In an article called The Time Bernanke Got It Wrong, Floyd Norris of the New York Times gives us a wonderful quote about rational economic man, also know as Homo economicus.
In his speech last week, Mr. Bernanke cited several assessments of the Great Moderation, including the one by the Fed economists. None questioned that it was wonderful.
The Fed chairman conceded that “one cannot look back at the Great Moderation today without asking whether the sustained economic stability of the period [1983-2007] somehow promoted the excessive risk-taking that followed. The idea that this long period of calm lulled investors, financial firms and financial regulators into paying insufficient attention to building risks must have some truth in it.”
One economist who would have expected that development was Hyman Minsky [image above]. In 1995, the year before Minsky died, Steve Keen, an Australian economist, used his ideas to set forth a possibility that now seems prescient. It was published in The Journal of Post Keynesian Economics...
When I talked to Mr. Keen this week, he called my attention to the fact that Mr. Bernanke, in his 2000 book “Essays on the Great Depression,” briefly mentioned, and dismissed, both Minsky and Charles Kindleberger, author of the classic “Manias, Panics and Crashes.”
They had, Mr. Bernanke wrote, “argued for the inherent instability of the financial system but in doing so have had to depart from the assumption of rational economic behavior.”
In a footnote, he added, “I do not deny the possible importance of irrationality in economic life; however it seems that the best research strategy is to push the rationality postulate as far as it will go.”
Before I push the "rational postulate" as far it will go in the Real World, note that "the Great Moderation" properly includes (on the lower end) what I call The Bubble Era (1995-???, and see here and here). Also note that "the Great Moderation" also defines the period (up to 2007) when almost all income gains went to the wealthiest Americans, and household debt grew and grew to make up for lost income.
Now, back to the "rational postulate" and two brief case studies. These examples embrace wildly different areas of our economic life.
Case Study 1 — Student Loan Rates
I'll quote from Cheaper student loans after Senate deal, for now (CNN Money, July 19, 2013).
According to the deal, undergraduates taking out loans this fall will pay just 3.86% in interest on new loans for this school year — cheaper than the 6.8% interest rate that kicked in on July 1. The new rates would apply for loans taken out after July 1.
But student advocates don't like the deal, because rates are expected to rise in coming years.
"It's a missed opportunity, because this is going to cost students more than leaving current rates in place," said Lauren Asher, president of the Institute for College Access & Success, a nonprofit that advocates for more affordable higher education.
Under the deal, a high school senior who takes out college loans in 2017 would see interest rates as high as 7%, higher than current law. And by 2015, graduate students would pay more in interest than is set by current law...
For loans this fall, undergraduate students would pay an overall interest rate of 3.86%, comprised of the June 1 yield on the 10-year Treasury note plus 2.05% extra. Graduate students will have to pay 5.41% on loans this fall, which is 3.6% over Treasury notes auctioned on June 1.
Every year that the economy improves and interest rates rise, the Treasury notes will rise. And so would student loan rates under the new deal. However, loans for undergraduates will be capped at 8.25% and for graduates at 9.5%.
If student loan rates climb into the expected range by 2017, which is likely if the Fed raises short-term rates and stops buying T-bills, it's fair to say that we're getting into some serious usury on the part of the federal government. Why is that happening?
Over 10 years, the bill will raise $715 million that will go toward reducing deficits, all from students paying higher interest rates than current law allows.
Thus the federal government, in small part, will attempt to fix its own recklessness on the backs of students paying exorbitant (and growing) tuition costs, as opposed, say, to raising corporate tax rates to reasonable levels. In so far as $715 million is not even a drop in the federal debt bucket, why bother to force former students to pay that money? And where does all the other revenue from student loan interest go? It's certainly not all going to pay the administrative costs of federal loan programs.
It is bad enough that economic policy itself is irrational and unfair. For example, household debt levels are not considered to have an important impact on long-term growth, and nobody seemed to think America's growing income inequality was worth talking about until Occupy Wall Street brought the subject to the public's attention. (That's all over now.)
What is worse is that economic policy is not defined by economists, as bad as that would be. Economic theories are merely props for politicians who can pick and choose among such theories to rationalize and justify whatever agenda they want to carry out. In so far as that agenda often ignores the needs of nearly all of the nation's citizens and puts the desires of the monied elites front and center, can we really speak of a "rational postulate" when discussing our economic life?
How rational is it to condemn many of the nation's young people to a life of student debt slavery? Saddling young people with huge amounts of debt will certainly not further the stated goal, which is fostering economic growth. Even Henry Ford understood that he had to pay his workers a living wage if they were going to be able to buy the Model Ts they were building.
At a higher level of inquiry, given the unfairness on display here, we might ask why do complex human societies exist? Why do nominally capitalistic economies exist? Who enjoys the immense benefits of human societies and "free enterprise" economies, not in theory but in practice? These are the questions that come to mind.
Do you see anything rational, not to mention Good, in usurious student loan rates? Anything at all?
Case Study 2 — Managing Fisheries
Let us skip questions regarding the long-term destruction of marine ecosystems, and focus on the smaller question of managing fisheries to maximize the economic benefits derived therein. I'll quote from Evolutionary Changes Could Aid Fisheries (Science Daily, July 18, 2013).
Sustainable fishing practices could lead to larger fishing yields in the long run, according to a new study that models in detail how ecology and evolution affect the economics of fishing.
Evolutionary changes induced by fisheries may benefit the fishers, according to a new study published last week in the Proceedings of the National Academy of Sciences. But if fisheries are not well-managed, this potential benefit turns into economic losses, as stocks decline from overfishing and further suffer from evolution.
The bad news is that today very few fisheries are managed in a way that will lead to yield increases in the long term. While these fisheries may not be in danger of collapsing, IIASA Evolution and Ecology Program Leader Ulf Dieckmann says, "There is a big difference between preventing stocks from collapsing and managing them so as to achieve an optimal harvest."
The new study, led by 2005 IIASA YSSP participant and Peccei Award winner Anna Maria Eikeset, examines Northeast Arctic cod [image above], one of the most commercially important fisheries in the world.
It builds on a growing body of work showing that fisheries-induced evolution typically leads to faster growth and earlier maturation.
These evolutionary changes may harm a fishery, since they tend to lead to smaller adult fish and could push the animals to reproduce at too early an age, when they are not yet good at it.
On the other hand, the changes can also lead to greater reproduction and hence more fish. But nobody knew how these negative and positive effects balance out economically.
The new study shows that the balance depends on how aggressively a stock is fished: if the fish are harvested optimally, evolution helps, whereas if the fish are harvested too aggressively, evolution harms the economic interests of fishers and fishing nations.
Consequently, to reap these long-term benefits, fisheries managers must first cut back substantially on the amount of fish that are harvested today.
"Harvesting Northeast Arctic cod optimally means taking 50% less fish," says Dieckmann. "Our model shows that by making this substantial cut and waiting for the stock to rebuild, evolution and natural growth could lead to sustainable yields over 30% greater than today."
The reason "very few fisheries" are managed in a way that increases long-term economic benefits is that nearly all fisheries are exploited to maximize short-term economic benefits, and the long-term health of the fishery be damned. There are only a few exceptions where regulation of fisheries is imposed from above by governments which can impose legal action and penalties. Otherwise, humans always take a myopic, devil-may-care view of ocean resources.
Do you think that fishermen, whether they are private citizens or corporations, would change their fishing practices if only Norwegian scientist Anna Maria Eikeset got a chance to sit down and talk to them about the consequences of overfishing?
I don't think so.
Is there anything rational about how humans exploit the world's ocean fisheries? Anything at all?
When we "push the rationality hypothesis as far as it will go," to quote Ben Bernanke, we see that it doesn't go very far, not just in these case studies but in thousands of others that could be brought to bear. Floyd Norris has something interesting to say about this.
It seems to me that [Bernanke] had both Minsky and Kindleberger wrong.
Their insight was that behavior that seems perfectly rational at the time can turn out to be destructive.
As Robert J. Barbera, now the co-director of the Center for Financial Economics at Johns Hopkins University, wrote in his 2009 book, “The Cost of Capitalism,” “One of Minsky’s great insights was his anticipation of the ‘Paradox of Goldilocks.’
Because rising conviction about a benign future, in turn, evokes rising commitment to risk, the system becomes increasingly vulnerable to retrenchment, notwithstanding the fact that consensus expectations remain reasonable relative to recent history.”
Behavior that seems "perfectly rational" in the short term turns out to be destructive over the longer term. These destructive outcomes decisively undermine the imputation of rationality in our economic life.
And there is nothing rational about "rising conviction about a benign future." I call that innate Optimism. What are the risks of creating generations of student debt slaves? What are the longer term risks of overfishing the oceans? What are the risks of letting the financial system run wild for decades?
The Realist says the risks are great. The Optimist, echoing Alfred E. Neuman, says "risks? what risks?"
That's the final word on "rationality" in our economic life.
Another way to look at the student loan legislation is that it basically halves the doubling time of the principal itself. It WILL mean the difference for many Americans in being able to pay off that loan or not.
It's simple insanity that it could possibly bring in extra revenue, as a lot of revenue will be lost in a declining economy due to those same people not contributing as they could do otherwise. It's nothing short of putting a leg iron on many of the most promising young Americans.
One thing not mentioned in the CNN article is that the rate for parents paying for their children's education will be capped at 10.5%. Because, clearly, they can afford it. Why else would they take out a loan?
Beyond the corporate tax rate, or tax rates for the highest incomes, or closing loopholes, our yearly defense budget is over 8,000x (not an exaggeration) the amount of extra revenue generated from raising the student loan interest rates. We couldn't shave off 1/8,000th of that?
I see Washington and politics as basically being about who gets the money. All the struggles going on right now come down to that simple element. Inside that struggle, factions constantly battle over who gets to sport the crown for the day. It's all pure self-interest. In this arena, money speaks the loudest, and so, more money naturally flows towards more money. There's nothing benign about it.
Posted by: Jim | 07/21/2013 at 02:08 PM