Posts Tagged ‘Robert Shiller’

Nobel Memorial Prize in Economics – 2013

Tuesday, October 15th, 2013

The Royal Swedish Academy of Sciences awarded this year’s “Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel” jointly to three economists: Eugene Fama, Lars Peter Hansen and Robert Shiller. Fama, from the University of Chicago, is a father of the “efficient market hypothesis“. Shiller, from Yale University, believes that investors’ behaviour is not fully rational, leading to booms and busts in housing and financial markets. Hansen, also at the University of Chicago, has confirmed empirically Shiller’s conjecture that models assuming rationality cannot explain the ups and downs of asset prices. (more…)

Shiller on speculative bubbles

Tuesday, July 23rd, 2013

Yale economist Robert Shiller writes that bubbles are difficult to define, and even more difficult to recognize.

The Oxford English Dictionary defines a bubble as “anything fragile, unsubstantial, empty, or worthless; a deceptive show. From 17th c. onwards often applied to delusive commercial or financial schemes.” The problem is that words like “show” and “scheme” suggest a deliberate creation, rather than a widespread social phenomenon that is not directed by any impresario.

Maybe the word bubble is used too carelessly.

Eugene Fama certainly thinks so. Fama, the most important proponent of the “efficient markets hypothesis,” denies that bubbles exist. As he put it in a 2010 interview with John Cassidy for The New Yorker, “I don’t even know what a bubble means. These words have become popular. I don’t think they have any meaning.”

In the second edition of my book Irrational Exuberance, I tried to give a better definition of a bubble. A “speculative bubble,” I wrote then, is “a situation in which news of price increases spurs investor enthusiasm, which spreads by psychological contagion from person to person, in the process amplifying stories that might justify the price increase.” This attracts “a larger and larger class of investors, who, despite doubts about the real value of the investment, are drawn to it partly through envy of others’ successes and partly through a gambler’s excitement.” ….

Speculative bubbles do not end like a short story, novel, or play. There is no final denouement that brings all the strands of a narrative into an impressive final conclusion. In the real world, we never know when the story is over.

Robert J. Shiller, “Bubbles Forever“, Project Syndicate, 17 July 2013.

As an example of how bubbles can end in complex ways, Shiller notes that “a major boom in real stock prices in the US after ‘Black Tuesday’ brought them halfway back to 1929 levels by 1930. This was followed by a second crash, another boom from 1932 to 1937, and a third crash.”

Robert Shiller on financial innovation

Monday, July 30th, 2012

Yale University economist Robert Shiller defends the social value of financial innovation, in a Vox Talks interview recorded in May 2012. He surprised me with a Panglossian response to the following two questions.

RV: You’ve described a couple of financial innovations [the benefit corporation and the social impact bond] that have a really pro-social motivation. But when a lot of people think of financial innovation they think of specific things like collaterised debt obligations and credit default swaps and the kinds of things that people think contributed to the crisis.

Shiller: Collateralised debt obligations are a source of problems because they were flawed and they did help worsen the crisis. But I think collateralised debt obligations are in the same category as the things I just mentioned. What they do is they make it easier for people to buy a house. What they do is they take mortgages and package them, and then they split them up into tranches, and they have a triple-A tranch which is thought to be safe. It wasn’t, as it turned out, but next time they’ll get the problems ironed out and it will be. So they ’re able to get investors investing in the mortgages. The ultimate thing is, and it’s kind of hard to see but it’s real, it ought to bring down the mortgage rate. And that means bringing more people into housing than there could have been. We don’ know who they are, but there are some families living in homes who otherwise couldn’t afford that if there weren’t collateralised debt obligations. I have nothing to do with these people who issue CDOs, and I don’ mean to sound like they did it right, but I don’ think it’s in a different category. I think it’s something that has a social benefit.


RV: In the wake of the crisis there’s also been talk about finance just being too complicated. Some of these innovations have been too complicated even for the organisations that have made them. So the kind of people who were running organisations, dreaming up new kinds of derivatives, didn’t really understand what was going on. That must be a real problem with financial innovation, that the people in charge don’ really understand the technology that they ’re using.

Shiller: That is a problem, and I would say that it’s a problem with technology in general. When someone designs an airplane, if it gets too complicated then the engineers don’ understand what’s happening. This is to do with systems, so if you ’re designing an air traffic control system and it’s too complicated, there’s going to be a catastrophe. But on the other hand I’ thinking that modern civilisation with modern computers can create some pretty complicated things. I’m thinking of, for example, the automobile. It’s got more and more complicated over the years and it’s getting harder and harder for the backyard mechanic who wants to fix the car. So you take it out to a dealer who has a computerised diagnostic system and so on. That’s the kind of society we’re living in. We always have to be mindful of some catastrophe that could result from our not understanding the complexity, definitely. But on the other hand I think we’re on a secure trend to more complexity, and computers are an important reason why we are. Life is going to get more and more complex and specialised, that’s pretty inevitable while civilisation advances.

Finance and the good society“, Robert Shiller interviewed by Romesh Vaitilingam, Vox Talks, 27 July 2012.

I don’t understand Shiller’s comparison of the complexity of machines (computers, automobiles, airplanes) to the complexity of financial products. There is no need for me to understand how a computer or an automobile is constructed in order to make an intelligent purchase or operate a particular model. And there is no need for me to repair a malfunctioning computer or automobile. Nor do pilots need to know how a airplane is built, or how to repair it. Financial products have more in common with air traffic control systems. If they become too complex, they might have design flaws that are unknown to users. In the case of finance, there is the added problem that financial ‘experts’ can (and do) sell complex, flawed products to investors, enriching themselves at the expense of their unsuspecting clients.

Flaws in the design of complex automobiles, airplanes and computers quickly reveal themselves, so damage is kept to a minimum. Flaws in the design of complex air traffic control systems or financial products, in contrast, might remain hidden for years, with catastrophic consequences. Simplicity is thus a virtue for the latter, but not for the former type of product. This, at least, is how I see the problem.

Simplicity alone, however, will not correct a poorly functioning financial industry. Basic financial literacy is essential. Life insurance is not a particularly complex product; nonetheless, the vast majority of consumers pay far more than they should for protection, often in the form of “whole life” instead of term insurance. Reliance on the advice of financial experts (or insurance salesman) is not likely to produce good results for consumers.

There is much more in the full interview, and in Professor Shiller’s new book, Finance and the good society (Princeton University Press, 2012).

humanizing finance

Friday, March 9th, 2012

An enlightened system of financial capitalism requires some government interventions, including a progressive income tax. There also needs to be a social safety net, and it has to be continually improved and reworked. ….

People aren’t inherently and uniformly loving to their neighbors, but our institutions can be changed to reward the better side of human nature.

One of these better sides is the charitable impulse, and the tendency, at least in the right social environment, for wealthy people to give much of their wealth away constructively. Such a tendency ought to be considered central to financial capitalism.

One other singularly important human impulse was emphasized by Adam Smith in his 1759 book, “The Theory of Moral Sentiments.” This is the desire for praise. We see this plainly in the behavior of the youngest children and the oldest and weakest people, those with no hope of attaining power over others.

Robert Shiller, “Logic of Finance Can Banish Corruption“, Bloomberg View, 7 March 2012.

HT The Browser

This is the last of 4 excerpts from Yale economist Robert Shiller’s new book Finance and the Good Society, to be published next month by Princeton University Press.

The other three excerpts can be accessed here and here and here.

a housing price bubble?

Saturday, November 19th, 2011

This TdJ from November 2003 reminds us that many economists – including Yale’s Robert Shiller and Wellesley College’s Karl Case – saw there was a housing bubble, long before prices crashed.

The Economist magazine continues to sound the alarm that there is a housing price bubble in many countries, including Britain and “large parts of America”. The short article in The Economist requires a subscription to view, but the authors draw on a much longer (61 page!) article by Robert Shiller and Karl Case, titled “Is there a Bubble in the Housing Market? An Analysis”. that can be downloaded at [new link].

While house prices have soared, rents have been fairly flat or have even fallen. In America, Britain and Spain the average net rental yield after maintenance and letting costs has dropped to 3-4%. This is less than mortgage rates, so many landlords are not covering their costs. No problem, retort many: we will make our profit from capital gains. This sounds ominously like an echo of the dotcom bubble, when it was argued that the old link between share prices and profits no longer mattered.

“Property prices: shaky foundations”, The Economist, 29 November 2003, p. 75.

Recycled from the 2003 TdJ archive.

debt to GDP ratios

Thursday, August 4th, 2011

Japan has the highest ratio of public debt to GDP in the world (225.8% according to the authoritative CIA World Factbook), and also the lowest borrowing rate, if not in the world, at least of 20 countries monitored by the Financial Times.

So, if the debt to GDP ratio is so important, why is the yield on Japanese sovereign debt so low? The answer is that investors have confidence in the capacity and willingness of Japan to honour its obligations. Debt to GDP ratios are important, but only if they cause investors to fear an eventual default. Lower demand for a country’s debt causes bond prices to fall, thus yield to rise, pushing borrowing costs up. This could lead to austerity budgets and economic collapse, causing investors to become more skeptical, pushing borrowing costs ever higher. Something like this has happened in Greece, where interest rates – according to the FT – have risen to 15.09%, while interest rates in Germany have dropped to 2.44%.

Joe Weisenthal highlights a column on this very subject that I had missed. It was written by Yale University economist Robert Shiller, who is concerned that markets (even economists – two of whom he names) are paying far too much attention to debt ratios and thresholds and too little attention to economic fundamentals.

A paper written last year by Carmen Reinhart and Kenneth Rogoff, called “Growth in a Time of Debt,” has been widely quoted for its analysis of 44 countries over 200 years, which found that when government debt exceeds 90% of GDP, countries suffer slower growth, losing about one percentage point on the annual rate.

One might be misled into thinking that, because 90% sounds awfully close to 100%, awful things start happening to countries that get into such a mess. But if one reads their paper carefully, it is clear that Reinhart and Rogoff picked the 90% figure almost arbitrarily. They chose, without explanation, to divide debt-to-GDP ratios into the following categories: under 30%, 30-60%, 60-90%, and over 90%. And it turns out that growth rates decline in all of these categories as the debt-to-GDP ratio increases, only somewhat more in the last category.

There is also the issue of reverse causality. Debt-to-GDP ratios tend to increase for countries that are in economic trouble. If this is part of the reason that higher debt-to-GDP ratios correspond to lower economic growth, there is less reason to think that countries should avoid a higher ratio, as Keynesian theory implies that fiscal austerity would undermine, rather than boost, economic performance.

The fundamental problem that much of the world faces today is that investors are overreacting to debt-to-GDP ratios, fearful of some magic threshold, and demanding fiscal-austerity programs too soon. They are asking governments to cut expenditure while their economies are still vulnerable. Households are running scared, so they cut expenditures as well, and businesses are being dissuaded from borrowing to finance capital expenditures.

Robert J. Shiller, “Debt and Delusion“, Project Syndicate, 21 July 2011.

Robert Shiller, one of my favourite economists, is co-author (with George Akerlof) of Animal Spirits: How human psychology drives the economy and why it matters for global capitalism (Princeton University Press, 2009).

housing boom and bust

Friday, April 15th, 2011

Via Mark Thoma, here is the the Case-Shiller chart for housing prices in the USA from 1890, updated in 2011 by Steve Barry  for The Big Picture. Note the effect of the 2009 tax credit for new home buyers.

Click on the image for a larger view. Here is the original version of the chart, published by the New York Times in August of 2006.

housing bubbles

Sunday, February 6th, 2011

Yale economist Robert Shiller writes that the enormous housing boom and bust we just experienced is without precedence.

In the 19th century and most of the 20th, speculation in land was a powerful phenomenon. There was little speculative activity around homes, however, which were usually viewed as rapidly depreciating assets whose value was to be found almost entirely in physical buildings, not the land beneath them. Eventually, the buildings were expected to be torn down and replaced, so there was little bubble psychology for housing on any large scale. People generally didn’t think about housing as an investment.

But they knew that land was fixed in quantity and would last forever, and many believed that as the economy grew and more people were born, there would be ever-increasing demand. ….

There have been many highly localized land price bubbles in the United States over the last couple of centuries, although bubbles over large areas have been rather rare. ….

So land manias have been rather infrequent, many decades apart. They suggest that the recent housing bubble is a similarly rare event, not to be repeated for many decades.

Robert J. Shiller, “Economic View: Housing Bubbles Are Few and Far Between“, New York Times, 6 February 2011.

Shiller cautions that housing markets have not yet settled, and bubbles can form so long as buyers continue to think of housing as an investment.

Robert Shiller on Adam Smith

Wednesday, January 26th, 2011

Yale University economist Robert Shiller, in an interview for “The Browser”, recommends five books on a fascinating but difficult subject: Human Traits Essential to Capitalism. Professor Shiller begins with a book by Adam Smith, my favourite economist. The book is  The Theory of Moral Sentiments (1759), which contains underpinnings for all his later work, including The Wealth of Nations (1776). Smith begins his book with a discussion of what he refers to as “sympathy”, but, Shiller explains,

he’s really focused on selfishness versus social consciousness. He sees that sometimes people are completely selfish, and that’s the problem for any economic theory – how to make a society work when people are completely, unremittingly selfish.

But he also notes something else: he doesn’t use the word ‘empathy’, because ‘empathy’ hadn’t been defined yet. But it’s a very important observation about human behaviour, which is that we are wired to feel each other’s emotions and to have a theory of other people’s minds (not that he would have used the words ‘wired’ or ‘theory of mind’ either). The English word ‘empathy’ was coined around 1900, in a translation of the German word Einfühlung from a German book by psychologist Theodor Lipps. What it means is that it’s not that I feel bad because I observe that you are suffering, it means I actually feel your feelings. So people may often be selfish, but they also have empathy.

Smith also talks about a selfish passion, which is a desire for praise. He argues that people instinctively desire praise, but that, as they mature, this feeling develops into a desire for praiseworthiness. …. He uses that to show that what people really want is to be deservedly praised. And that turn of mind, which develops as people mature, is what makes us into people with integrity. ….

I think this underlies how the economy works. We start out with selfish feelings, which are intermixed with feelings of empathy for others, and then we develop this mature desire to be praiseworthy. I think it is central to our civilisation that people do that.

Robert Shiller on Human Traits Essential to Capitalism“, Interview by Sophie Roell, The Browser, January 2011.

Adam Smith was a great thinker, and Robert Shiller shows deep appreciation and affection for him. This choice pleased me. I was also pleased with Shiller’s second pick, a book by Albert Hirschman (1915-), whose prolific writings have influenced me very much. The book is The Passions and The Interests: Political Arguments for Capitalism Before its Triumph (Princeton University Press, 1977).

“Animal Spirits” explained

Sunday, October 10th, 2010

One week ago, I promised a full explanation of what economists mean by the term “animal spirits”. I am now fulfilling that promise by posting relevant passages from the delightful book written by economists George Akerlof and Robert Shiller.

John Maynard Keynes [in  The General Theory (1936)] sought to explain departures from full employment, and he emphasized the importance of animal spirits. He stressed their fundamental role in businessmen’s calculations. “Our basis of knowledge for estimating the yield ten years hence of a  railway, a copper mine, a textile factory, the goodwill of a patent medicine, an Atlantic liner, a building in the City of London amounts to little and sometimes to nothing,” he wrote. If people are so uncertain, how are decisions made? They “can only be taken as a result of animal spirits.” They are the result of “a spontaneous urge to action.” They are not as rational economic theory would dictate, “the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities.”

In the original use of the term, in its ancient and medieval Latin form spiritus animalis, the word animal means “of the mind” or “animating.” It refers to a basic mental energy and life force. But in modern economics animal spirits has acquired a somewhat different meaning; it is now an economic term, referring to a restless and inconsistent element in the economy. It refers to our peculiar relationship with ambiguity and uncertainty. Sometimes we are paralyzed by it. Yet at other times it refreshes and energizes us, overcoming our fears and indecisions.


The term animal spirits originated in ancient times, and the works of the ancient physician Galen (ca. 130-ca. 200) have been widely quoted ever since as a source for it. The term was commonly used in medicine through medieval times and up until Robert Burton’s The Anatomy of Melancholy (1632) and Rene Descartes’ Traité de l’Homme (1664). There were said to be three spirits: the spiritus vitalis that originated in the heart, the spiritus naturalis that originated in the liver, and the spiritus animalis that originated in the brain. The philosopher George Santayana (1923) built a system of philosophy around the  centrality of “animal faith,” which he defined as “a pure and absolute spirit, an imperceptible cognitive energy, whose essence is intuition.”

George Akerlof and Robert Shiller, Animal Spirits: How human psychology drives the economy and why it matters for global capitalism (Princeton University Press, 2009), pp. 3-4, 177-178.