.

Ryan Avent of the Economist said

It's getting ever more difficult to avoid concluding that the Fed's inflation target is not the 2% we'd all come to expect, but something much closer to zero. This obviously impacts economic behaviour. The Fed could potentially have a significant effect on conditions simply by letting markets know that it's not actually happy with the current inflation trajectory.

Recently (Sept 2010) Bernanke has said that, with good effect; let's hope he goes further. There's some evidence that it will happen, e.g. Calculated Risk's Fed's Lockhart: The Approaching Monetary Policy Decision Dilemma

I think a consensus is building for QE2 in early November.

But I don't trust Bernanke to follow through, or at least I don't trust the Fed he leads...and that's what it depends on.

Or then again (I hope), maybe not.

Update: I see Avent saying in The perils of prediction: Forget forecasts, trust markets | The Economist that

I like to point out that in June of 2008 the Federal Reserve forecast real GDP growth in 2009 of 2.0% to 2.8%, when in fact the economy shrank in 2009 by over 2%. Of course, this doesn't mean that central banks have no basis on which to make policy. All they need do is look at the evidence in front of them. Markets...

I trust markets a lot more than I trust the Fed.

Perhaps I should note that Sumner does not blame the Fed for failure to predict, as he said in TheMoneyIllusion » The Fed doesn’t have a crystal ball

All the major investment banks with their million dollar Ivy League employees missed this crisis (and its eventual impact), and yet the Fed was supposed to have predicted it? The Fed pays much lower salaries than Wall Street.

Indeed, I wouldn't blame the Fed for the housing bubble recession-trigger at all if Greenspan (and then Bernanke) had simply said "Bubble-detection is not part of my job, I can't help you with that." But this is not what I understood them to be saying.

update: Ah-ha! An actual reputable economist, Nick Rowe, says at least that

If I had my druthers, the Fed would buy stocks. Something like the S&P500 index.

This is not equivalent to saying that the Fed should do a large part of its monetary policy via a rebalancing portfolio somewhat similar to what investment people prescribe for individuals, but it's a start. Yay!

(Or then again, maybe not.)

upd: The same Nick Rowe is quoted approvingly by Brad Delong in Against Money-Financed Fiscal Expansion, For Open Market Operations in Equity Indexes

OK. Start with the Fed buying bridges. That will work. Now, wouldn't it be nice if the Fed could also sell those bridges again later, if it needs to, as it probably will. Bridges aren't very liquid. And, the Fed is good at clipping coupons on bonds, but perhaps not very experienced at collecting tolls on bridges. Hmmm. Maybe if the Fed just bought shares in bridges instead, that would be as good as bridges, but even better from the practical point of view. Hmmm. Why stop at bridges? Why not buy shares in everything? Why not just buy the Wilshire 5000, or some such index?

Excellent. The right index identified, along with the need for later sale; we are close to portfolio rebalancing.

Bubble Thoughts

I haven't posted for a long time, but it's not that I haven't made any mistakes. Indeed, I've participated to some extent in one of the biggest mistakes of my lifetime -- the market crash of 2008.

Personally, I did see the bubble as such, earlier than some...I sent a message titled "Housing bubble warning" on June 5, 2003. Was I prescient? No, I was just quoting the Economist of that time:

 http://www.economist.com/displaystory.cfm?story_id=1794873

 This survey will conclude that the latest housing boom has inflated
 bubbles in several countries, notably America, Australia, Britain,
 Ireland, the Netherlands and Spain. Within the next year or so those
 bubbles are likely to burst, .... ... ... Significant numbers of
 owners may be left with homes worth less than their mortgages...  

After the quote, I closed that message saying

 And of course if houses are worth less than their mortgages, there
 might be bunches of trouble of various kinds. "Within the next year or so".

 Tom of-course,with-stocks-irrational-exuberance-kept-going-for-years Myers 

And I went on talking about it for the next few years, as I had talked about the original "irrational exuberance" starting around 1997, and I sold some real estate and urged people to read Shiller's second edition when it came out, and urged my son not to buy real estate (and he didn't), but I didn't foresee the crash. I didn't realize that the global financial system was betting trillions that Shiller was wrong.

It doesn't worry me that I didn't foresee the timing of the pop; I never expected to be able to do so, so I did not even think about betting against the market myself. ("The market can remain irrational longer than you can remain solvent.") It does bother me that neither I nor the experts foresaw the disaster it has become. If you'd told me in 2006 that we'd be having a banking crisis, I'd have said something like

"of course we have a real estate bubble, and when it pops we'll have a wealth-effect problem, perhaps a small recession, but people who run banks or investment firms know what Shiller has been saying and they know they've got to hedge against his being right, even if they don't believe him. I read a bunch of economists' blogs; they talk about the housing bubble, they're not talking about a crash."

In other words, I depended upon experts. There were some who kept on predicting one disaster or another, most notably Paul Krugman and Nouriel Roubini. They seem to have gained credibility from the meltdown and recession, but they both predicted a dramatic fall in the dollar as part of the meltdown they predicted. Krugman, it seems, has been predicting a dramatic fall in the dollar since the mid-1980s. Understandable, of course, but that doesn't count heavily as a prediction. As to Roubini, it doesn't really bother me that he "was one of those who predicted 10 crises out of three", but it does bother me that, like Krugman, "In 2004, he predicted that the oncoming recession would precipitate the crash of the dollar. The crisis has mainly buoyed it."

Of course the dollar still might fall -- it seems to me I put something about that in class notes (computer science, looking around for random examples of numerical stuff to model) of the late 1980s, and I may have been reading Krugman back then. For me it went along with a comparison of the savings rates of Americans vs. Japanese, as now it would go along with thoughts about our suddenly increased Federal debt, with the prospect of continuing increases. But the dollar didn't fall as part of the crash we're talking about, so the crash we're talking about is not the one Krugman and Roubini predicted. Or so it seems to me.

To a disturbing extent, I think expertise in (macro)economics has been discredited. I don't believe this is adequately answered by Greg Mankiw's

It is fair to say that this crisis caught most economists flat-footed.
In the eyes of some people, this forecasting failure is an indictment
of the profession.

But that is the wrong interpretation. In one way, the current downturn
is typical: Most economic slumps take us by surprise. Fluctuations
in economic activity are largely unpredictable....

Likewise, students should understand that a good course in economics
will not equip them with a crystal ball. Instead, it will allow them
to assess the risks and to be ready for surprises. 

Yes, but macroeconomists did not assess the risks, at least not correctly, and were not ready for surprises. We were all clueless. The academics, the legislators, the regulators, the raters, the financial moguls, investment advisors, ordinary investors... clueless. That's not good. So, do I have a theory? Sure. Lots of overlapping theories, and I think that each of them is probably somewhat true. More later.

Or then again, maybe not.