Bubbles, Financial Crises, and The Good Society

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Bubbles, Financial Crises, and The Good Society

• Robert Shiller, Yale University
• 2013 Tinbergen Lecture on Economic Policy
• Royal Netherlands Economic Association, Amsterdam
  
• October 18, 2013

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Part I Bubbles and Financial Crises
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USA Real SP500 and Earnings 1871-2013
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USA Real Home Prices and Housing
Fundamentals1890-2013
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Real Home Prices Herengracht, Piet Eichholtz,
1649-2013
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(No Transcript)
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Amsterdam- Herengracht RegionBerckheyde, 1685
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Epidemics and Word of Mouth

• Spread of ideas is similar to spread of
  infectious diseases
• Memes (Richard Dawkins, The Selfish Gene, 1976)
  
• Thought viruses replicate as do viruses
• Tropes in literary theory
• Mathematics of epidemiology is therefore relevant
  to economics

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SIR Model (Susceptibles, Infectives, Removed)
Kermack and McKendrick, 1927

• n individuals, x susceptibles, y infectives, z no
  longer contagious, nxyz. Infection rate is ß,
  removal rate is ?, and define the relative
  removal rate ??/ß.
• dx/dt-ßxy
• dy/dtßxy-?y
• dz/dt?y

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Properties of SIR Model

• No epidemic can start unless relative removal
  rate ? lt x0 (the initial number of susceptibles)
• In an epidemic, number of infectives first rises,
  then falls.
• Epidemic peaks when x falls below ?
• Size of epidemic z8 is the total number of
  people who eventually contract the disease
• Size relative to population is determined by ?,
  low ? promoting large size

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Economics of Rumors Abhijit V. Banerjee REStud
1993

• In earlier literature on epidemic models in
  economics, no attempt is made to derive an
  optimal decision rule for each decision maker. In
  this paper, the decision to believe in the rumour
  and to pass it on is based on optimizing
  behaviour.
• Banerjee wants to incorporate epidemic models
  into neoclassical economics, all players are true
  Bayesians

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Individuals agreeing with the statement The
stock market is the best investment for long-term
holders, who can just buy and hold through the
ups and downs of the market
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Individuals agreeing with the statement The
Housing market is the best investment for
long-term holders, who can just buy and hold
through the ups and downs of the market
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How would one ever calculate the probability that
the statements above are true?

• The statements represents memes, that have
  intuitive sense of truthfulness
• They are evaluated by Daniel Kahnemans System 1,
  instantaneously, without computations, not System
  2, Thinking Fast and Slow, 2011

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Case Shiller Thompson BPEA 2012
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Table 4a Regressions Testing Hypothesis of Rational Expectations of Future 12-Month Home Price Change 2003-2011 Table 4a Regressions Testing Hypothesis of Rational Expectations of Future 12-Month Home Price Change 2003-2011 Table 4a Regressions Testing Hypothesis of Rational Expectations of Future 12-Month Home Price Change 2003-2011 Table 4a Regressions Testing Hypothesis of Rational Expectations of Future 12-Month Home Price Change 2003-2011 Table 4a Regressions Testing Hypothesis of Rational Expectations of Future 12-Month Home Price Change 2003-2011 Table 4a Regressions Testing Hypothesis of Rational Expectations of Future 12-Month Home Price Change 2003-2011

      Regression    
Independent Variable Alameda Boston Milwaukee Orange All Cities
Constant -12.79 -4.75 -5.67 -9.48 -9.13
  (8.84) (2.85) (4.52) (5.16) (2.52)

Trimmed-Mean Own-City 2.57 1.50 1.43 2.71 2.34
Expected 12-Month Change (1.42) (0.71) (0.94) (0.78) (0.46)

Nobs 9 9 9 9 36

R Squared 0.32 0.39 0.25 0.63 0.43
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Ten-Year Expectations And 30-Year Mortgage Rate
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CME Home Price Futures Market
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Implications of Keynesian Beauty Contest Metaphor
for Speculative Trading

• On Aug. 4, 2011, the market, as measured by the
  Standard Poors 500-stock index, fell by almost
  5 percent. The next day was quiet, but the
  following Monday, the index dropped almost 7
  percent. In successive days, it rose 4.7 percent,
  fell 4.4 percent and rose 4.3 percent. after the
  near-default.
• Keynesian beauty contest
• Peculiar timing of public reaction to near
  default may repeat this month

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Alan Greenspan, Aug 7, 2011 (just before the
nearly 7 drop)

• What I think the S. P. thing did was to hit a
  nerve that theres something basically bad going
  on, and its hit the self-esteem of the United
  States, the psyche. And its having a much
  profounder effect than I conceived could happen.
  
• He was talking about what other investors were
  thinking, not about the substance of the S. P.
  downgrade.

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The Economist June 16, 2005

• PERHAPS the best evidence that America's house
  prices have reached dangerous levels is the fact
  that house-buying mania has been plastered on the
  front of virtually every American newspaper and
  magazine over the past month.

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Time Magazine, June 13, 2005

• HOME WEET HOME Why Were going gaga over real
  estate
• Will your house make you rich?
• Super hot markets.
• Is it time to buy or sell?
• The case for renting

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Barrons, June 20, 2005

• Economist Robert Shiller whose book predicting a
  stock market rout arrived just before the Nasdaq
  began its sickening slide in 2000, sees another
  bubble ready to burst. Home prices, he contends,
  could fall by as much as 50 adjusted for
  inflation.
• (Ex post Actual US peak to trough decline was
  43, over 50 in many cities)

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Percentage of Respondents Unprompted Use of
Housing Bubble in Open-ended Questions
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Percent of Respondents Unprompted Use of Land
(usually as in land shortage) in Open-Ended
Questions
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Google Trends Web Searches for Housing Bubble
peak Aug 2005
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Part II Finance and Society
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Walter Lippman The Good Society 1936

• Defines Good Society by its adherence to the
  Golden Rule Do unto others as you would have
  them do onto you.
• How are such events, driven by epidemics,
  possibly consistent with the good society?

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Financial Innovation and Financial Progress,
Google NGrams 1700-2008
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Financial Innovation and Academic Revolutions,
Google NGrams 1700-2008
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Finance Providing Structure for Civilization
Itself

• Financing of organizations necessary for
  long-term consistent behavior
• Human inconsistencies revealed by bubbles and
  bursts are likely less severe than if in the
  absence of modern financial institutions
• The institutions can be improved.