market clearing

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pages: 348 words: 99,383

The Financial Crisis and the Free Market Cure: Why Pure Capitalism Is the World Economy's Only Hope by John A. Allison

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Affordable Care Act / Obamacare, bank run, banking crisis, Bernie Madoff, clean water, collateralized debt obligation, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, disintermediation, fiat currency, financial innovation, Fractional reserve banking, full employment, high net worth, housing crisis, invisible hand, life extension, low skilled workers, market bubble, market clearing, minimum wage unemployment, money market fund, moral hazard, negative equity, obamacare, Paul Samuelson, price mechanism, price stability, profit maximization, quantitative easing, race to the bottom, reserve currency, risk/return, Robert Shiller, Robert Shiller, The Bell Curve by Richard Herrnstein and Charles Murray, too big to fail, transaction costs, yield curve, zero-sum game

Therefore, the wage rate for garbage collectors is relatively low, as it should be. When government arbitrarily raises the wage rate above the market-clearing price, labor will go unsold, exactly as in the previous milk example. Minimum-wage laws raise the wage rate above the market-clearing price and thereby create unemployment. From immediately before the financial crisis until today, the minimum wage has been raised from $5.15 per hour to $7.25 per hour, or 41 percent. The prices for practically all other goods and services have either fallen or risen only a little. So in the face of a severe economic correction, the government has raised the price of labor far above the market-clearing price. The minimum-wage laws are the primary cause of the high unemployment levels in the United States today. In a free market, labor rates (wages) for many jobs would have fallen just as prices for other goods and services have fallen.

Economic laws are immutable. The law of supply and demand is not negotiable, any more than the laws of thermodynamics are. This is true whether the politicians like it or not. The law of supply and demand demonstrates that there is a market-clearing price at which supply and demand are equal. At this price, the producers of a good or service (supply) will provide exactly the amount of the good or service that the users (demand) want to purchase. The market will clear; that is, all the production will be sold to willing buyers. If the price is forced below the market-clearing price by government policy (price controls), the users of the good or service will want to purchase more than the providers of the good or service are willing to provide at that price. Some users will not be able to purchase the quantity of the good or service that they want at this price.

There is another set of state laws that has played an important role in keeping the housing market from correcting rapidly and has increased the losses and the destruction of wealth in the housing correction, the state home foreclosure laws. There are price corrections in all types of markets; stock markets and commodity markets are clear examples of markets in which price corrections are rapid and sometimes dramatic. Even though the price corrections may be challenging if you are on the wrong side of the bet, markets clear and everyone can get on with his business based on the new prices that more properly value the commodity or stock. For example, I started my career as a farm lender. Every spring, some of our farm clients would plant a soybean crop. Some of them would hedge the price they were to receive in the fall; some would not. Nobody would attempt to hedge the total expected production because too many factors could affect the actual crop size.


pages: 153 words: 12,501

Mathematics for Economics and Finance by Michael Harrison, Patrick Waldron

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Brownian motion, buy low sell high, capital asset pricing model, compound rate of return, discrete time, incomplete markets, law of one price, market clearing, Myron Scholes, Pareto efficiency, risk tolerance, riskless arbitrage, short selling, stochastic process

Thus finance is just a subset of micoreconomics. What do consumers do? They maximise ‘utility’ given a budget constraint, based on prices and income. What do firms do? They maximise profits, given technological constraints (and input and output prices). Microeconomics is ultimately the theory of the determination of prices by the interaction of all these decisions: all agents simultaneously maximise their objective functions subject to market clearing conditions. What is Mathematics? This section will have all the stuff about logic and proof and so on moved into it. Revised: December 2, 1998 NOTATION xi NOTATION Throughout the book, x etc. will denote points of <n for n > 1 and x etc. will denote points of < or of an arbitrary vector or metric space X. X will generally denote a matrix. Readers should be familiar with the symbols ∀ and ∃ and with the expressions ‘such that’ and ‘subject to’ and also with their meaning and use, in particular with the importance of presenting the parts of a definition in the correct order and with the process of proving a theorem by arguing from the assumptions to the conclusions.

Definition 5.4.2 A complex security is a random variable or lottery which can take on arbitrary values. The payoffs of a typical complex security will be represented by a column vector, yj ∈ <M , where yij is the payoff in state i of security j. The set of all complex securities on a given finite sample space is an M -dimensional vector space and the M possible Arrow-Debreu securities constitute the standard basis for this vector space. State contingent claims prices are determined by the market clearing equations in a general equilibrium model: Aggregate consumption in state i = Aggregate endowment in state i. Each individual will have an optimal consumption choice depending on endowments and preferences and conditional on the state of the world. Optimal future consumption is denoted  ∗  x1  x∗   x∗ =   2 . (5.4.1)  ...  x∗N If there are N complex securities, then the investor must find a portfolio w = (w1 , . . . , wN ) whose payoffs satisfy x∗i = N X yij wj .

MARKET EQUILIBRIUM AND THE CAPM Proof By Jensen’s inequality and monotonicity, the riskless asset dominates any portfolio with E[r̃] < rf (6.5.14) for E[u(W0 (1 + r̃))] ≤ u(E[W0 (1 + r̃)]) < u(W0 (1 + rf )) (6.5.15) (6.5.16) Hence the expected returns on all individuals’ portfolios exceed rf . It follows that the expected return on the market portfolio must exceed rf . Q.E.D. Now we can calculate the risk premium of the market portfolio. CAPM gives a relation between the risk premia on individual assets and the risk premium on the market portfolio. The risk premium on the market portfolio must adjust in equilibrium to give market-clearing. In some situations, the risk premium on the market portfolio can be written in terms of investors’ utility functions. Assume there is a riskless asset and returns are multivariate normal (MVN). Recall the first order conditions for the canonical portfolio choice problem: 0 = E[u0i (W̃i )(r̃j − rf )] ∀ i, j (6.5.17) h = E[u0i (W̃i )]E[r̃j − rf ] + Cov u0i (W̃i ), r̃j i h = E[u0i (W̃i )]E[r̃j − rf ] + E[u00i (W̃i )]Cov W̃i , r̃j (6.5.18) i (6.5.19) using the definition of covariance and Stein’s lemma for MVN distributions.


pages: 363 words: 107,817

Modernising Money: Why Our Monetary System Is Broken and How It Can Be Fixed by Andrew Jackson (economist), Ben Dyson (economist)

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bank run, banking crisis, banks create money, Basel III, Bretton Woods, call centre, capital controls, cashless society, central bank independence, credit crunch, David Graeber, debt deflation, double entry bookkeeping, eurozone crisis, financial exclusion, financial innovation, Financial Instability Hypothesis, financial intermediation, floating exchange rates, Fractional reserve banking, full employment, Hyman Minsky, inflation targeting, informal economy, information asymmetry, intangible asset, land reform, London Interbank Offered Rate, market bubble, market clearing, Martin Wolf, means of production, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, negative equity, Northern Rock, price stability, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, risk-adjusted returns, seigniorage, shareholder value, short selling, South Sea Bubble, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, total factor productivity, unorthodox policies

(Stiglitz & Weiss, 1988) Therefore, if banks charge interest rates at the market clearing level they will drive the less risky borrowers out of the market, leaving only the high-risk borrowers. Higher risk implies a higher number of defaults on loans, which will adversely affect bank profits. The relationship between bank profits and the interest rate charged on loans is shown in figure 3.3. In response to these theoretical issues and anecdotal and empirical evidence on the number of rejected loan applications, Stiglitz and Weiss (1981) developed a theory of credit rationing. Credit rationing implies that banks respond to a situation whereby they have imperfect information (i.e. they cannot tell good borrowers from bad) by setting interest rates below the market clearing rate (to a level which maximises their profits – i* on figure 3.3) and ration credit instead.12 In conclusion, the credit rationing theory sees causality in the banking system occurring in the following way (shown overleaf).

Finally, the Bank of England cannot reliably limit money creation by changing the price of central bank reserves – the base or policy rate of interest – for the wide variety of reasons discussed above. Credit rationing What then determines the level of bank lending, and therefore the money supply? Faced with a huge demand for credit, and little limit on how much they are able to supply, banks could simply supply as much lending as is demanded, by granting a loan to everyone who applied for one. With such high demand, however, the market-clearing rate of interest would be very high. As Stiglitz and Weiss (1988) point out this will create two problems. First: “among those who are most likely to bid high interest rates are risk lovers (who are willing to undertake very risky projects, with a small probability of success, but high returns if successful); optimists (who overestimate the probability of projects succeeding and the return if successful); and crooks (who, because they do not plan to pay back the money anyway, are virtually indifferent to the interest rate which they promise).

Credit rationing implies that banks respond to a situation whereby they have imperfect information (i.e. they cannot tell good borrowers from bad) by setting interest rates below the market clearing rate (to a level which maximises their profits – i* on figure 3.3) and ration credit instead.12 In conclusion, the credit rationing theory sees causality in the banking system occurring in the following way (shown overleaf). Faced with a large demand for credit, banks set interest rates below the market clearing rate and ration credit instead (by rejecting some loan applications). When banks lend, deposits are created. This increases demand for reserves in order to settle payments. The central bank provides reserves to banks on demand, thus accommodating a bank’s lending decisions. We can conclude that the primary determinant of bank lending is how profitable banks believe that lending will be. For banks, profitability depends on the proceeds of a loan (the interest charged) exceeding the costs of making a loan (the interest paid to acquire the funds needed to settle net payments to other banks, plus other costs – e.g. salaries).


pages: 209 words: 13,138

Empirical Market Microstructure: The Institutions, Economics and Econometrics of Securities Trading by Joel Hasbrouck

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Alvin Roth, barriers to entry, conceptual framework, correlation coefficient, discrete time, disintermediation, distributed generation, experimental economics, financial intermediation, index arbitrage, information asymmetry, interest rate swap, inventory management, market clearing, market design, market friction, market microstructure, martingale, price discovery process, price discrimination, quantitative trading / quantitative finance, random walk, Richard Thaler, second-price auction, selection bias, short selling, statistical model, stochastic process, stochastic volatility, transaction costs, two-sided market, ultimatum game, zero-sum game

In his model, buyers and sellers arrive randomly in continuous time, as Poisson/exponential arrival processes (section 6.1), and transact a single quantity. The arrival intensity for buyers is λBuy (p), a function of the price they pay. The arrival intensity for sellers is λSell (p), a function of the price they receive. These functions are depicted in figure 11.1. They describe demand and supply, but not in the usual static sense. Market clearing in this context means that buyers and sellers arrive at the same average rate, that is, with the same intensity. If the dealer were to quote the same price to buyers and sellers, market clearing would occur where the intensity functions cross. This is defined by λBuy (pEq ) = λSell (pEq ) = λEq . As long as the intensities are the same, the dealer is on average buying and selling at the same rate. If the dealer is buying and selling at the same price, of course, there is no profit. If the dealer quotes an ask price to the buyers and a bid quote to the sellers, he will make the spread on every unit turned over (the “turn”).

In modeling, this is often introduced as heterogeneous private values. 1.1.2 Mechanisms in Economic Settings Microstructure analyses are usually very specific about the mechanism or protocol used to accomplish trade. One common and important mechanism is the continuous limit order market. The full range, though, includes search, bargaining, auctions, dealer markets, and a variety of derivative markets. These mechanisms may operate in parallel: Many markets are hybrids. 1.1.3 Multiple Characterizations of Prices The market-clearing price, at least at it arises in usual Walrasian tatonnement, rarely appears in microstructure analyses. At a single instant there may be many prices, depending on direction (buying or selling), the speed with which the trade must be accomplished, the agent’s identity or other attribute, and the agent’s relationship to the counterparty (as well as, of course, quantity). Some prices (like bids and offers) may be hypothetical and prospective. 1.2 Liquidity Security markets are sometimes characterized by their liquidity.

There is one informed trader who knows v and enters a demand x. Liquidity (“noise”) traders submit a net order flow u ∼ N (0, σu2 ), independent of v . The market maker (MM) observes the total demand y = x + u and then sets a price, p. All of the 61 62 EMPIRICAL MARKET MICROSTRUCTURE trades are cleared at p. If there is an imbalance between buyers and sellers, the MM makes up the difference. Nobody knows the market clearing price when they submit their orders. Because the liquidity trader order flow is exogenous, there are really only two players we need to concentrate on: the informed trader and the MM. The informed trader wants to trade aggressively, for example, buying a large quantity if her information is positive. But the MM knows that if he sells into a large net customer buy, he his likely to be on the wrong side of the trade.


pages: 471 words: 97,152

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof, Robert J. Shiller

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affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, collateralized debt obligation, conceptual framework, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, experimental subject, financial innovation, full employment, George Akerlof, George Santayana, housing crisis, Hyman Minsky, income per capita, inflation targeting, invisible hand, Isaac Newton, Jane Jacobs, Jean Tirole, job satisfaction, Joseph Schumpeter, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, new economy, New Urbanism, Paul Samuelson, Plutocrats, plutocrats, price stability, profit maximization, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, South Sea Bubble, The Chicago School, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, working-age population, Y2K, Yom Kippur War

We have seen that even education and experience together explain relatively little of the variation in weekly wages. In contrast, however, when the unemployment rate rises quits invariably go down.10 Indeed a simple relation between quits and unemployment explains three-quarters of the variation. When unemployment goes up by 1 percentage point, the monthly quit rate per hundred employees falls by 1.26.11 These changes in the quit rate suggest that unemployment is exactly caused by wages in excess of market clearing. That of course exactly corresponds to the predictions of efficiency wage theory. In its view, when unemployment goes up the gap between the supply of and demand for labor increases. Workers with jobs at existing wages realize that they are lucky. They see how they would fare elsewhere, and they are therefore highly reluctant to quit their jobs. Why Employers Really Pay More Than They Need To There are two principal versions of the efficiency wage theory.

The appeal of this explanation for unemployment—that it depends only on cool economic motivation—is also its Achilles’ heel. Why? Because economists who consider themselves yet smarter than Shapiro and Stiglitz have pointed out that if workers only care about money and how hard they work, employers could devise incentive schemes that are yet more profitable for themselves, and that do not result in wages in excess of market clearing. For example, Edward Lazear, who was a successor to Stiglitz as the chair of the Council of Economic Advisers, has shown that seniority rights give an alternative incentive to keep workers from shirking.13 If you get caught shirking and have to find a new job, you lose all those privileges you may have earned from working at your job for so long. Perhaps yet more important, educated workers have a great deal to lose if they are fired and lose reputation.

This view of the labor market is at once simpler and also more complex than the traditional economic argument. It is more complex because we ascribe to the employee motives that are more realistic than those of the strictly economic model. It is simpler because we think that we can represent the wage as depending at least in part on what workers think would be fair, and those fair wages are almost always above the market clearing wage. They are also slow to change. It is an explanation for unemployment that seems to hit the sweet spot. It is simple and realistic, and it also fits the facts. In particular it explains easily and naturally why quits go up as unemployment falls. This is a fundamental building block of the economy. If jobs are really what people care about, then a theory of the macroeconomy must begin by explaining the reason for the perennial job shortage.


pages: 346 words: 90,371

Rethinking the Economics of Land and Housing by Josh Ryan-Collins, Toby Lloyd, Laurie Macfarlane, John Muellbauer

agricultural Revolution, asset-backed security, balance sheet recession, bank run, banking crisis, barriers to entry, basic income, Bretton Woods, Capital in the Twenty-First Century by Thomas Piketty, collective bargaining, Corn Laws, correlation does not imply causation, creative destruction, credit crunch, debt deflation, deindustrialization, falling living standards, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, garden city movement, George Akerlof, ghettoisation, Gini coefficient, Hernando de Soto, housing crisis, Hyman Minsky, income inequality, information asymmetry, knowledge worker, labour market flexibility, labour mobility, land reform, land tenure, land value tax, Landlord’s Game, low skilled workers, market bubble, market clearing, Martin Wolf, means of production, money market fund, mortgage debt, negative equity, Network effects, new economy, New Urbanism, Northern Rock, offshore financial centre, Pareto efficiency, place-making, price stability, profit maximization, quantitative easing, rent control, rent-seeking, Richard Florida, Right to Buy, rising living standards, risk tolerance, Second Machine Age, secular stagnation, shareholder value, the built environment, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, transaction costs, universal basic income, urban planning, urban sprawl, working poor, working-age population

As a result, landowners can command returns from those who must use their land based purely on their ownership of it, unrelated to their costs of bringing it into production or any efforts they have expended. Such returns are known as ‘economic rent’. The fixed supply of land for particular uses means it does not fit easily in mainstream economic theories where supply and demand set prices in a free market. If the demand for iPhones increases, Apple can increase the quantity of phones produced – at a cost to themselves – until an equilibrium is reached, whereby demand meets supply and the market ‘clears’. Apple may instead choose to increase the price of iPhones; however they then face the risk that some consumers may choose to buy a different brand of phone. The idea is that market competition generates an efficient trade-off between quantity and price and economic rents are minimised. But the quantity of land cannot be increased in the way the quantity of iPhones can. If demand for land increases, the price goes up without triggering a supply response.

In practice, the market largely froze, as developers cut back their outgoings and sought to recapitalise. This sustained relatively high land and house prices, and preserved the developers and banks, but at the price of transactions and output plummeting. There was no clearing of the market, no rebasing of land and house prices as after the last three booms, no opportunities for new entrants to enter the market, or for a new cohort of owner-occupiers to buy. In the absence of a market clear-out, the new government resorted to ever more massive demand-side subsidies to help push a few more middle-income households over the line into homeownership. The new land economy settlement that had emerged by the end of the 1980s – minimal supply-side intervention and demand-side support for homeownership – was being pushed to its limits. Tenure: the limits to homeownership Just as redistribution of agricultural land had broken open monopolies on political and economic power in previous eras, and in the reconstruction of the losing countries after the First World War, so the spread of homeownership during the twentieth century brought many benefits (Linklater, 2013).

Evidence from the UK and Australia suggests that rather than spending their accumulated wealth in later life, households have been passing it on to their children as inheritance, while younger cohorts have increasingly been making use of mortgage equity withdrawal (see section 5.5) to fund large, one-off expenditures (Parkinson et al., 2009). Unrealistic assumptions are also made about the financial sector and banks in the lifecycle model. Banks are assumed to willingly lend at the market rate of interest where the supply of mortgage credit meets demand (where the market ‘clears’). This is based on the assumption that both households and financial intermediaries (banks) have very high – if not perfect – levels of information and are able to make accurate judgements about the future based upon a range of knowable probabilities (the ‘rational expectations’ hypothesis). In reality, empirical research shows that there are, again, asymmetries of information between lenders and borrowers; generally a borrower always has more information about their future ability to repay a loan than a bank (Stiglitz and Weiss, 1981).


pages: 500 words: 145,005

Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

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3Com Palm IPO, Albert Einstein, Alvin Roth, Amazon Mechanical Turk, Andrei Shleifer, Apple's 1984 Super Bowl advert, Atul Gawande, Berlin Wall, Bernie Madoff, Black-Scholes formula, capital asset pricing model, Cass Sunstein, Checklist Manifesto, choice architecture, clean water, cognitive dissonance, conceptual framework, constrained optimization, Daniel Kahneman / Amos Tversky, delayed gratification, diversification, diversified portfolio, Edward Glaeser, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, George Akerlof, hindsight bias, Home mortgage interest deduction, impulse control, index fund, information asymmetry, invisible hand, Jean Tirole, John Nash: game theory, John von Neumann, Kenneth Arrow, late fees, law of one price, libertarian paternalism, Long Term Capital Management, loss aversion, market clearing, Mason jar, mental accounting, meta analysis, meta-analysis, money market fund, More Guns, Less Crime, mortgage debt, Myron Scholes, Nash equilibrium, Nate Silver, New Journalism, nudge unit, Paul Samuelson, payday loans, Ponzi scheme, presumed consent, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, random walk, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, technology bubble, The Chicago School, The Myth of the Rational Market, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, transaction costs, ultimatum game, Vilfredo Pareto, Walter Mischel, zero-sum game

In this example, that means that subjects 7, 8, and 11 will buy tokens from subjects 2, 5, and 6, as illustrated in panel C. We can figure out the price that will make this market “clear,” meaning equate supply and demand, by working from the two ends of the distribution toward the middle. Subject 11 will have no trouble finding a price at which Subject 2 will give up his token, so they are bound to make a deal. The same applies to Subjects 8 and 5. But to get Subject 7 to buy a token from Subject 6, the price will have to be between their two reservation prices. Since we only allowed prices in increments of 50 cents, the market-clearing price will be $3. FIGURE 7 Since both the values and the tokens are being handed out at random, the particular outcome will differ each time, but on average the six people with the highest valuations will have been allocated half of the tokens, and as in this example, they will have to buy three tokens to make the market clear.

FIGURE 7 Since both the values and the tokens are being handed out at random, the particular outcome will differ each time, but on average the six people with the highest valuations will have been allocated half of the tokens, and as in this example, they will have to buy three tokens to make the market clear. In other words, the predicted volume of trading is half the number of tokens distributed. Now suppose we repeat the experiment, but this time we do it with some good such as a chocolate bar. Again we could rank the subjects from high to low based on how much they like the chocolate bar, but in this case we are not telling the subjects how much they like the good; they are determining that themselves. Now we distribute the chocolate bars at random, just as in the token experiment, and ask the same series of questions. What should happen? The theory yields exactly the same prediction. On average, half of the chocolate bars will change hands, moving from those who don’t care so much for chocolate (or are on a diet) to the chocoholics who can’t wait to start munching on one of those bars.

“Cooperation and Punishment in Public Goods Experiments.” American Economic Review 66, no. 2: 980–94. ———. 2002. “Altruistic Punishment in Humans.” Nature 415, no. 6868: 137–40. Fehr, Ernst, and Lorenz Goette. 2007. “Do Workers Work More If Wages re High? Evidence from a Randomized Field Experiment.” American Economic Review 97, no. 1: 298–317. Fehr, Ernst, George Kirchsteiger, and Arno Riedl. 1993. “Does Fairness Prevent Market Clearing? An Experimental Investigation.” Quarterly Journal of Economics 108, no. 2: 437–59. Fehr, Ernst, and Klaus M. Schmidt. 1999. “A Theory of Fairness, Competition, and Cooperation.” Quarterly Journal of Economics 114, no. 3: 817–68. Fischbacher, Urs, Simon Gächter, and Ernst Fehr. 2001. “Are People Conditionally Cooperative? Evidence from a Public Goods Experiment.” Economics Letters 71, no. 3: 397–404.


pages: 261 words: 103,244

Economists and the Powerful by Norbert Haring, Norbert H. Ring, Niall Douglas

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accounting loophole / creative accounting, Affordable Care Act / Obamacare, Albert Einstein, asset allocation, bank run, barriers to entry, Basel III, Bernie Madoff, British Empire, central bank independence, collective bargaining, commodity trading advisor, corporate governance, creative destruction, credit crunch, Credit Default Swap, David Ricardo: comparative advantage, diversified portfolio, financial deregulation, George Akerlof, illegal immigration, income inequality, inflation targeting, information asymmetry, Jean Tirole, job satisfaction, Joseph Schumpeter, Kenneth Arrow, knowledge worker, labour market flexibility, law of one price, light touch regulation, Long Term Capital Management, low skilled workers, mandatory minimum, market bubble, market clearing, market fundamentalism, means of production, minimum wage unemployment, moral hazard, new economy, obamacare, old-boy network, open economy, Pareto efficiency, Paul Samuelson, pension reform, Ponzi scheme, price stability, principal–agent problem, profit maximization, purchasing power parity, Renaissance Technologies, rolodex, Sergey Aleynikov, shareholder value, short selling, Steve Jobs, The Chicago School, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, ultimatum game, union organizing, Vilfredo Pareto, working-age population, World Values Survey

This quote may explain why his new theory was met with such enthusiastic support and had such lasting impact, despite a few rather fundamental shortcomings and contradictions that we will further explore in Chapter 4. His theory says that the workings of the market make sure that workers and capital are paid exactly what they contribute to the value of the product at the margin, i.e. by what they contribute to the last unit of the good that can gainfully be produced (Clark 1899/2001). Finding market-clearing prices for goods, labor and capital is tricky both in theory and reality. They have to be found not only for each market separately, but for all markets at the same time. Leon Walras (1834–1910) was the first to tackle this problem. He formulated a large number of equations describing the whole economy. He was able to show that the system could have an equilibrium. However, he had to realize that there was no guarantee that any equilibrium would be unique and stable.

The Swiss economist Ernst Fehr has pioneered the use of the gift exchange game for this purpose. The name of the game refers to an influential theoretical paper by Nobel Memorial Prize winner George Akerlof, called “Labor Contracts as a Partial Gift Exchange.” In the gift exchange model, the effort of workers depends on whether they consider their pay as fair. Therefore many firms pay more than the market clearing wage in order to elicit more effort. One consequence of this policy is that the market does not clear and there is involuntary unemployment (Akerlof 1982). The typical results of such experiments confirm that higher wage offers by firms, on average, induce workers to provide more effort. This contradicts a fundamental neoclassical assumption that the quality of the labor unit is independent of what is paid for it.

But the secondary market is also suffering from the recession. This means that low-wage workers in the secondary market are supposed to cut their wages even more in order to create enough demand for their own labor and for the labor of those descending from the primary labor market. Most modern neoclassical theorists will admit that the wage cuts needed to achieve this can be steep. There is no guarantee at all that you can live on the market-clearing wage (Kaufman 2009). In an open economy with exports, external demand might eventually solve the problem at low enough wages, but there is certainly no guarantee. With flexible exchange rates, the exchange rate often appreciates if wages and prices go down. This can cancel out the improvement in competitiveness brought about by lower wages. However, the most important problem is that low-wage workers in the non-export sector have to take the brunt of wage cuts to put the labor market back into equilibrium.


pages: 576 words: 105,655

Austerity: The History of a Dangerous Idea by Mark Blyth

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accounting loophole / creative accounting, balance sheet recession, bank run, banking crisis, Black Swan, Bretton Woods, capital controls, Carmen Reinhart, Celtic Tiger, central bank independence, centre right, collateralized debt obligation, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, debt deflation, deindustrialization, disintermediation, diversification, en.wikipedia.org, ending welfare as we know it, Eugene Fama: efficient market hypothesis, eurozone crisis, financial repression, fixed income, floating exchange rates, Fractional reserve banking, full employment, German hyperinflation, Gini coefficient, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, information asymmetry, interest rate swap, invisible hand, Irish property bubble, Joseph Schumpeter, Kenneth Rogoff, liberal capitalism, liquidationism / Banker’s doctrine / the Treasury view, Long Term Capital Management, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, mortgage tax deduction, Occupy movement, offshore financial centre, paradox of thrift, Philip Mirowski, price stability, quantitative easing, rent-seeking, reserve currency, road to serfdom, savings glut, short selling, structural adjustment programs, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, unorthodox policies, value at risk, Washington Consensus, zero-sum game

Figure 2.2 The Keynesian Phillips Curve The new instruction sheet, which came to be known as “neoclassical,” or more popularly, “neoliberal” economics, was quite technical, but basically it started from the premise that individuals were not the shortsighted, animal-sprit, driven businessmen lampooned by Keynes, but were instead supersmart processors of information.31 The new approach distrusted anything bigger than the individual, insisting that accounts of the behavior of aggregates such as “financial markets” had to be based in prior accounts of the behavior of the individuals (investors, firms, funds) that made them up, and that any theory of the behavior of aggregates must be generated from the two main assumptions of this new neoclassical economics, that individuals are self-interested agents who maximize the pursuit of those interests, and that markets clear.32 According to this new view, the Keynesian instruction sheet must, in some sense, see individuals as being deluded all the time by government policy; otherwise, they would see the policy coming and anticipate it in their decisions, thus cancelling out its effects on real variables—so-called expectations or “Ricardian equivalence” effects. For example, if I know that the Democrats like to spend money, and that the money they like to spend is my taxes, I will change my spending decisions in advance of the Democrats coming to power to protect my money.

These same ideas were offered as explanations and implemented as policies in many countries in the 1920s and 1930s, and as we shall see in chapter 6, they didn’t work then either. As Keynes demonstrated, there is no reason for an economy to “naturally” return to a full-employment equilibrium after a shock. It can settle into a state far from full employment for a very long time.53 The Austrian explanation of sustained unemployment after a bust—the inability of the economy to self-heal as it should—is that trade unions are holding up the market-clearing wage. But in the United States, for example, where unions cover less than one in eight workers, such an explanation is simply not credible.54 Moreover, Germany and Sweden, countries with much higher unemployment rates through the business cycle, also have far higher unionization rates. Second, if the only policy on offer is to get the government out of economic affairs completely, then its not clear how one does it short of engaging in a kind of “year zero” purge of the modern economy and polity.

With inflation rising and unemployment not improving, Keynesianism, according to monetarists, eventually eats itself. Friedman’s monetarism pushed hard against one of the key ideas of the postwar economic instruction sheet—the Phillips curve—that we also discussed in chapter 2.61 Crucial was his idea that there is a natural rate of unemployment, an evolutionary throwback to classical ideas about labor markets clearing at the equilibrium wage, with the amount of employment generated being a function of structural supply-side factors plus the degree of trade-union militancy. As Michael Bleaney once observed, accepting Milton’s monetarism ensures that “ideas concerning a lack of effective demand have disappeared out the window … we are back in a completely classical world where … full employment follows automatically.”62 Indeed, monetarism was in many ways simply a restatement of the quantity theory of money that goes all the way back to David Hume.


pages: 443 words: 98,113

The Corruption of Capitalism: Why Rentiers Thrive and Work Does Not Pay by Guy Standing

3D printing, Airbnb, Albert Einstein, Amazon Mechanical Turk, Asian financial crisis, asset-backed security, bank run, banking crisis, basic income, Ben Bernanke: helicopter money, Bernie Sanders, Big bang: deregulation of the City of London, bilateral investment treaty, Bonfire of the Vanities, Bretton Woods, Capital in the Twenty-First Century by Thomas Piketty, carried interest, cashless society, central bank independence, centre right, Clayton Christensen, collapse of Lehman Brothers, collective bargaining, credit crunch, crony capitalism, crowdsourcing, debt deflation, declining real wages, deindustrialization, Doha Development Round, Donald Trump, Double Irish / Dutch Sandwich, ending welfare as we know it, eurozone crisis, falling living standards, financial deregulation, financial innovation, Firefox, first-past-the-post, future of work, gig economy, Goldman Sachs: Vampire Squid, Growth in a Time of Debt, housing crisis, income inequality, information retrieval, intangible asset, invention of the steam engine, investor state dispute settlement, James Watt: steam engine, job automation, John Maynard Keynes: technological unemployment, labour market flexibility, light touch regulation, Long Term Capital Management, lump of labour, Lyft, manufacturing employment, Mark Zuckerberg, market clearing, Martin Wolf, means of production, mini-job, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, Neil Kinnock, non-tariff barriers, North Sea oil, Northern Rock, nudge unit, Occupy movement, offshore financial centre, oil shale / tar sands, open economy, openstreetmap, patent troll, payday loans, peer-to-peer lending, Plutocrats, plutocrats, Ponzi scheme, precariat, quantitative easing, remote working, rent control, rent-seeking, ride hailing / ride sharing, Right to Buy, Robert Gordon, Ronald Coase, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, sharing economy, Silicon Valley, Silicon Valley startup, Simon Kuznets, sovereign wealth fund, Stephen Hawking, Steve Ballmer, structural adjustment programs, TaskRabbit, The Chicago School, The Future of Employment, the payments system, Thomas Malthus, Thorstein Veblen, too big to fail, Uber and Lyft, Uber for X, Y Combinator, zero-sum game, Zipcar

An equitable labour market would be one in which the bargaining strengths of buyers and sellers were roughly equal. Yet, in contrast to the stated justification for minimum wages, governments have been weakening the bargaining power of employees and trade unions. Defenders of ‘free market’ capitalism justify curbing unions’ bargaining strength on the grounds that they push wages above market-clearing and productivity-driven levels. Defenders of unions argue that without them employers can and do take advantage of workers’ vulnerability to force wages below market-clearing levels and even below the cost of subsistence. Governments have lowered wages by more indirect means as well. Thus they have allowed and encouraged the spread of unpaid or low-paid interns which, through substitution and threat effects, drives down the wages of others doing similar labour in regular jobs.36 A more systemic intervention has been the use of tax credits, discussed in Chapter 3, which enable firms to pay very low wages.

The costs include the withering of occupational ethics and routes of social mobility through professions and crafts. Taskers have the potential advantage of flexible working. But they are being used to undermine professional qualifications, further marginalising the time-honoured concept of the professional and craft community. This is what platform corporations want, and what neo-liberals have always wanted, because they depict all collective bodies as distorting the market and preventing market clearing.30 The platforms are reducing the rental income gained by those inside occupational communities and transferring that to themselves, further reducing the returns to labour and work. One of the least analysed aspects of the neo-liberal agenda has been the re-regulation of occupations, including all the great professions. Milton Friedman, an architect of the Chicago school of economics, wrote his first book (with Simon Kuznets) in 1945 on the medical professions, criticising their rent seeking through restricting the supply of doctors, imposing high standards, controlling fees and so on.


pages: 225 words: 11,355

Financial Market Meltdown: Everything You Need to Know to Understand and Survive the Global Credit Crisis by Kevin Mellyn

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asset-backed security, bank run, banking crisis, Bernie Madoff, bonus culture, Bretton Woods, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, disintermediation, diversification, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Francis Fukuyama: the end of history, George Santayana, global reserve currency, Home mortgage interest deduction, Isaac Newton, joint-stock company, liquidity trap, London Interbank Offered Rate, long peace, margin call, market clearing, mass immigration, money market fund, moral hazard, mortgage tax deduction, Northern Rock, offshore financial centre, paradox of thrift, pattern recognition, pension reform, pets.com, Plutocrats, plutocrats, Ponzi scheme, profit maximization, pushing on a string, reserve currency, risk tolerance, risk-adjusted returns, road to serfdom, Ronald Reagan, shareholder value, Silicon Valley, South Sea Bubble, statistical model, The Great Moderation, the new new thing, the payments system, too big to fail, value at risk, very high income, War on Poverty, Y2K, yield curve

This might be in a village that is conveniently located near both farms and woods. It might occur at an open-air fair that meets from time to time. The larger and more frequently the market between trappers and farmers happens, the more trades will happen. These trades will set the ‘‘price’’ between pelts and corn after anyone who wants to swap one for the other has done so. This is how markets set prices. The markets ‘‘clear,’’ as economists put it, when all the stuff brought to a market gets exchanged or swapped, so nobody wanting corn is still holding out for more pelts and vice versa. This establishes what corn is worth in terms of pelts and what pelts are worth in terms of corn. Introduction Commodity Money The question not solved by this system is, what are corn and pelts worth relative to other ‘‘stuff ’’?

It has been the largest single cause of financial crises over the last forty years, from the U.S. banking crisis of 1974, triggered by collapsing real estate investment trusts, the collapse of the U.S. savings and loan industry in the 1980s, the collapse of the Japanese bubble economy in 1990, the Swedish and Finnish banking crises of the same period, and the Asian banking crisis of 1997. The only response to this inconvenient fact that the U.S. Congress seems capable of is to throw money at the collapsing U.S. housing market instead of simply letting the market clear at prices that attract buyers who can actually afford a house. To protect distressed homeowners, our political masters have felt quite free to violate centuries of contract law and property rights essential to a functioning market economy. There is nothing to stop them from doing so. They have effectively deflected public anger away from themselves and succeeded in demonizing not only the whole financial world but free market capitalism itself.


pages: 243 words: 77,516

Straight to Hell: True Tales of Deviance, Debauchery, and Billion-Dollar Deals by John Lefevre

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airport security, blood diamonds, colonial rule, credit crunch, fixed income, Goldman Sachs: Vampire Squid, high net worth, income inequality, jitney, market clearing, Occupy movement, Sloane Ranger, the market place

After all, many of the other guys whom we had “sounded out” the deal to ahead of time have no such complaints. The book-building process varies significantly from a single-day drive-by to a heavily marketed two-week roadshow. The simple idea is to work with the sales force to bring in orders and solicit price sensitivities and feedback from the investors. This “market color” is reflected by me to the issuer. It’s then my job to convince the issuer to agree to a price that reflects where a market-clearing deal works. Once we get the issuer to sign off on the deal terms, we’re ready to allocate bonds to investors, get the deal across the finish line, and then move on to the next one. The allocation process is one of the most nuanced and contentious aspects of the execution process, and probably the most important. Our primary focus when it comes to allocating bonds is to do what’s in the best interests of the deal—place the bonds in safe hands (i.e., serious long-term buy-and-hold accounts who are participating in the deal because they know and like the credit, not because they think it’s a hot deal and they can “flip the bonds on the break,” or sell them immediately after the deal prices).

After several catastrophic days on the road, the relationship bankers delicately convince the chairman to come back to Hong Kong and allow the rest of the deal team—including his highly impressive, Western-educated CFO—to complete the remainder of the roadshow on the company’s behalf. Not only have we been telling the deal team that market conditions have weakened and investor appetite for risk has diminished for first-time issuers, things really have deteriorated. We’re now looking at a market-clearing transaction in the context of 10.5%, or 100 basis points higher than what we promised—not an immaterial difference in the context of a $300 million deal. The time has finally come for us to drop the hammer; we’re already late on providing formal price guidance to the market. We’ve been whispering “low/mid-10s” to investors, and even that doesn’t get them too excited. We now need the chairman’s approval to go out to the market with official price guidance in the range of 10.5% area.


pages: 206 words: 70,924

The Rise of the Quants: Marschak, Sharpe, Black, Scholes and Merton by Colin Read

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Albert Einstein, Bayesian statistics, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, collateralized debt obligation, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, discovery of penicillin, discrete time, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, floating exchange rates, full employment, Henri Poincaré, implied volatility, index fund, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, Long Term Capital Management, Louis Bachelier, margin call, market clearing, martingale, means of production, moral hazard, Myron Scholes, naked short selling, Paul Samuelson, price stability, principal–agent problem, quantitative trading / quantitative finance, RAND corporation, random walk, risk tolerance, risk/return, Ronald Reagan, shareholder value, Sharpe ratio, short selling, stochastic process, The Chicago School, the scientific method, too big to fail, transaction costs, tulip mania, Works Progress Administration, yield curve

The Kiel School approach shifted the economic debate in two important ways. Up to that point, economics at the macro level was considered a trivial extension of economics of the small, or microeconomics. In the microeconomics of a market, a price that is too high results in supply that exceeds demand and a reduction in the price until the surpluses in the market clear. The trivial extension to the macroeconomy commends that such symptoms of excess supply as unemployment should result in lower wages and market clearing. In other words, individual 18 The Rise of the Quants markets are either at or converging toward equilibrium at all times, and so must the aggregation of all markets at the macroeconomic level. The Kiel School also recognized that aggregates of markets do not behave as simplistically as classically trained microeconomists might wish.


pages: 483 words: 141,836

Red-Blooded Risk: The Secret History of Wall Street by Aaron Brown, Eric Kim

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, Asian financial crisis, Atul Gawande, backtesting, Basel III, Bayesian statistics, beat the dealer, Benoit Mandelbrot, Bernie Madoff, Black Swan, capital asset pricing model, central bank independence, Checklist Manifesto, corporate governance, creative destruction, credit crunch, Credit Default Swap, disintermediation, distributed generation, diversification, diversified portfolio, Edward Thorp, Emanuel Derman, Eugene Fama: efficient market hypothesis, experimental subject, financial innovation, illegal immigration, implied volatility, index fund, Long Term Capital Management, loss aversion, margin call, market clearing, market fundamentalism, market microstructure, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, natural language processing, open economy, Pierre-Simon Laplace, pre–internet, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, special drawing rights, statistical arbitrage, stochastic volatility, The Myth of the Rational Market, Thomas Bayes, too big to fail, transaction costs, value at risk, yield curve

Suppose I study all the people making markets (that is, setting prices at which they will buy from or sell to anyone) in, say, oil futures. They set different prices, implying different betting odds on oil prices in the future. I’m only interested in the market makers generating consistent profits. But even within this group there is a variety of prices and also differences in the positions they have built up. You might argue that the differences in prices are going to be pretty small, and some kind of average or market-clearing price is the best estimate of probability. One issue with this is none of the prices directly measure probability; all of them blend in utility to some degree. A person who locks in a price for future oil may not believe the price of oil is going up. She may be unable to afford higher prices if that does happen, and is willing to take an expected loss in order to ensure survival of her business.

Other market makers may actually lose money on their oil future bets, but make money overall because they use the oil bets to hedge other bets in an overall profitable strategy. Following their probabilities is also bad. The probability we care about is that of a hypothetical risk-neutral oil market maker who makes consistent money in stand-alone oil futures trading averaging over all future scenarios. That turns out to give significantly different probabilities than our subjective estimates, or long-term frequency, or market-clearing prices; even if we agree on numeraire and the identity of the bettors on the other side. The result of all this is rocket scientists invented their own notion of probability. A probability distribution can only be defined with respect to a numeraire, and therefore cannot be defined for all possible outcomes. If you flip a coin, heads you win a dollar and tails you lose a dollar, the coin could stick to the ceiling or land on its edge, you could win the bet and not get paid, or you could get paid but dollars might be worthless at the time—or a 100 percent tax on gambling winnings could be passed while the coin is in the air, or you could die before the coin lands.

Unlike more primitive forms of money, they exist in zero net supply: For every long position there is an offsetting short position. Therefore, there is no need for a pool of loans or pile of gold to support their value. The net value is zero. What is important is that the derivatives will pay off as promised. That payoff is secured by the initial margin and daily mark-to-market payments made by derivative holders. That security, in turn, depends on two things: that we can establish a daily market-clearing price for the derivative and that the price doesn’t change in any day more than the amount of initial margin required. Accurate, transparent prices and smooth price changes are both features of liquidity. Futures markets often have daily price change limits; the price is not allowed to move more than a certain amount in a day. That doesn’t solve the problem of large price movements, however; it only gives participants some extra time to meet large margin calls.


pages: 310 words: 90,817

Paper Money Collapse: The Folly of Elastic Money and the Coming Monetary Breakdown by Detlev S. Schlichter

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bank run, banks create money, British Empire, capital controls, Carmen Reinhart, central bank independence, currency peg, fixed income, Fractional reserve banking, German hyperinflation, global reserve currency, inflation targeting, Kenneth Rogoff, Long Term Capital Management, market clearing, Martin Wolf, means of production, money market fund, moral hazard, mortgage debt, open economy, Ponzi scheme, price discovery process, price mechanism, price stability, pushing on a string, quantitative easing, reserve currency, rising living standards, risk tolerance, savings glut, the market place, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, Y2K

A temporary drop in the statistical average of all prices cannot be excluded. Additionally, rising uncertainty in the crisis may lift the demand for cash holdings, which, in the absence of further money injections, will lead to a rise in the purchasing power of money. These deflationary processes must be allowed to proceed. They are part of a necessary readjustment of prices away from money-induced distortions and back toward market-clearing levels. However, no specific policies are necessary, such as shrinking the money supply or lowering prices to return to a specific price average or a previous gold price. All that is needed is simply a complete stop to money injections followed by the abstention from any interference with the market process. Another misconception is that opposition to interventionist policies after a crisis must be based on considerations of moral hazard.

However, in that case, the world would at least be closer to the solution of the crisis, as the market would have been allowed to liquidate resource misallocations and adjust prices to reflect the true voluntary demand for assets, and the true availability of private savings. The antideflation policy that has been adopted is largely a policy of price fixing, a policy of preventing the market from exposing capital misallocations and then liquidating them. The root causes of the crisis remain in place and the underlying problems unaddressed. For example, mortgage-backed securities worth billions have still not been placed at market-clearing levels with private investors but are being artificially supported either directly by the Federal Reserve or indirectly by the banking sector that has been encouraged with vast amounts of free money from the Fed to hold onto these securities. Without a free market and uninhibited price formation, there is simply no way of telling what the true demand for these securities is and which of them are supported by private capital and true savings.


pages: 258 words: 83,303

Why Your World Is About to Get a Whole Lot Smaller: Oil and the End of Globalization by Jeff Rubin

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air freight, banking crisis, big-box store, BRICs, carbon footprint, collateralized debt obligation, collective bargaining, creative destruction, credit crunch, David Ricardo: comparative advantage, decarbonisation, energy security, food miles, hydrogen economy, illegal immigration, immigration reform, Intergovernmental Panel on Climate Change (IPCC), invisible hand, James Watt: steam engine, Just-in-time delivery, market clearing, megacity, North Sea oil, oil shale / tar sands, oil shock, peak oil, profit maximization, reserve currency, South Sea Bubble, the market place, The Wealth of Nations by Adam Smith, trade liberalization, zero-sum game

The basic rules in economics are pretty simple, despite all the fancy mathematical packaging that comes with the discipline these days. The two fundamental axioms of the dismal science are that the demand curve slopes down and the supply curve slopes up. That is, the more people want something, the more it should cost. And the more it costs, the more of it there should be. Find the point of intersection between those two curves, and voilà, you have found the market clearing price. If Porsche Carreras were given away to all ticket holders at NFL games, they would be worth a lot less than they are today. If we started running out of, say, shampoo, the price would go up. Manufacturers would have an incentive to ramp up shampoo production, and the price would come back down. Pretty simple. The basic laws of demand and supply dictate that higher oil prices should draw additional supply from the ground while at the same time killing off demand.

How many more pioneers from the urbanized south will head north in the future, when triple-digit oil prices will make the Yukon and the rest of the Canadian North as remote as it ever has been? Warren has already announced that he will only operate the fishing lodge business every other year. At least for now, I can still come back in 2010. But he also tells me there are seven salmon-fishing lodges for sale on one river alone in Alaska. Basic economics tells me that if seven fishing lodges suddenly come on the market at the same time, the market clearing price for an Alaskan fishing lodge is going to be falling. In short, there are more sellers than buyers of Alaskan fishing lodges. And for good reason. Who is going to come in and buy what are hugely oil-intensive businesses when the price of delivering oil to the lodge amounts to as much as $420 per barrel? At the same time, our lodge owner is also an astute businessman. To survive out here you have to be.


pages: 411 words: 108,119

The Irrational Economist: Making Decisions in a Dangerous World by Erwann Michel-Kerjan, Paul Slovic

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Andrei Shleifer, availability heuristic, bank run, Black Swan, Cass Sunstein, clean water, cognitive dissonance, collateralized debt obligation, complexity theory, conceptual framework, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-subsidies, Daniel Kahneman / Amos Tversky, endowment effect, experimental economics, financial innovation, Fractional reserve banking, George Akerlof, hindsight bias, incomplete markets, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Isaac Newton, iterative process, Kenneth Arrow, Loma Prieta earthquake, London Interbank Offered Rate, market bubble, market clearing, money market fund, moral hazard, mortgage debt, Pareto efficiency, Paul Samuelson, placebo effect, price discrimination, price stability, RAND corporation, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, source of truth, statistical model, stochastic process, The Wealth of Nations by Adam Smith, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, ultimatum game, University of East Anglia, urban planning, Vilfredo Pareto

The elements of the analysis are competitive markets in the individual commodities, each characterized by a large number of participants on both sides, all facing the same price, and by market clearing (buyers purchase the commodity from the sellers at this market price). Under these assumptions, there is no question of liquidity; any individual, taken to be small compared with the total market, can buy or sell at the unique market price. Money plays no essential role, except as a useful tool of accounting. The markets are linked because the same individuals appear in all or at least many markets, and make choices as consumers or producers based on all prices. Hence, the price of one commodity affects market behavior on all other markets. Under these and other conditions, some remarkable theoretical results have been obtained. There will be a set of prices (possibly not unique) such that equilibrium (market clearing) can be achieved on all markets (with a suitable meaning for clearing when there is excess supply at zero price).


pages: 1,088 words: 228,743

Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

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Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, survivorship bias, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

., if price is equal to value), the expected return on the market portfolio, the return forecast for the equity market or any other market, should equal that market’s required return. The expected return determines how high a return the market can feasibly supply, while the required return determines how high a return market participants (as a group) demand (in order to hold the amount of an asset that is on offer, so that markets clear and all assets are held). As always, market prices adjust to balance supply and demand. For example, if all investors suddenly require higher risk premia, current market prices of risky assets must fall. Time variation in objectively feasible future returns may reflect mispricing caused by irrational expectations or sentiment fluctuations—but its origins could also be fully rational, reflecting risk premia that are time varying due to variation in the amount of risk in the market or in market participants’ tolerance for risk.

., frictionless markets); • investors are rational mean variance optimizers (only caring about means and covariances can be motivated by normally distributed asset returns or by a quadratic utility function); and • investors have homogeneous expectations (all agree about asset means and covariances; all investors see the same picture). These assumptions ensure that every investor holds the same portfolio of risky assets, combining it with some amount, positive or negative, of the riskless asset (this latter amount depends on the specific risk aversion of a given investor). Moreover, these assumptions lead to the conclusion that the holdings just described are optimal. Finally, in equilibrium, market clearing requires that the risky asset portfolio demanded in common by all investors equals the market portfolio of risky assets. The CAPM’s asset-pricing implication is that assets with a higher sensitivity to the market [2] should offer a higher expected return—see equation (5.2), which is a simple rendition of the CAPM. Why? Investors require compensation for the risk each asset contributes to their portfolio—not for accepting an asset’s standalone risk.

Most equilibrium models ignore the production side by assuming an exchange economy with one consumption good and then focus on the preferences of a representative agent who maximizes the expected utility of lifetime consumption. The prototypical case involves time-separable utility (only current and future consumption matter, not past consumption) and constant relative risk aversion (the same proportion of wealth is invested in the risky asset at all wealth levels). In equilibrium, asset prices are set so that the consumer holds all the assets (market clearing) and is indifferent to buying or selling a small unit of any asset. Such optimizing behavior implies the fundamental valuation equation (5.3), that asset price is equal to the expected product of a future payoff and the SDF. [6] A common formal specification assumes a representative agent and time-separable utility of consumption. Then the SDF equals an impatience factor times a ratio of MU next period over MU today (where MU is the marginal utility of one additional unit of consumption).


pages: 475 words: 155,554

The Default Line: The Inside Story of People, Banks and Entire Nations on the Edge by Faisal Islam

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Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Big bang: deregulation of the City of London, British Empire, capital controls, carbon footprint, Celtic Tiger, central bank independence, centre right, collapse of Lehman Brothers, credit crunch, Credit Default Swap, crony capitalism, dark matter, deindustrialization, Deng Xiaoping, disintermediation, energy security, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, financial repression, floating exchange rates, forensic accounting, forward guidance, full employment, G4S, ghettoisation, global rebalancing, global reserve currency, hiring and firing, inflation targeting, Irish property bubble, Just-in-time delivery, labour market flexibility, light touch regulation, London Whale, Long Term Capital Management, margin call, market clearing, megacity, Mikhail Gorbachev, mini-job, mittelstand, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, negative equity, North Sea oil, Northern Rock, offshore financial centre, open economy, paradox of thrift, Pearl River Delta, pension reform, price mechanism, price stability, profit motive, quantitative easing, quantitative trading / quantitative finance, race to the bottom, regulatory arbitrage, reserve currency, reshoring, Right to Buy, rising living standards, Ronald Reagan, savings glut, shareholder value, sovereign wealth fund, The Chicago School, the payments system, too big to fail, trade route, transaction costs, two tier labour market, unorthodox policies, uranium enrichment, urban planning, value at risk, working-age population, zero-sum game

It adds to the national debt for five years, but not the annual deficit, because the Treasury takes a 20 per cent stake in the house. Although it is borrowed money, it doesn’t count as public-sector borrowing but as a ‘financial transaction’ instead. The banks fund 75 per cent, a less risky and therefore cheaper mortgage, and the buyer pays a 5 per cent deposit. It basically opens up affordable mortgages to buyers with small deposits. Was there not a simpler solution to jump-start the market? Why not let the market clear, and prices fall to reflect falling real incomes, weak economic growth? Indeed, why doesn’t Taylor Wimpey just cut the prices of its homes? ‘Life’s not that simple,’ Redfern tells me. He mentions the impact on local existing homes if new home prices were cut. ‘I don’t think it’s very desirable for people who have already bought from us, and people in the surrounding village. Everybody wants a certain stability in housing.’

DEFAULT LINE #6: The role of economics Economics has developed into something of a state-backed theology in public policy. It is social science that has become a language for the calculation of costs and benefits. Its magical powers have been overstated, however. Many of these economic analyses are just extrapolations and the only accurate analysis is provided with hindsight. Conventional market-clearing equilibrium economics inculcates a mindset of econofatalism: a belief that nothing can be done to change the inevitable financial fate of a nation’s economy. Milton Friedman developed the concept of the ‘superneutrality’ of money. Superneutrality is an apt description of the approach to public policy that arises out of the overuse of economics. I know enough about economics to appreciate its flaws.

Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor by John Kay

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Albert Einstein, Asian financial crisis, Barry Marshall: ulcers, Berlin Wall, Big bang: deregulation of the City of London, California gold rush, complexity theory, computer age, constrained optimization, corporate governance, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, Donald Trump, double entry bookkeeping, double helix, Edward Lloyd's coffeehouse, equity premium, Ernest Rutherford, European colonialism, experimental economics, Exxon Valdez, failed state, financial innovation, Francis Fukuyama: the end of history, George Akerlof, George Gilder, greed is good, Gunnar Myrdal, haute couture, illegal immigration, income inequality, industrial cluster, information asymmetry, intangible asset, invention of the telephone, invention of the wheel, invisible hand, John Meriwether, John Nash: game theory, John von Neumann, Kenneth Arrow, Kevin Kelly, knowledge economy, labour market flexibility, late capitalism, light touch regulation, Long Term Capital Management, loss aversion, Mahatma Gandhi, market bubble, market clearing, market fundamentalism, means of production, Menlo Park, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Naomi Klein, Nash equilibrium, new economy, oil shale / tar sands, oil shock, Pareto efficiency, Paul Samuelson, pets.com, popular electronics, price discrimination, price mechanism, prisoner's dilemma, profit maximization, purchasing power parity, QWERTY keyboard, Ralph Nader, RAND corporation, random walk, rent-seeking, Right to Buy, risk tolerance, road to serfdom, Ronald Coase, Ronald Reagan, second-price auction, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, Steve Jobs, telemarketer, The Chicago School, The Death and Life of Great American Cities, The Market for Lemons, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, total factor productivity, transaction costs, tulip mania, urban decay, Vilfredo Pareto, Washington Consensus, women in the workforce, yield curve, yield management

Competitive markets-whether for electricity or for flowers, for oil or for milk, for risk or for money-produce their own local equilibrium that equates supply and demand. The lights stay on, the flowers that arrive at San Remo at the beginning of the morning leave it at the end. This solves part of the coordination problem, but only part. The remarkable feature of the market economy is that it seems to solve a large variety of coordination problems simultaneously. The flower market clears, and at the same time electricity demand balances supply. There are enough trucks at the market, but not too many; enough gas for power stations, but not too much. Central planners always found it easy to deal with any particular coordination failure. By switching resources you can always relieve a shortage or a surplus: this is what we do when we plan our households or our businesses, and it is what the people who ran the Soviet { 174} John Kay economy did all the time.

The firm that accepts the offer is saying, "We are more concerned with our costs than with the caliber of our staf£" In a market in which quality is important but hard to judge price competition is rarely effective or intense. And in the labor market, quality is important to both parties. The employer is concerned about the abilities and commitment of his staff; the worker wants a pleasant environment and congenial and capable colleagues. Concepts of the "going rate" are important to the decisions of employers and employees. And since prices have an informational function as well as a market-clearing function, there are good reasons for this. But a consequence is that in the labor market, as in the property market, prices will adjust only slowly to changing economic conditions. So there is unemployment in slumps, and labor shortages in booms. 11 And so the Arrow-Debreu model can be no more than a partial explanation of how market economies solve coordination problems. In that world, price equates supply and demand, and shortages or surpluses never occur because movements in prices eliminate them.


pages: 436 words: 114,278

Crude Volatility: The History and the Future of Boom-Bust Oil Prices by Robert McNally

American energy revolution, Asian financial crisis, banking crisis, barriers to entry, Bretton Woods, collective bargaining, credit crunch, energy security, energy transition, housing crisis, hydraulic fracturing, index fund, Induced demand, interchangeable parts, invisible hand, joint-stock company, market clearing, market fundamentalism, moral hazard, North Sea oil, oil rush, oil shale / tar sands, oil shock, peak oil, price discrimination, price stability, sovereign wealth fund, transfer pricing

Meanwhile, prices on crude and refined products remained frozen for the big oil producers and importers accounting for 95 percent of the market, constrained in their ability to expand production.41 Customers of the big companies—independent marketers, fuel oil distributors, and other large fuel purchasers—found themselves unable to get the supply they needed at controlled prices. This is not surprising, since basic economics tells us when prices are held below market–clearing level, producers suffer losses if they produce or expand. Physical shortages result. Rising prices and shortages thrust the oil industry into the public’s crosshairs. Claims that the big firms were “holding back” supplies began to surface. Political pressure rose for the federal government to expand regulation beyond prices onto supply via the direct allocation (in other words, rationing) of supplies of crude and refined products.

Rather than produce for $5.25, they preferred to keep the oil in the ground and sell later at a higher price. Domestic production fell, which increased dependence on imports.45 Second, the price controls increased incentives to import oil which in turn emboldened OPEC and made the U.S. more likely to see higher prices.46 The famous gas lines and shortages of the mid-1970s originated partly from price controls47 (to the extent controls held prices below market—clearing levels, they stimulated consumption), but mainly from allocation programs, state regulations, and consumer panic. Allocation programs, which stipulated the geographic allotment of fuel and were based on historical consumption patterns, denied oil companies the flexibility to move supplies from ample to lacking parts of the country. State regulations limited how long stations could remain open (previously they were open around the clock) and allocated purchases based on an odd or even license plate.


pages: 464 words: 139,088

The End of Alchemy: Money, Banking and the Future of the Global Economy by Mervyn King

Andrei Shleifer, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bretton Woods, British Empire, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, centre right, collapse of Lehman Brothers, creative destruction, Credit Default Swap, crowdsourcing, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Doha Development Round, Edmond Halley, Fall of the Berlin Wall, falling living standards, fiat currency, financial innovation, financial intermediation, floating exchange rates, forward guidance, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, German hyperinflation, Hyman Minsky, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, large denomination, liquidity trap, Long Term Capital Management, manufacturing employment, market clearing, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Nick Leeson, North Sea oil, Northern Rock, oil shale / tar sands, oil shock, open economy, paradox of thrift, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, quantitative easing, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Satoshi Nakamoto, savings glut, secular stagnation, seigniorage, stem cell, Steve Jobs, The Great Moderation, the payments system, Thomas Malthus, too big to fail, transaction costs, Tyler Cowen: Great Stagnation, yield curve, Yom Kippur War, zero-sum game

When bidding in the auction, consumers must bid not only for the good they want – lunch in their favourite Manhattan restaurant, say – and the date on which they want it – next Tuesday – but also for the ‘state of the world’ in which they wish to purchase it. For example, if the restaurant is outdoors you might bid high for a table if next Tuesday were to be sunny and perhaps zero for a table if it were cold or wet. Market-clearing prices are likely to be high in the former ‘state of the world’ and low in the latter. The key point is that all transactions can be made in advance because it is possible, in this theoretical view, to identify all relevant states of the world and make the auction contingent on them. In other words, radical uncertainty is ruled out by assumption. Obviously, there are many ways in which the world is very far removed from this abstract description, apart from the obvious impracticability of organising the grand auction.

With high-speed electronic transfers it is becoming feasible to transfer stocks and shares and other forms of marketable wealth from the buyer to the seller instead of money, so enabling buyers and sellers to avoid holding some of their wealth in a form that earns little or no interest. Pre-agreed instructions embedded in computer algorithms would determine the sequence in which financial assets belonging to the purchaser were sold and used to augment the financial assets of the vendor, also in a pre-agreed sequence. Assets used in this way could be any for which there were market-clearing prices in ‘real time’. Someone buying a meal in a restaurant might use a card, as now, but the result would not be a transfer from their bank account to that of the restaurant; instead there would be a sale of shares from the diner’s portfolio and the acquisition of different shares, or other assets, to the same value by the restaurant. The key to any such development is the ability of computers to communicate in ‘real time’ to permit instantaneous verification of the creditworthiness of the buyer and the seller, thereby enabling private sector settlement to occur with finality.


pages: 161 words: 44,488

The Business Blockchain: Promise, Practice, and Application of the Next Internet Technology by William Mougayar

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Airbnb, airport security, Albert Einstein, altcoin, Amazon Web Services, bitcoin, Black Swan, blockchain, business process, centralized clearinghouse, Clayton Christensen, cloud computing, cryptocurrency, disintermediation, distributed ledger, Edward Snowden, en.wikipedia.org, ethereum blockchain, fault tolerance, fiat currency, fixed income, global value chain, Innovator's Dilemma, Internet of things, Kevin Kelly, Kickstarter, market clearing, Network effects, new economy, peer-to-peer, peer-to-peer lending, prediction markets, pull request, QR code, ride hailing / ride sharing, Satoshi Nakamoto, sharing economy, smart contracts, social web, software as a service, too big to fail, Turing complete, web application

They will be routinely updated in a decentralized fashion from secure, trusted locations and healthcare providers. Legally binding governance-related matters will be easily implemented across distributed teams. Remote voting will be trusted, even at national levels, in legally binding political elections. Trading exchanges (stocks, commodity, financial instruments) will adopt blockchain-based trust services for validating transactions, and streamlining their market-clearing activities. Most banks will support routine bi-directional cryptocurrency transactions (between regular currency and cryptocurrency). Most merchants will accept cryptocurrency as a payment option. Accounting, billing and financial packages will include cryptocurrency as standard choices, including crypto-equity. Digital goods will be invisibly stamped for their origin authenticity, as a routine.


pages: 172 words: 54,066

The End of Loser Liberalism: Making Markets Progressive by Dean Baker

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Asian financial crisis, banking crisis, Bernie Sanders, collateralized debt obligation, collective bargaining, corporate governance, currency manipulation / currency intervention, Doha Development Round, financial innovation, full employment, Home mortgage interest deduction, income inequality, inflation targeting, invisible hand, manufacturing employment, market clearing, market fundamentalism, medical residency, patent troll, pets.com, pirate software, price stability, quantitative easing, regulatory arbitrage, rent-seeking, Robert Shiller, Robert Shiller, Silicon Valley, too big to fail, transaction costs

This sort of charade has allowed both the Obama and Bush administrations to claim that they are concerned about the overvaluation of the dollar and that they are doing what they can to rectify the situation. Yet the United States has the power to unilaterally take steps to lower the value of the dollar against other currencies. It can be difficult or even impossible to keep the price of a currency above the market-clearing level, but it is always possible to push down the value of a currency, through relatively simple mechanisms. One route, which is completely legal under all U.S. trade agreements, would be to tax the interest earnings of a country that we believe is maintaining an undervalued currency against the dollar. For example, the United States could impose a 20 percent tax on all of the earnings on dollar assets held by China’s central bank or state-owned enterprises.


pages: 257 words: 13,443

Statistical Arbitrage: Algorithmic Trading Insights and Techniques by Andrew Pole

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algorithmic trading, Benoit Mandelbrot, Chance favours the prepared mind, constrained optimization, Dava Sobel, George Santayana, Long Term Capital Management, Louis Pasteur, mandelbrot fractal, market clearing, market fundamentalism, merger arbitrage, pattern recognition, price discrimination, profit maximization, quantitative trading / quantitative finance, risk tolerance, Sharpe ratio, statistical arbitrage, statistical model, stochastic volatility, systematic trading, transaction costs

Here, however, the rules are defined by human modelers and not the laws of the physical universe, and they are changeable. Noise is omnipresent as human traders still directly preempt a sizable chunk of market activity and originate all transactions. Notwithstanding the noise, the new forces for equilibrium are searching not for fair relative prices but fair (mutually accepted by participating entities) market clearing. This new paradigm may be a reversion (!!!) to an age-old paradigm of economics: perfect competition. Now, on that train of thought one might conjure ideas of dynamic cobweb algorithms, game theoretic strategies, and perhaps a necessary repositioning of research into behavioral finance. Volatility will remain consumed by the algorithms. Instead of human-to-human interaction either face-to-face on the floor of the NYSE or face-to-screen-to-face in electronic marts, there will be algorithm-to-algorithm exchange.


pages: 183 words: 17,571

Broken Markets: A User's Guide to the Post-Finance Economy by Kevin Mellyn

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banking crisis, banks create money, Basel III, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, call centre, Carmen Reinhart, central bank independence, centre right, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, crony capitalism, currency manipulation / currency intervention, disintermediation, eurozone crisis, fiat currency, financial innovation, financial repression, floating exchange rates, Fractional reserve banking, global reserve currency, global supply chain, Home mortgage interest deduction, index fund, information asymmetry, joint-stock company, Joseph Schumpeter, labor-force participation, labour market flexibility, light touch regulation, liquidity trap, London Interbank Offered Rate, lump of labour, market bubble, market clearing, Martin Wolf, means of production, mobile money, money market fund, moral hazard, mortgage debt, mortgage tax deduction, negative equity, Ponzi scheme, profit motive, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, rising living standards, Ronald Coase, seigniorage, shareholder value, Silicon Valley, statistical model, Steve Jobs, The Great Moderation, the payments system, Tobin tax, too big to fail, transaction costs, underbanked, Works Progress Administration, yield curve, Yogi Berra, zero-sum game

There was the opportunity to simultaneously increase temporary income support while making pro-growth reforms in the tax code and providing a road map to sustainable public finances, something the bipartisan Simpson-Bowles Commission sketched out. Even an increase in direct government purchases of military hardware might have helped, as it did after 1940. So would a plan to let the financial, especially the mortgage, markets clear through actually finding a bottom at which assets would find ready buyers.The window for bold action with bipartisan support was there, as it was in 1933. Whatever one thinks of the New Deal, Roosevelt treated the Depression as a national emergency equivalent to war and focused on nothing else in his famous 100 days. One of Roosevelt’s best early strokes was the Bank Holiday of 1933, which halted the implosion of the banking system.


pages: 282 words: 80,907

Who Gets What — and Why: The New Economics of Matchmaking and Market Design by Alvin E. Roth

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Affordable Care Act / Obamacare, Airbnb, algorithmic trading, barriers to entry, Berlin Wall, bitcoin, Build a better mousetrap, centralized clearinghouse, Chuck Templeton: OpenTable, commoditize, computer age, computerized markets, crowdsourcing, deferred acceptance, desegregation, experimental economics, first-price auction, Flash crash, High speed trading, income inequality, Internet of things, invention of agriculture, invisible hand, Jean Tirole, law of one price, Lyft, market clearing, market design, medical residency, obamacare, proxy bid, road to serfdom, school choice, sealed-bid auction, second-price auction, second-price sealed-bid, Silicon Valley, spectrum auction, Spread Networks laid a new fibre optics cable between New York and Chicago, Steve Jobs, The Wealth of Nations by Adam Smith, two-sided market

Xiaolin Xing and I studied the labor market for professional psychologists at a time when they tried to implement something like the deferred acceptance algorithm by telephone. It was too congested for them to get to a stable matching: trying to conduct all the steps of the deferred acceptance algorithm through long chains of phone calls took too long. See A. E. Roth and X. Xing, “Turnaround Time and Bottlenecks in Market Clearing: Decentralized Matching in the Market for Clinical Psychologists,” Journal of Political Economy 105 (April 1997): 284–329. Today they use the same kind of computerized clearinghouse that we designed for the medical Match. [>] counterexample: Gale and Shapley’s proof that a stable matching always exists when no couples are present is what mathematicians call a theorem, while an example that shows that conclusion no longer follows when couples are present is called a counterexample, because it is an example that goes counter to what we might have expected from the theorem.


pages: 252 words: 73,131

The Inner Lives of Markets: How People Shape Them—And They Shape Us by Tim Sullivan

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Airbnb, airport security, Al Roth, Alvin Roth, Andrei Shleifer, attribution theory, autonomous vehicles, barriers to entry, Brownian motion, centralized clearinghouse, Chuck Templeton: OpenTable, clean water, conceptual framework, constrained optimization, continuous double auction, creative destruction, deferred acceptance, Donald Trump, Edward Glaeser, experimental subject, first-price auction, framing effect, frictionless, fundamental attribution error, George Akerlof, Goldman Sachs: Vampire Squid, Gunnar Myrdal, helicopter parent, information asymmetry, Internet of things, invisible hand, Isaac Newton, iterative process, Jean Tirole, Jeff Bezos, Johann Wolfgang von Goethe, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, late fees, linear programming, Lyft, market clearing, market design, market friction, medical residency, multi-sided market, mutually assured destruction, Nash equilibrium, Occupy movement, Pareto efficiency, Paul Samuelson, Peter Thiel, pets.com, pez dispenser, pre–internet, price mechanism, price stability, prisoner's dilemma, profit motive, proxy bid, RAND corporation, ride hailing / ride sharing, Robert Shiller, Robert Shiller, Ronald Coase, school choice, school vouchers, sealed-bid auction, second-price auction, second-price sealed-bid, sharing economy, Silicon Valley, spectrum auction, Steve Jobs, Tacoma Narrows Bridge, technoutopianism, telemarketer, The Market for Lemons, The Wisdom of Crowds, Thomas Malthus, Thorstein Veblen, trade route, transaction costs, two-sided market, uranium enrichment, Vickrey auction, Vilfredo Pareto, winner-take-all economy

(New York: Cambridge University Press, 1997), 7; interview with Findlay. 6. Congestion pricing is related to Uber’s surge pricing, where prices go up when there are fewer cars or more people looking for a ride. But the rationale is a bit different. Vickrey was focused on preventing the negative externalities that occur when a system is overloaded by too many customers. Uber just wants to reequilibrate supply and demand in real time to let markets clear—to make sure supply meets demand—by the minute. 7. A classic result in auction theory, the Revenue Equivalence Theorem, shows that, with appropriate assumptions on buyer and seller attributes like risk preferences, first- and second-price auctions can be expected to generate the same revenues for the seller, on average. Essentially, bidders in a first-price auction will shave their bids by “just enough” so that on average the amount paid to the seller is about the same.


pages: 270 words: 73,485

Hubris: Why Economists Failed to Predict the Crisis and How to Avoid the Next One by Meghnad Desai

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3D printing, bank run, banking crisis, Berlin Wall, Big bang: deregulation of the City of London, Bretton Woods, BRICs, British Empire, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, correlation coefficient, correlation does not imply causation, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, German hyperinflation, Gunnar Myrdal, Home mortgage interest deduction, imperial preference, income inequality, inflation targeting, invisible hand, Isaac Newton, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, laissez-faire capitalism, liquidity trap, Long Term Capital Management, market bubble, market clearing, means of production, Mexican peso crisis / tequila crisis, mortgage debt, Myron Scholes, negative equity, Northern Rock, oil shale / tar sands, oil shock, open economy, Paul Samuelson, price stability, purchasing power parity, pushing on a string, quantitative easing, reserve currency, rising living standards, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, secular stagnation, seigniorage, Silicon Valley, Simon Kuznets, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, Tobin tax, too big to fail, women in the workforce

Samuelson’s student Lawrence Klein, who had coined the term “the Keynesian Revolution,” became known for translating Keynesian ideas into econometric models, which could then be used for policy purposes.10 There was, however, a problem at the heart of economics. In microeconomics, the theory of single markets taken individually (partial equilibrium) or taken simultaneously (general equilibrium) was taught. Economists learnt that the market works, that is, that all markets clear and there is no excess supply left unsold or excess demand left unsatisfied at the end of the day. In macroeconomics, they learnt that the labor market often failed to clear and hence public policy was needed to correct that anomaly. The two strands seemed incompatible. Walrasian or Marshallian economics did not face this problem. It had no need of a theory of aggregate output or employment.


pages: 662 words: 180,546

Never Let a Serious Crisis Go to Waste: How Neoliberalism Survived the Financial Meltdown by Philip Mirowski

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Alvin Roth, Andrei Shleifer, asset-backed security, bank run, barriers to entry, Basel III, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, blue-collar work, Bretton Woods, Brownian motion, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, constrained optimization, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, dark matter, David Brooks, David Graeber, debt deflation, deindustrialization, Edward Glaeser, Eugene Fama: efficient market hypothesis, experimental economics, facts on the ground, Fall of the Berlin Wall, financial deregulation, financial innovation, Flash crash, full employment, George Akerlof, Goldman Sachs: Vampire Squid, Hernando de Soto, housing crisis, Hyman Minsky, illegal immigration, income inequality, incomplete markets, information asymmetry, invisible hand, Jean Tirole, joint-stock company, Kenneth Arrow, Kenneth Rogoff, knowledge economy, l'esprit de l'escalier, labor-force participation, liberal capitalism, liquidity trap, loose coupling, manufacturing employment, market clearing, market design, market fundamentalism, Martin Wolf, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Naomi Klein, Nash equilibrium, night-watchman state, Northern Rock, Occupy movement, offshore financial centre, oil shock, Pareto efficiency, Paul Samuelson, payday loans, Philip Mirowski, Ponzi scheme, precariat, prediction markets, price mechanism, profit motive, quantitative easing, race to the bottom, random walk, rent-seeking, Richard Thaler, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, school choice, sealed-bid auction, Silicon Valley, South Sea Bubble, Steven Levy, technoutopianism, The Chicago School, The Great Moderation, the map is not the territory, The Myth of the Rational Market, the scientific method, The Wisdom of Crowds, theory of mind, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Vilfredo Pareto, War on Poverty, Washington Consensus, We are the 99%, working poor

While the focus on procyclical movement of leverage and asset prices is an important departure from much of orthodox models, the commitment to Walrasian general equilibrium so hampers the formalism that good intentions ended up in Bedlam. Geanakoplos likes to phrase his commentary in terms of “cycles,” but in fact, general equilibrium forces him to posit separate and unconnected sequential states of equilibrium, driven in a Rube Goldberg fashion by the arbitrarily sequenced arrival of asset issuance→“news”→valuation. Each state along the way is in “equilibrium,” as defined by constrained optimization and market clearing. Because everything is always already in equilibrium, the only reason anything changes is the deus ex machina imposed from outside by the model builder. Worse, the sequence itself is completely arbitrary, dictated more by the math than by anything that happens in the world: for instance, each player has only one chance to issue assets, is proscribed from trading them on secondary markets, and consumption can happen only at the initial issuance and at the end of time.108 It seems that, however proud he may be of hewing to Walrasian heuristics, the suite of models he has constructed rarely do much to actually illuminate the actual crisis and aftermath.

By purchasing these assets, the government would reestablish liquidity, not merely by removing toxic assets from the banks’ balance sheets, but by releasing information that would establish the assets’ true values. One immediate consequence of this view was that the imposing magnitude of the toxic asset problem was not necessarily worrisome, nor was the possibility that the TARP program would be unable to remove the vast majority of the toxic assets from banks’ balance sheets: The “losers” are not left high and dry. By determining the market clearing price, the auction increases liquidity . . . The auction has effectively aggregated information about the security’s value. This price information is the essential ingredient needed to restore the secondary market for mortgage backed securities.130 What mattered, they insisted, was “information”: information would summon forth funds from private actors, thereby thawing frozen secondary markets.


pages: 544 words: 168,076

Red Plenty by Francis Spufford

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affirmative action, anti-communist, Anton Chekhov, asset allocation, Buckminster Fuller, clean water, cognitive dissonance, computer age, double helix, Fellow of the Royal Society, John von Neumann, Kitchen Debate, linear programming, market clearing, New Journalism, oil shock, Philip Mirowski, Plutocrats, plutocrats, profit motive, RAND corporation, Simon Kuznets, the scientific method

Other sources, without Ellman’s bite and analytical clarity, are John Pearce Hardt, ed., Mathematics and Computers in Soviet Economic Planning (New Haven CT: Yale University Press, 1967), and Martin Cave, Computers and Economic Planning: The perience (Cambridge: CUP, 1980). 6 The recording clerks sally out from the Ministry of Trade’s little booths: among other things, as an information-gathering exercise, to collect a set of market-clearing prices which could then be used to help establish the price level for the bulk of food trade, in state stores. The state price was always cheaper, guaranteeing that food at the state price would always be in shortage relative to the money available to pay for it, but how much cheaper it was varied, depending both on the irregular jumps of the official prices and the more continuous adjustment of the market prices.

Other sources, without Ellman’s bite and analytical clarity, are John Pearce Hardt, ed., Mathematics and Computers in Soviet Economic Planning (New Haven CT: Yale University Press, 1967), and Martin Cave, Computers and Economic Planning: The Soviet Experience (Cambridge: CUP, 1980). 6 The recording clerks sally out from the Ministry of Trade’s little booths: among other things, as an information-gathering exercise, to collect a set of market-clearing prices which could then be used to help establish the price level for the bulk of food trade, in state stores. The state price was always cheaper, guaranteeing that food at the state price would always be in shortage relative to the money available to pay for it, but how much cheaper it was varied, depending both on the irregular jumps of the official prices and the more continuous adjustment of the market prices.


pages: 823 words: 220,581

Debunking Economics - Revised, Expanded and Integrated Edition: The Naked Emperor Dethroned? by Steve Keen

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accounting loophole / creative accounting, banking crisis, banks create money, barriers to entry, Benoit Mandelbrot, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, butterfly effect, capital asset pricing model, cellular automata, central bank independence, citizen journalism, clockwork universe, collective bargaining, complexity theory, correlation coefficient, creative destruction, credit crunch, David Ricardo: comparative advantage, debt deflation, diversification, double entry bookkeeping, en.wikipedia.org, Eugene Fama: efficient market hypothesis, experimental subject, Financial Instability Hypothesis, fixed income, Fractional reserve banking, full employment, Henri Poincaré, housing crisis, Hyman Minsky, income inequality, information asymmetry, invisible hand, iterative process, John von Neumann, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market clearing, market microstructure, means of production, minimum wage unemployment, money market fund, open economy, Pareto efficiency, Paul Samuelson, place-making, Ponzi scheme, profit maximization, quantitative easing, RAND corporation, random walk, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Coase, Schrödinger's Cat, scientific mainstream, seigniorage, six sigma, South Sea Bubble, stochastic process, The Great Moderation, The Wealth of Nations by Adam Smith, Thorstein Veblen, time value of money, total factor productivity, tulip mania, wage slave, zero-sum game

In considering why the data so strongly contradicted the theory, Fama admitted two points that I labored to make in this chapter: that the theory assumes that all agents have the same expectations about the future and that those expectations are correct. Though they put this in a very awkward way, this is unmistakably what they said in this paragraph: Sharpe (1964) and Lintner […] add two key assumptions to the Markowitz model to identify a portfolio that must be mean-variance-efficient. The first assumption is complete agreement: given market clearing asset prices at t-1, investors agree on the joint distribution of asset returns from t-1 to t. And this distribution is the true one – that is, it is the distribution from which the returns we use to test the model are drawn. (Ibid.: 26; emphasis added) A whole generation of economists has thus been taught a theory about finance that assumes that people can predict the future – without that being admitted in the textbook treatments to which they have been exposed, where instead euphemisms such as ‘investors make use of all available information’ hide the absurd assumptions at the core of the theory.

As a New Keynesian model it allows for various ‘imperfections,’ and tellingly they remark that without ‘short-run nominal wage rigidity’ and a stylized but trivial role for money (‘Money is introduced into the model through a restriction that households require money to purchase goods’), the model would simply predict that full-employment equilibrium would apply at all times: The model also allows for short-run nominal wage rigidity (by different degrees in different countries) and therefore allows for significant periods of unemployment depending on the labor-market institutions in each country. This assumption, when taken together with the explicit role for money, is what gives the model its ‘macroeconomic’ characteristics. (Here again the model’s assumptions differ from the standard market-clearing assumption in most CGE models.) […] Although it is assumed that market forces eventually drive the world economy to neoclassical steady-state growth equilibrium, unemployment does emerge for long periods owing to wage stickiness, to an extent that differs between countries owing to differences in labor-market institutions. (McKibbin and Stoeckel 2009: 584; emphases added) As with Ireland, they manipulate the shocks applied to their model until its short-run deviations from the steady state mimic what occurred during the Great Recession, and as with Ireland, one shock is not enough – three have to be used: 1 the bursting of the housing bubble, causing a reallocation of capital and a loss of household wealth and drop in consumption; 2 a sharp rise in the equity risk premium (the risk premium of equities over bonds), causing the cost of capital to rise, private investment to fall, and demand for durable goods to collapse; 3 a reappraisal of risk by households, causing them to discount their future labor income and increase savings and decrease consumption.


pages: 279 words: 87,910

How Much Is Enough?: Money and the Good Life by Robert Skidelsky, Edward Skidelsky

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banking crisis, basic income, Bertrand Russell: In Praise of Idleness, Bonfire of the Vanities, call centre, creative destruction, David Ricardo: comparative advantage, death of newspapers, financial innovation, Francis Fukuyama: the end of history, full employment, happiness index / gross national happiness, income inequality, income per capita, informal economy, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, lump of labour, market clearing, market fundamentalism, Paul Samuelson, profit motive, purchasing power parity, Ralph Waldo Emerson, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, Tobin tax, union organizing, University of East Anglia, Veblen good, wage slave, wealth creators, World Values Survey, zero-sum game

In more recent times, they have been advocated by Quakers and socialists, and by James Meade, Samuel Brittan, André Gorz among others.15 In 1943, the Liberal politician Lady Rhys Williams proposed a “social dividend,” payable to all families, regardless of income, to be financed by income taxes, with the dividend increasing in line with national income. More recent proposals, such as Milton Friedman’s “negative income tax”—a single cash payment to all those whose incomes fell below a certain threshold—have been seen as cheaper way of providing social security.16 Something called “basic income” has also been promoted as a way of topping up wages when the market-clearing wage fell below subsistence, and in this form has been widely adopted in the form of tax credits. Most of the earlier arguments were rights-, or entitlement-, based, a typical one being that each citizen had a right to a share of the nation’s patrimony—its stock of assets, natural or inherited—in compensation for the original act of property despoliation. There was also an appreciation of the value of independence and leisure.


pages: 339 words: 109,331

The Clash of the Cultures by John C. Bogle

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asset allocation, collateralized debt obligation, commoditize, corporate governance, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, diversification, diversified portfolio, estate planning, Eugene Fama: efficient market hypothesis, financial innovation, financial intermediation, fixed income, Flash crash, Hyman Minsky, income inequality, index fund, interest rate swap, invention of the wheel, market bubble, market clearing, money market fund, mortgage debt, new economy, Occupy movement, passive investing, Paul Samuelson, Ponzi scheme, principal–agent problem, profit motive, random walk, rent-seeking, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, statistical arbitrage, survivorship bias, The Wealth of Nations by Adam Smith, transaction costs, Vanguard fund, William of Occam, zero-sum game

However, I hold as a general principle that government should, under nearly all circumstances, keep its hands off the free functioning of the marketplace. I wince when the Federal Reserve states its intention to raise asset prices—including “higher stock prices”—apparently irrespective of the level of underlying intrinsic stock values. Substantive limits on short selling are another nonstarter for me. The overriding principle should be: Let the markets clear, at whatever prices that willing and informed buyers agree to pay to willing and informed (but often better-informed) sellers. Individual investors need to wake up. Adam Smith–like, they need to look after their own best interests. Of course, that would mean that individual investors must demand much better, clearer, and more pointed disclosures. We need a campaign to educate investors about the hard realities of investing.


pages: 385 words: 111,807

A Pelican Introduction Economics: A User's Guide by Ha-Joon Chang

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Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, banks create money, Berlin Wall, bilateral investment treaty, borderless world, Bretton Woods, British Empire, call centre, capital controls, central bank independence, collateralized debt obligation, colonial rule, Corn Laws, corporate governance, corporate raider, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, deindustrialization, discovery of the americas, Eugene Fama: efficient market hypothesis, eurozone crisis, experimental economics, Fall of the Berlin Wall, falling living standards, financial deregulation, financial innovation, Francis Fukuyama: the end of history, Frederick Winslow Taylor, full employment, George Akerlof, Gini coefficient, global value chain, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, Gunnar Myrdal, Haber-Bosch Process, happiness index / gross national happiness, high net worth, income inequality, income per capita, information asymmetry, intangible asset, interchangeable parts, interest rate swap, inventory management, invisible hand, Isaac Newton, James Watt: steam engine, Johann Wolfgang von Goethe, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, knowledge economy, laissez-faire capitalism, land reform, liberation theology, manufacturing employment, Mark Zuckerberg, market clearing, market fundamentalism, Martin Wolf, means of production, Mexican peso crisis / tequila crisis, Northern Rock, obamacare, offshore financial centre, oil shock, open borders, Pareto efficiency, Paul Samuelson, post-industrial society, precariat, principal–agent problem, profit maximization, profit motive, purchasing power parity, quantitative easing, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, savings glut, Scramble for Africa, shareholder value, Silicon Valley, Simon Kuznets, sovereign wealth fund, spinning jenny, structural adjustment programs, The Great Moderation, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade liberalization, transaction costs, transfer pricing, trickle-down economics, Vilfredo Pareto, Washington Consensus, working-age population, World Values Survey

Even so, there is some discretion left on the part of the worker over their labour process, and the capitalist somehow needs to make sure that the worker puts in the maximum amount of effort – or does not ‘shirk’, as some would put it. The best way to impose such discipline on workers, according to this argument, is to make job loss costly to them by raising their wages above the market rate – if workers can get another job with equal pay easily, they will not be afraid of the threat of being fired. However, since all capitalists do the same, the result is that the overall wage rate is pushed above the ‘market-clearing’ level and unemployment is created. It is on the basis of this reasoning that Marx called the unemployed workers the reserve army of labour, who can be called upon any time if the hired workers become too unwieldy. It is on this ground that Michal Kalecki (1899–1970), the Polish economist who invented Keynes’s theory of effective demand before Keynes, argued that full employment is incompatible with capitalism.


pages: 378 words: 110,518

Postcapitalism: A Guide to Our Future by Paul Mason

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Alfred Russel Wallace, bank run, banking crisis, banks create money, Basel III, basic income, Bernie Madoff, Bill Gates: Altair 8800, bitcoin, Branko Milanovic, Bretton Woods, BRICs, British Empire, business process, butterfly effect, call centre, capital controls, Cesare Marchetti: Marchetti’s constant, Claude Shannon: information theory, collaborative economy, collective bargaining, Corn Laws, corporate social responsibility, creative destruction, credit crunch, currency manipulation / currency intervention, currency peg, David Graeber, deglobalization, deindustrialization, deskilling, discovery of the americas, Downton Abbey, drone strike, en.wikipedia.org, energy security, eurozone crisis, factory automation, financial repression, Firefox, Fractional reserve banking, Frederick Winslow Taylor, full employment, future of work, game design, income inequality, inflation targeting, informal economy, information asymmetry, intangible asset, Intergovernmental Panel on Climate Change (IPCC), Internet of things, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Arrow, Kevin Kelly, knowledge economy, knowledge worker, late capitalism, low skilled workers, market clearing, means of production, Metcalfe's law, money: store of value / unit of account / medium of exchange, mortgage debt, Network effects, new economy, Norbert Wiener, Occupy movement, oil shale / tar sands, oil shock, Paul Samuelson, payday loans, Pearl River Delta, post-industrial society, precariat, price mechanism, profit motive, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, RFID, Richard Stallman, Robert Gordon, Robert Metcalfe, secular stagnation, sharing economy, Stewart Brand, structural adjustment programs, supply-chain management, The Future of Employment, the scientific method, The Wealth of Nations by Adam Smith, Transnistria, union organizing, universal basic income, urban decay, urban planning, Vilfredo Pareto, wages for housework, women in the workforce

There are attempts to stimulate wage growth, while most of the inputs to labour can now be produced with less labour. In its first major macro-economic study of the internet, in 2013, the OECD admitted: ‘While the internet’s impact on market transactions and value added has been undoubtedly far-reaching, its effect on non-market interactions … is even more profound. Non-market interactions on the internet are broadly characterised by the absence of a price and market-clearing mechanism.’ Marginalism supplies no metric, no model to understand how a price economy becomes a substantially non-price economy. As the OECD team put it: ‘Little attention has been paid to non-market interactions since few, if any, well-defined and well-grounded measurements have been commonly adopted.’33 Let’s admit, then, that only marginalism enables us to build price models in a capitalist society where everything is scarce.


pages: 561 words: 87,892

Losing Control: The Emerging Threats to Western Prosperity by Stephen D. King

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Admiral Zheng, asset-backed security, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, BRICs, British Empire, capital controls, Celtic Tiger, central bank independence, collateralized debt obligation, corporate governance, credit crunch, crony capitalism, currency manipulation / currency intervention, currency peg, David Ricardo: comparative advantage, demographic dividend, demographic transition, Deng Xiaoping, Diane Coyle, Fall of the Berlin Wall, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, full employment, George Akerlof, German hyperinflation, Gini coefficient, hiring and firing, income inequality, income per capita, inflation targeting, invisible hand, Isaac Newton, knowledge economy, labour market flexibility, labour mobility, liberal capitalism, low skilled workers, market clearing, Martin Wolf, mass immigration, Mexican peso crisis / tequila crisis, Naomi Klein, new economy, old age dependency ratio, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, rent-seeking, reserve currency, rising living standards, Ronald Reagan, savings glut, Silicon Valley, Simon Kuznets, sovereign wealth fund, spice trade, statistical model, technology bubble, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Market for Lemons, The Wealth of Nations by Adam Smith, Thomas Malthus, trade route, transaction costs, Washington Consensus, women in the workforce, working-age population, Y2K, Yom Kippur War

As I shall explain in more detail in Chapter 6, levels of income inequality are remarkably high. China, for example, has a level of income inequality similar to that of the US, an ironic result given the countries’ differing political systems. In an attempt to deliver social cohesion in the light of rising commodity prices, many fast-growing emerging markets choose to subsidize the prices of staples such as food and energy. This effectively raises consumption over and above the market clearing level. Higher consumption in the emerging world must, though, imply lower consumption elsewhere: the developed world ends up paying an even higher price for access to the world’s raw materials. Inflation in the emerging markets may tend to drift higher as a result of economic catch-up accompanied by fixed nominal exchange rates, but there is also a danger of nasty inflation surprises that stem from emerging-market linkages to the US dollar.


pages: 376 words: 109,092

Paper Promises by Philip Coggan

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accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, balance sheet recession, bank run, banking crisis, barriers to entry, Berlin Wall, Bernie Madoff, Black Swan, Bretton Woods, British Empire, call centre, capital controls, Carmen Reinhart, carried interest, Celtic Tiger, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, delayed gratification, diversified portfolio, eurozone crisis, Fall of the Berlin Wall, falling living standards, fear of failure, financial innovation, financial repression, fixed income, floating exchange rates, full employment, German hyperinflation, global reserve currency, hiring and firing, Hyman Minsky, income inequality, inflation targeting, Isaac Newton, John Meriwether, joint-stock company, Kenneth Rogoff, labour market flexibility, light touch regulation, Long Term Capital Management, manufacturing employment, market bubble, market clearing, Martin Wolf, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, negative equity, Nick Leeson, Northern Rock, oil shale / tar sands, paradox of thrift, peak oil, pension reform, Plutocrats, plutocrats, Ponzi scheme, price stability, principal–agent problem, purchasing power parity, quantitative easing, QWERTY keyboard, railway mania, regulatory arbitrage, reserve currency, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, short selling, South Sea Bubble, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, The Wealth of Nations by Adam Smith, time value of money, too big to fail, trade route, tulip mania, value at risk, Washington Consensus, women in the workforce, zero-sum game

Apart from the abandonment of Bretton Woods, it also saw a battle between two very different visions of how economic policy should be run: Keynesianism and monetarism. The hold of Keynesianism was hard to shake. During the Great Depression of the 1930s, orthodox (or classical) economists argued that the economy would eventually right itself. Unemployment was the result of an excessive price for labour: if wages were allowed to fall, workers would be priced back into jobs. Governments should balance the budget and not interfere with the market-clearing process, since any budget deficit would simply ‘crowd out’ private-sector spending. But the long period of stagnation, and the massed ranks of unemployed, undermined the classical economists’ case. Keynes offered a reasoned rebuttal. A recession was caused by a shortfall in demand, or to put it another way, an excess of saving (income can only be spent or saved). This led to the ‘paradox of thrift’.


pages: 326 words: 106,053

The Wisdom of Crowds by James Surowiecki

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AltaVista, Andrei Shleifer, asset allocation, Cass Sunstein, Daniel Kahneman / Amos Tversky, experimental economics, Frederick Winslow Taylor, George Akerlof, Howard Rheingold, I think there is a world market for maybe five computers, interchangeable parts, Jeff Bezos, John Meriwether, Joseph Schumpeter, knowledge economy, lone genius, Long Term Capital Management, market bubble, market clearing, market design, moral hazard, Myron Scholes, new economy, offshore financial centre, Picturephone, prediction markets, profit maximization, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, The Nature of the Firm, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Toyota Production System, transaction costs, ultimatum game, Yogi Berra, zero-sum game

If you were a buyer whose card said $35, you might start bidding by shouting out “Six dollars!” If no one accepted the bid, then you’d presumably raise it until you were able to find someone to accept your price. Smith was doing this experiment for a simple reason. Economic theory predicts that if you let buyers and sellers trade with each other, the bids and asks will quickly converge on a single price, which is the price where supply and demand meet, or what economists call the “market-clearing price.” What Smith wanted to find out was whether economic theory fit reality. It did. The offers in the experimental market quickly converged on one price. They did so even though none of the students wanted this result (buyers wanted prices to be lower, sellers wanted prices to be higher), and even though the students didn’t know anything except the prices on their cards. Smith also found that the student market maximized the group’s total gain from trading.

When the Money Runs Out: The End of Western Affluence by Stephen D. King

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Albert Einstein, Asian financial crisis, asset-backed security, banking crisis, Basel III, Berlin Wall, Bernie Madoff, British Empire, capital controls, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, congestion charging, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, cross-subsidies, debt deflation, Deng Xiaoping, Diane Coyle, endowment effect, eurozone crisis, Fall of the Berlin Wall, financial innovation, financial repression, fixed income, floating exchange rates, full employment, George Akerlof, German hyperinflation, Hyman Minsky, income inequality, income per capita, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, London Interbank Offered Rate, loss aversion, market clearing, mass immigration, moral hazard, mortgage debt, new economy, New Urbanism, Nick Leeson, Northern Rock, Occupy movement, oil shale / tar sands, oil shock, old age dependency ratio, price mechanism, price stability, quantitative easing, railway mania, rent-seeking, reserve currency, rising living standards, South Sea Bubble, sovereign wealth fund, technology bubble, The Market for Lemons, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Tobin tax, too big to fail, trade route, trickle-down economics, Washington Consensus, women in the workforce, working-age population

If economies are incapable of healing on their own, we put our faith in the policy-­maker’s magic wand. The debate on the ability or otherwise of economies to ‘self-­adjust’ is long and tortuous. Before the Weimar Republic’s hyperinflation in the early 1920s and the Great Depression of the 1930s, there had been few recognized instances of major macroeconomic calamities. The assumption was that markets ‘cleared’. A rise in unemployment would be met by a fall in wages, thereby allowing workers to price themselves back into the market. An excessive increase in consumer demand would lead to higher prices: wage earners would end up worse off in real terms, bringing demand back on track. A sudden reduction in capital spending would lead to lower interest rates – the supply of savings would now be greater than the demand for loans – thus 55 4099.indd 55 29/03/13 2:23 PM When the Money Runs Out encouraging households to spend rather than save.


pages: 350 words: 103,988

Reinventing the Bazaar: A Natural History of Markets by John McMillan

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accounting loophole / creative accounting, Albert Einstein, Alvin Roth, Andrei Shleifer, Anton Chekhov, Asian financial crisis, congestion charging, corporate governance, corporate raider, crony capitalism, Dava Sobel, Deng Xiaoping, experimental economics, experimental subject, fear of failure, first-price auction, frictionless, frictionless market, George Akerlof, George Gilder, global village, Hernando de Soto, I think there is a world market for maybe five computers, income inequality, income per capita, informal economy, information asymmetry, invisible hand, Isaac Newton, job-hopping, John Harrison: Longitude, John von Neumann, Kenneth Arrow, land reform, lone genius, manufacturing employment, market clearing, market design, market friction, market microstructure, means of production, Network effects, new economy, offshore financial centre, ought to be enough for anybody, pez dispenser, pre–internet, price mechanism, profit maximization, profit motive, proxy bid, purchasing power parity, Ronald Coase, Ronald Reagan, sealed-bid auction, second-price auction, Silicon Valley, spectrum auction, Stewart Brand, The Market for Lemons, The Nature of the Firm, The Wealth of Nations by Adam Smith, trade liberalization, transaction costs, War on Poverty, Xiaogang Anhui farmers, yield management

Each day, companies wanting to buy electricity submit bids stating the amount of electricity they want the next day and the price they are willing to pay. Companies wanting to sell submit offers of quantity and price. A bank of computers array the bids and offers and, hour by hour, calculate the price at which supply meets demand. (Such an auction would not have been feasible a few years earlier, by the way, for powerful computers are needed to instantly compare the bids, compute the market-clearing price, and allocate the quantity orders to the buyers and sellers.) The auction prices rose higher and higher. “We are so far into the realm of extraordinary gouging we are orders of magnitude off the chart,” California Assembly Speaker Fred Keeley told the Federal Energy Regulatory Commission in 2001. Why did prices rise following deregulation, rather then fall as they were supposed to? The primary reason for California’s electricity problems, it must be said, predated deregulation.


pages: 293 words: 88,490

The End of Theory: Financial Crises, the Failure of Economics, and the Sweep of Human Interaction by Richard Bookstaber

asset allocation, bank run, bitcoin, butterfly effect, capital asset pricing model, cellular automata, collateralized debt obligation, conceptual framework, constrained optimization, Craig Reynolds: boids flock, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, dark matter, disintermediation, Edward Lorenz: Chaos theory, epigenetics, feminist movement, financial innovation, fixed income, Flash crash, Henri Poincaré, information asymmetry, invisible hand, Isaac Newton, John Conway, John Meriwether, John von Neumann, Joseph Schumpeter, Long Term Capital Management, margin call, market clearing, market microstructure, money market fund, Paul Samuelson, Pierre-Simon Laplace, Piper Alpha, Ponzi scheme, quantitative trading / quantitative finance, railway mania, Ralph Waldo Emerson, Richard Feynman, Richard Feynman, risk/return, Saturday Night Live, self-driving car, sovereign wealth fund, the map is not the territory, The Predators' Ball, the scientific method, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, tulip mania, Turing machine, Turing test, yield curve

Refute these all in periods of crisis. H. L. Mencken wrote that there is “always an easy solution to every human problem—neat, plausible, and wrong.” And neoclassical economics has been wrong. Its main result, so far, has been to demonstrate the futility of trying to build a bridge between axiomatic, deductive models and the real world. Assuming, for example, perfect knowledge and instant market clearing simply misses the point. Economists cast aside the very subject we want to study: crises that are wrapped in uncertainty, that alter our views of the world in surprising ways beyond the scope of our precrisis probabilities and worldview, that create an instability that is not merely a local aberration but is running off the tracks and careening down the mountain. Crises that are made up of distinct, heterogeneous actors, each acting based on their unique context.


pages: 275 words: 84,980

Before Babylon, Beyond Bitcoin: From Money That We Understand to Money That Understands Us (Perspectives) by David Birch

agricultural Revolution, Airbnb, bank run, banks create money, bitcoin, blockchain, Bretton Woods, British Empire, Broken windows theory, Burning Man, capital controls, cashless society, Clayton Christensen, clockwork universe, creative destruction, credit crunch, cross-subsidies, crowdsourcing, cryptocurrency, David Graeber, dematerialisation, Diane Coyle, distributed ledger, double entry bookkeeping, ethereum blockchain, facts on the ground, fault tolerance, fiat currency, financial exclusion, financial innovation, financial intermediation, floating exchange rates, Fractional reserve banking, index card, informal economy, Internet of things, invention of the printing press, invention of the telegraph, invention of the telephone, invisible hand, Irish bank strikes, Isaac Newton, Jane Jacobs, Kenneth Rogoff, knowledge economy, Kuwabatake Sanjuro: assassination market, large denomination, M-Pesa, market clearing, market fundamentalism, Marshall McLuhan, Martin Wolf, mobile money, money: store of value / unit of account / medium of exchange, new economy, Northern Rock, Pingit, prediction markets, price stability, QR code, quantitative easing, railway mania, Ralph Waldo Emerson, Real Time Gross Settlement, reserve currency, Satoshi Nakamoto, seigniorage, Silicon Valley, smart contracts, social graph, special drawing rights, technoutopianism, the payments system, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, wage slave, Washington Consensus, wikimedia commons

In his original work de Bono puts it quite nicely when he says: Pre-agreed algorithms would determine which financial assets were sold by the purchaser of the good or service depending on the value of the transaction. And the supplier of that good or service would know that the incoming funds would be allocated to the appropriate combination of assets as prescribed by another pre-agreed algorithm. Eligible assets will be any financial assets for which there were market clearing prices in real time. The same system could match demands and supplies of financial assets, determine prices and make settlements. I cannot resist pointing out that de Bono also wrote that the key to any such developments ‘is the ability of computers to communicate in real time to permit instantaneous verification of the creditworthiness of counterparties’: this is an early vision of what we might now call the reputation economy, which I explored in my previous book, where I noted that identities and credentials are easy to create and destroy but reputations are much harder to subvert since they depend not on what anyone thinks but on what everyone thinks (Birch 2014).


pages: 464 words: 116,945

Seventeen Contradictions and the End of Capitalism by David Harvey

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accounting loophole / creative accounting, bitcoin, Branko Milanovic, Bretton Woods, BRICs, British Empire, business climate, California gold rush, call centre, central bank independence, clean water, cloud computing, collapse of Lehman Brothers, colonial rule, creative destruction, Credit Default Swap, David Ricardo: comparative advantage, deindustrialization, demographic dividend, Deng Xiaoping, deskilling, drone strike, end world poverty, falling living standards, fiat currency, first square of the chessboard, first square of the chessboard / second half of the chessboard, Food sovereignty, Frank Gehry, future of work, global reserve currency, Guggenheim Bilbao, Gunnar Myrdal, income inequality, informal economy, invention of the steam engine, invisible hand, Isaac Newton, Jane Jacobs, Jarndyce and Jarndyce, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Just-in-time delivery, knowledge worker, low skilled workers, Mahatma Gandhi, market clearing, Martin Wolf, means of production, microcredit, new economy, New Urbanism, Occupy movement, peak oil, phenotype, Plutocrats, plutocrats, Ponzi scheme, quantitative easing, rent-seeking, reserve currency, road to serfdom, Robert Gordon, Ronald Reagan, short selling, Silicon Valley, special economic zone, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, transaction costs, Tyler Cowen: Great Stagnation, wages for housework, Wall-E, women in the workforce, working poor, working-age population

This transition was successfully accomplished in the English case by using freedom as a means to create governmentality (much as Amartya Sen later advocated for the developing world). This meant that the capitalist state had to internalise limitations upon its autocratic powers and devolve the production of consensus to freely functioning individuals who internalised notions of social cohesion around the nation state. Above all, they had to consent to the regulation of activity through the procedures of the market. Clear limits were placed upon centralised power. The politics of the Tea Party as well as those of the autonomistas and the anarchists in the United States converge in seeking to limit or even to destroy the state, though in the name of pure individualism on the right and some sort of individualistically anchored associationism on the left. What is particularly interesting is how the existing mode of production and its current political articulations define both the spaces and the forms of it own primary forms of opposition.


pages: 512 words: 162,977

New Market Wizards: Conversations With America's Top Traders by Jack D. Schwager

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backtesting, beat the dealer, Benoit Mandelbrot, Berlin Wall, Black-Scholes formula, butterfly effect, commodity trading advisor, computerized trading, Edward Thorp, Elliott wave, fixed income, full employment, implied volatility, interest rate swap, Louis Bachelier, margin call, market clearing, market fundamentalism, money market fund, paper trading, pattern recognition, placebo effect, prediction markets, Ralph Nelson Elliott, random walk, risk tolerance, risk/return, Saturday Night Live, Sharpe ratio, the map is not the territory, transaction costs, War on Poverty

Here it was on the day of the crash down to $22. To me, it seemed ridiculous that people were pricing stocks that way. You make it sound like you completely shrugged off the panic that engulfed the markets that week. I don’t think I underestimated the risk of the trade when I bought ten S&P futures on the day of the crash. However, in retrospect, I certainly was naive in having faith that the markets, clearing firms, and banks 304 / The New Market Wizard would continue to function. The subsequent realization that if the Fed had been less aggressive, my clearing firm, along with many others, could have gone bankrupt, obliterating my account equity in the process, really shook me up. Does it ever bother you when you lose? Not at all. It never bothered me to lose, because I always knew that I would make it right back.


pages: 545 words: 137,789

How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

When OPEC cuts its production quotas, and the price of heating oil rises, some moderate-income households will be forced to cut back on purchases of food and clothing; the demand for gas boilers, electric radiators, and window insulation will increase. Is there any reason to suppose that a set of market prices exists at which all of these goods will be supplied in exactly the quantities that people demand? Yes, there is. As long as each industry contains many competing suppliers, and firms aren’t able to lower their unit costs merely by raising output, it can be mathematically demonstrated that a market-clearing set of prices exists. Once these prices are posted, supply will equal demand in every industry, and no resources will be idle. There are two more bits of good news. At this “equilibrium” set of prices, labor, land, and other inputs will be directed to their most productive uses. It won’t be possible, by rearranging production, to produce more output. Moreover—and this is the real kicker—it won’t be possible to make anybody better off without making somebody else worse off.


pages: 524 words: 143,993

The Shifts and the Shocks: What We've Learned--And Have Still to Learn--From the Financial Crisis by Martin Wolf

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air freight, anti-communist, Asian financial crisis, asset allocation, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Basel III, Ben Bernanke: helicopter money, Berlin Wall, Black Swan, bonus culture, break the buck, Bretton Woods, call centre, capital asset pricing model, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, collateralized debt obligation, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, debt deflation, deglobalization, Deng Xiaoping, diversification, double entry bookkeeping, en.wikipedia.org, Erik Brynjolfsson, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, fiat currency, financial deregulation, financial innovation, financial repression, floating exchange rates, forward guidance, Fractional reserve banking, full employment, global rebalancing, global reserve currency, Growth in a Time of Debt, Hyman Minsky, income inequality, inflation targeting, information asymmetry, invisible hand, Joseph Schumpeter, Kenneth Rogoff, labour market flexibility, labour mobility, light touch regulation, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandatory minimum, margin call, market bubble, market clearing, market fragmentation, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, moral hazard, mortgage debt, negative equity, new economy, North Sea oil, Northern Rock, open economy, paradox of thrift, Paul Samuelson, price stability, private sector deleveraging, purchasing power parity, pushing on a string, quantitative easing, Real Time Gross Settlement, regulatory arbitrage, reserve currency, Richard Feynman, Richard Feynman, risk-adjusted returns, risk/return, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, Second Machine Age, secular stagnation, shareholder value, short selling, sovereign wealth fund, special drawing rights, The Chicago School, The Great Moderation, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, The Wealth of Nations by Adam Smith, too big to fail, Tyler Cowen: Great Stagnation, very high income, winner-take-all economy, zero-sum game

Meanwhile demand and supply for non-tradeables returned to balance, producing the full employment the Federal Reserve was seeking. In this way, internal balance – full employment – was achieved, albeit temporarily, at the price of a huge external imbalance – excess demand for tradeables and so trade and current-account deficits. The global market for the US dollar is rigged. It is one in which governments are prepared to buy massively, to prevent prices from reaching natural market clearing levels. We do not know how much lower the dollar would have been if there had been no such intervention, but surely it would have been substantially weaker and US monetary policy would have consequently needed to be less expansionary. As Pettis puts it, ‘Excessive use of the US dollar internationally actually forces up either American debt or American unemployment.’31 Inevitably, the Fed chose debt over unemployment.


pages: 566 words: 155,428

After the Music Stopped: The Financial Crisis, the Response, and the Work Ahead by Alan S. Blinder

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Affordable Care Act / Obamacare, asset-backed security, bank run, banking crisis, banks create money, break the buck, Carmen Reinhart, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, conceptual framework, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, Detroit bankruptcy, diversification, double entry bookkeeping, eurozone crisis, facts on the ground, financial innovation, fixed income, friendly fire, full employment, hiring and firing, housing crisis, Hyman Minsky, illegal immigration, inflation targeting, interest rate swap, Isaac Newton, Kenneth Rogoff, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, market bubble, market clearing, market fundamentalism, McMansion, money market fund, moral hazard, naked short selling, new economy, Nick Leeson, Northern Rock, Occupy movement, offshore financial centre, price mechanism, quantitative easing, Ralph Waldo Emerson, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, statistical model, the payments system, time value of money, too big to fail, working-age population, yield curve, Yogi Berra

When the highest price bid for an asset is $20, and the lowest asking price is $60—and gaps like that were common at the time—discerning the “true” market value becomes a question for philosophers, not for economists, and certainly not for traders. The big hazard for the original TARP idea was therefore this: If Treasury offered to buy that asset at, say, $40, would it be overpaying or underpaying? How would it even know? BID-ASK SPREADS You remember your first Economics 101 lesson, right? Free markets clear at the point where the demand curve and the supply curve cross. Well, that’s not exactly right. In any given market at any given time, there normally will be a gap, or spread, between the highest price any demander is willing to pay (“the bid”) and lowest price any supplier is willing to accept (“the ask”). In thick markets that are functioning smoothly, the bid-ask spread is very tight—maybe a penny on a New York Stock Exchange–traded stock.


pages: 514 words: 152,903

The Best Business Writing 2013 by Dean Starkman

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Asperger Syndrome, bank run, Basel III, call centre, clean water, cloud computing, collateralized debt obligation, Columbine, computer vision, Credit Default Swap, credit default swaps / collateralized debt obligations, crowdsourcing, Erik Brynjolfsson, eurozone crisis, Exxon Valdez, factory automation, fixed income, full employment, Goldman Sachs: Vampire Squid, hiring and firing, hydraulic fracturing, income inequality, jimmy wales, job automation, John Markoff, late fees, London Whale, low skilled workers, Mahatma Gandhi, market clearing, Maui Hawaii, Menlo Park, Occupy movement, oil shale / tar sands, Parag Khanna, Pareto efficiency, price stability, Ray Kurzweil, Silicon Valley, Skype, sovereign wealth fund, stakhanovite, Steve Jobs, Stuxnet, the payments system, too big to fail, Vanguard fund, wage slave, Y2K, zero-sum game

Started selling everything that wasn’t permanent. I was going to sell the doors, the windows, the gates if I could, but they told me I couldn’t.” She decided not to file for bankruptcy: It would have cost her thousands of dollars and require her to give up her van, which she was determined to keep. When she had nothing left to sell to make her mortgage payments, she was forced to put her home on the market, clearing only $4,000 on the sale. “I was spinning out of control,” she says. “I was starting to lose my wits. It’s very surreal being at a level of depression where it’s easier to think about suicide and dying than it is to bend over and pick something up you’re stepping over. It was getting bad enough that my friends started looking at me, going, ‘You better get out of here.’ The only functional thing I could figure out was to just go.


pages: 490 words: 117,629

Unconventional Success: A Fundamental Approach to Personal Investment by David F. Swensen

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asset allocation, asset-backed security, capital controls, cognitive dissonance, corporate governance, diversification, diversified portfolio, fixed income, index fund, law of one price, Long Term Capital Management, market bubble, market clearing, market fundamentalism, money market fund, passive investing, Paul Samuelson, pez dispenser, price mechanism, profit maximization, profit motive, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Silicon Valley, Steve Ballmer, survivorship bias, technology bubble, the market place, transaction costs, Vanguard fund, yield curve, zero-sum game

A tight relationship between market price and fair value ensures that market participants trade at realistic prices. ETFs largely avoid the stale pricing problem that haunts standard mutual funds, as continuous pricing of ETF shares during trading hours affords investors the opportunity to trade at fresh market prices. Table 11.3 includes core-asset-class ETF ticker symbols for both market price and fair value. Even though demand or supply imbalances for particular ETFs may cause the market-clearing price to deviate from fair value, when deviations between market price and fair value reach sufficient magnitude, an arbitrage mechanism allows certain large investors to profit by redressing the imbalances. As a result, markets generally operate effectively throughout the trading day. So-called authorized participants perform the arbitrage function by buying or selling institutional blocks of ETF shares, usually sized at 50,000 shares for equity ETFs and 100,000 shares for fixed-income ETFs.


pages: 442 words: 39,064

Why Stock Markets Crash: Critical Events in Complex Financial Systems by Didier Sornette

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Asian financial crisis, asset allocation, Berlin Wall, Bretton Woods, Brownian motion, capital asset pricing model, capital controls, continuous double auction, currency peg, Deng Xiaoping, discrete time, diversified portfolio, Elliott wave, Erdős number, experimental economics, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, global village, implied volatility, index fund, information asymmetry, intangible asset, invisible hand, John von Neumann, joint-stock company, law of one price, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, market design, market fundamentalism, mental accounting, moral hazard, Network effects, new economy, oil shock, open economy, pattern recognition, Paul Erdős, Paul Samuelson, quantitative trading / quantitative finance, random walk, risk/return, Ronald Reagan, Schrödinger's Cat, selection bias, short selling, Silicon Valley, South Sea Bubble, statistical model, stochastic process, Tacoma Narrows Bridge, technological singularity, The Coming Technological Singularity, The Wealth of Nations by Adam Smith, Tobin tax, total factor productivity, transaction costs, tulip mania, VA Linux, Y2K, yield curve

According to survey studies reported by Kahneman, Knetsch, and Thaler [227], people indicate that it is unfair for firms to raise prices and increase profits in response to certain changes in the environment that are not justified by an increase in costs. Thus, respondents report that it is “unfair” for firms to raise the price of snow shovels after a snowstorm or to raise the price of plywood after a hurricane. In these circumstances, economic theory predicts shortages, an increase in prices toward the new market clearing levels, and, eventually, an increase in output. In other words, the increase of price is the equilibrium solution associated with the new supply–demand relationship, 88 chapter 4 but this is considered unfair by people. How this perception impacts the real dynamics of the price and the behavior of firms and buyers to give rise to efficient or inefficient markets remains a subject of research. 5.


pages: 466 words: 127,728

The Death of Money: The Coming Collapse of the International Monetary System by James Rickards

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Affordable Care Act / Obamacare, Asian financial crisis, asset allocation, Ayatollah Khomeini, bank run, banking crisis, Ben Bernanke: helicopter money, bitcoin, Black Swan, Bretton Woods, BRICs, business climate, capital controls, Carmen Reinhart, central bank independence, centre right, collateralized debt obligation, collective bargaining, complexity theory, computer age, credit crunch, currency peg, David Graeber, debt deflation, Deng Xiaoping, diversification, Edward Snowden, eurozone crisis, fiat currency, financial innovation, financial intermediation, financial repression, fixed income, Flash crash, floating exchange rates, forward guidance, G4S, George Akerlof, global reserve currency, global supply chain, Growth in a Time of Debt, income inequality, inflation targeting, information asymmetry, invisible hand, jitney, John Meriwether, Kenneth Rogoff, labor-force participation, labour mobility, Lao Tzu, liquidationism / Banker’s doctrine / the Treasury view, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market clearing, market design, money market fund, money: store of value / unit of account / medium of exchange, mutually assured destruction, obamacare, offshore financial centre, oil shale / tar sands, open economy, Plutocrats, plutocrats, Ponzi scheme, price stability, quantitative easing, RAND corporation, reserve currency, risk-adjusted returns, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Satoshi Nakamoto, Silicon Valley, Silicon Valley startup, Skype, sovereign wealth fund, special drawing rights, Stuxnet, The Market for Lemons, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, too big to fail, trade route, uranium enrichment, Washington Consensus, working-age population, yield curve

Buyers might assume that all used cars are lemons, otherwise the sellers would hang on to them. This belief causes buyers to lower the prices they are willing to pay. Sellers of high-quality used cars might reject the extra-low prices offered by buyers and refuse to sell. In an extreme case, there might be no market at all for used cars because buyers and sellers are too far apart on price, even though there would theoretically be a market-clearing price if both sides to the transaction knew all the facts. Used cars are just one illustration of the asymmetric information problem, which can apply to a vast array of goods and services, including financial transactions. Interestingly, gold does not suffer this problem because it has a uniform grade. Absent fraud, there are no “lemons” when it comes to gold bars. A touchstone for economists since 1970, Akerlof’s work has been applied to numerous problems.


pages: 504 words: 139,137

Efficiently Inefficient: How Smart Money Invests and Market Prices Are Determined by Lasse Heje Pedersen

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activist fund / activist shareholder / activist investor, algorithmic trading, Andrei Shleifer, asset allocation, backtesting, bank run, banking crisis, barriers to entry, Black-Scholes formula, Brownian motion, buy low sell high, capital asset pricing model, commodity trading advisor, conceptual framework, corporate governance, credit crunch, Credit Default Swap, currency peg, David Ricardo: comparative advantage, declining real wages, discounted cash flows, diversification, diversified portfolio, Emanuel Derman, equity premium, Eugene Fama: efficient market hypothesis, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, Gordon Gekko, implied volatility, index arbitrage, index fund, interest rate swap, late capitalism, law of one price, Long Term Capital Management, margin call, market clearing, market design, market friction, merger arbitrage, money market fund, mortgage debt, Myron Scholes, New Journalism, paper trading, passive investing, price discovery process, price stability, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, systematic trading, technology bubble, time value of money, total factor productivity, transaction costs, value at risk, Vanguard fund, yield curve, zero-coupon bond

In summary, short-selling can be difficult as it requires locating a lendable share, it requires posting margin collateral, it is associated with a loan fee, and it evolves recall risk and funding liquidity risk (the risk that you run out of capital before the trade converges). 8.2. SHORT SALE FRICTIONS MEAN THAT COMPANIES CAN BE OVERVALUED Dedicated short bias managers sell short to profit from stocks being overvalued. If short sellers could do so without all the costs and risks discussed above, the market clearing price would incorporate both the views of pessimists and optimists, thus reflecting more information. The difficulties in shorting, however, make it harder to express negative views, opening the potential for stocks to be overvalued in an efficiently inefficient way. To understand the effect of short sale frictions, suppose that people have different opinions about a stock: Some are very optimistic, and others are skeptical.


pages: 505 words: 127,542

If You're So Smart, Why Aren't You Happy? by Raj Raghunathan

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Broken windows theory, business process, cognitive dissonance, deliberate practice, en.wikipedia.org, epigenetics, fundamental attribution error, job satisfaction, Mahatma Gandhi, market clearing, meta analysis, meta-analysis, new economy, Phillip Zimbardo, placebo effect, science of happiness, Skype, The Fortune at the Bottom of the Pyramid, Thorstein Veblen, Tony Hsieh, working poor, zero-sum game, Zipcar

., “Oxytocin Increases Trust in Humans,” Nature 435 (2005): 673–76. Some other papers that use a similar setup include: D. J. De Quervain, et al., “The Neural Basis of Altruistic Punishment,” Science 305(5688) (2004): 1254–58; C. Camerer and K. Weigelt, “Experimental Tests of a Sequential Equilibrium Reputation Model,” Econometrica 56(1) (1988): 1–36; E. Fehr, G. Kirchsteiger, and A. Riedl, “Does Fairness Prevent Market Clearing? An Experimental Investigation,” The Quarterly Journal of Economics 108(2) (1993): 437–59; and I. Bohnet and R. Zeckhauser, “Trust, Risk and Betrayal,” Journal of Economic Behavior & Organization 55(4) (2004): 467–84. 95 percent . . . don’t walk away: See www.theguardian.com/science/2012/jul/15/interview-dr-love-paul-zak; for a review of this research, see P. J. Zak, The Moral Molecule: The New Science of What Makes Us Good or Evil (New York: Random House, 2013); for Paul Zak’s TED talk: www.ted.com/talks/paul_zak_trust_morality_and_oxytocin?


pages: 331 words: 60,536

The Sovereign Individual: How to Survive and Thrive During the Collapse of the Welfare State by James Dale Davidson, Rees Mogg

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affirmative action, agricultural Revolution, bank run, barriers to entry, Berlin Wall, borderless world, British Empire, California gold rush, clean water, colonial rule, Columbine, compound rate of return, creative destruction, Danny Hillis, debt deflation, ending welfare as we know it, epigenetics, Fall of the Berlin Wall, falling living standards, feminist movement, financial independence, Francis Fukuyama: the end of history, full employment, George Gilder, Hernando de Soto, illegal immigration, income inequality, informal economy, information retrieval, Isaac Newton, Kevin Kelly, market clearing, Martin Wolf, Menlo Park, money: store of value / unit of account / medium of exchange, new economy, New Urbanism, offshore financial centre, Parkinson's law, pattern recognition, phenotype, price mechanism, profit maximization, rent-seeking, reserve currency, road to serfdom, Ronald Coase, school vouchers, seigniorage, Silicon Valley, spice trade, statistical model, telepresence, The Nature of the Firm, the scientific method, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, trade route, transaction costs, Turing machine, union organizing, very high income, Vilfredo Pareto

Without such support, they were unsustainable because owners could depend upon the government for protection. While unions sometimes attempted through intimidation to prevent local officials from enforcing injunctions, these efforts, too, were seldom successful. Even the most violent strikes were usually suppressed within days or weeks by military means. Blackmail Made Easy There is a lesson to be learned for the Information Age in the fact that union attempts to achieve wages above market-clearing levels were seldom successful when firm size was small. Not even those lines of business that were clearly vulnerable to sabotage, such as canals, railways, streetcars, and mines, were easily brought under control. This is not because the unions shrank from using violence. To the contrary. Violence was lavishly employed, sometimes against high-profile individuals. For example, in a case celebrated in the American labor movement as a case of "'miners' vengeance," Governor Frank Steunenberg of Idaho, who had opposed an attempt by miners to blockade properties at Coeur d'Alene, was assassinated by a bomb tossed by a contract killer hired by the union. 21 But even murder and threats of murder were usually insufficient to obtain union recognition prior to the emergence of large-scale factories and mass-production enterprises in the twentieth century.


pages: 584 words: 187,436

More Money Than God: Hedge Funds and the Making of a New Elite by Sebastian Mallaby

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Andrei Shleifer, Asian financial crisis, asset-backed security, automated trading system, bank run, barriers to entry, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Bonfire of the Vanities, Bretton Woods, capital controls, Carmen Reinhart, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, currency peg, Elliott wave, Eugene Fama: efficient market hypothesis, failed state, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, full employment, German hyperinflation, High speed trading, index fund, John Meriwether, Kenneth Rogoff, Long Term Capital Management, margin call, market bubble, market clearing, market fundamentalism, merger arbitrage, money market fund, moral hazard, Myron Scholes, natural language processing, Network effects, new economy, Nikolai Kondratiev, pattern recognition, Paul Samuelson, pre–internet, quantitative hedge fund, quantitative trading / quantitative finance, random walk, Renaissance Technologies, Richard Thaler, risk-adjusted returns, risk/return, rolodex, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical arbitrage, statistical model, survivorship bias, technology bubble, The Great Moderation, The Myth of the Rational Market, the new new thing, too big to fail, transaction costs

The firm’s government-bond trader, Paul Mozer, had cheated repeatedly in the auctions; Meriwether, who was responsible for overseeing Mozer, resigned from the firm and paid a $50,000 fine imposed by the Securities and Exchange Commission.6 After scouting about for opportunities, Meriwether resolved to set up on his own. He would reassemble his team of rocket scientists and would do it without the unnecessary trappings of a big bank: Functions like marketing, clearing, settling, and operations would be outsourced, so that there would be no need to spread the professors’ trading profits through undeserving back-office departments. The way Meriwether saw it, he was inventing a new kind of financial institution for a new age. A world in which a small brotherhood of academics could earn more than a large bank required a fresh kind of setup. It required “Salomon without the bullshit.”7 IN FEBRUARY 1994, MERIWETHER LAUNCHED LONG-TERM Capital Management.


pages: 678 words: 216,204

The Wealth of Networks: How Social Production Transforms Markets and Freedom by Yochai Benkler

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affirmative action, barriers to entry, bioinformatics, Brownian motion, call centre, Cass Sunstein, centre right, clean water, commoditize, dark matter, desegregation, East Village, fear of failure, Firefox, game design, George Gilder, hiring and firing, Howard Rheingold, informal economy, invention of radio, Isaac Newton, iterative process, Jean Tirole, jimmy wales, John Markoff, Kenneth Arrow, market bubble, market clearing, Marshall McLuhan, New Journalism, optical character recognition, pattern recognition, peer-to-peer, pre–internet, price discrimination, profit maximization, profit motive, random walk, recommendation engine, regulatory arbitrage, rent-seeking, RFID, Richard Stallman, Ronald Coase, Search for Extraterrestrial Intelligence, SETI@home, shareholder value, Silicon Valley, Skype, slashdot, social software, software patent, spectrum auction, technoutopianism, The Fortune at the Bottom of the Pyramid, The Nature of the Firm, transaction costs, Vilfredo Pareto

More importantly, as aspects of performance that are harder to fully specify in advance or monitor--like creativity over time given the occurrence of new opportunities to be creative, or implicit know-how--become a more significant aspect of what is valuable about an individual's contribution, market mechanisms become more and more costly to maintain efficiently, and, as a practical matter, simply lose a lot of information. 218 People have different innate capabilities; personal, social, and educational histories; emotional frameworks; and ongoing lived experiences, which make [pg 111] for immensely diverse associations with, idiosyncratic insights into, and divergent utilization of existing information and cultural inputs at different times and in different contexts. Human creativity is therefore very difficult to standardize and specify in the contracts necessary for either market-cleared or hierarchically organized production. As the weight of human intellectual effort increases in the overall mix of inputs into a given production process, an organization model that does not require contractual specification of the individual effort required to participate in a collective enterprise, and which allows individuals to self-identify for tasks, will be better at gathering and utilizing information about who should be doing what than a system that does require such specification.


pages: 772 words: 203,182

What Went Wrong: How the 1% Hijacked the American Middle Class . . . And What Other Countries Got Right by George R. Tyler

8-hour work day, active measures, activist fund / activist shareholder / activist investor, affirmative action, Affordable Care Act / Obamacare, bank run, banking crisis, Basel III, Black Swan, blood diamonds, blue-collar work, Bolshevik threat, bonus culture, British Empire, business process, capital controls, Carmen Reinhart, carried interest, cognitive dissonance, collateralized debt obligation, collective bargaining, commoditize, corporate governance, corporate personhood, corporate raider, corporate social responsibility, creative destruction, credit crunch, crony capitalism, crowdsourcing, currency manipulation / currency intervention, David Brooks, David Graeber, David Ricardo: comparative advantage, declining real wages, deindustrialization, Diane Coyle, Double Irish / Dutch Sandwich, eurozone crisis, financial deregulation, financial innovation, fixed income, Francis Fukuyama: the end of history, full employment, George Akerlof, George Gilder, Gini coefficient, Gordon Gekko, hiring and firing, income inequality, invisible hand, job satisfaction, John Markoff, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, labor-force participation, labour market flexibility, laissez-faire capitalism, lake wobegon effect, light touch regulation, Long Term Capital Management, manufacturing employment, market clearing, market fundamentalism, Martin Wolf, minimum wage unemployment, mittelstand, moral hazard, Myron Scholes, Naomi Klein, Northern Rock, obamacare, offshore financial centre, Paul Samuelson, pension reform, performance metric, pirate software, Plutocrats, plutocrats, Ponzi scheme, precariat, price stability, profit maximization, profit motive, purchasing power parity, race to the bottom, Ralph Nader, rent-seeking, reshoring, Richard Thaler, rising living standards, road to serfdom, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, Sand Hill Road, shareholder value, Silicon Valley, South Sea Bubble, sovereign wealth fund, Steve Ballmer, Steve Jobs, The Chicago School, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, transcontinental railway, transfer pricing, trickle-down economics, tulip mania, Tyler Cowen: Great Stagnation, union organizing, Upton Sinclair, upwardly mobile, women in the workforce, working poor, zero-sum game

With his company selling Model T’s as fast as it could make them, his workers deserved to share in the profits, he said. His rivals were horrified. The Wall Street Journal accused him of injecting ‘Biblical or spiritual principles into a field where they do not belong.’ The New York Times correspondent who traveled to Detroit to interview him that week asked him if he was a socialist.”11 Ford could pay higher than market-clearing wages, because the productivity of his workers was relatively high; a Model T was produced every twenty-four seconds, compared to 12 hours previously.12 Better productivity performance also enabled Ford to grow fabulously rich, despite paying better wages than his competitors. Malcolm Gladwell has concluded that Ford is the most successful auto man ever and the seventh richest person in history, resting between Andrew Mellon and the Roman Senator Marcus Crassus.13 He was no fool, producing 15.5 million model Ts and revolutionizing the global auto industry; Ford certainly didn’t become wealthy overpaying for anything.


pages: 1,242 words: 317,903

The Man Who Knew: The Life and Times of Alan Greenspan by Sebastian Mallaby

airline deregulation, airport security, Andrei Shleifer, anti-communist, Asian financial crisis, balance sheet recession, bank run, barriers to entry, Benoit Mandelbrot, Bretton Woods, central bank independence, centralized clearinghouse, collateralized debt obligation, conceptual framework, corporate governance, correlation does not imply causation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, energy security, equity premium, fiat currency, financial deregulation, financial innovation, fixed income, Flash crash, forward guidance, full employment, Hyman Minsky, inflation targeting, information asymmetry, interest rate swap, inventory management, invisible hand, Kenneth Rogoff, Kitchen Debate, laissez-faire capitalism, Long Term Capital Management, low skilled workers, market bubble, market clearing, Martin Wolf, money market fund, moral hazard, mortgage debt, Myron Scholes, new economy, Nixon shock, Northern Rock, paper trading, paradox of thrift, Paul Samuelson, Plutocrats, plutocrats, popular capitalism, price stability, RAND corporation, rent-seeking, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, Saturday Night Live, savings glut, secular stagnation, short selling, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, unorthodox policies, upwardly mobile, WikiLeaks, women in the workforce, Y2K, yield curve, zero-sum game

Unless savings rise commensurately, this extra demand for capital means that interest rates should, all else equal, go up. However, since productivity gains also create deflationary pressure, and since that deflationary pressure is easier to see than the rise in the natural interest rate, an inflation-targeting central bank will tend to cut interest rates. Monetary authorities, therefore, will tend to push interest rates below the stable, market-clearing level. The result will be too much leverage and soaring asset prices: in short, a bubble. This argument was made by Richmond Fed president Al Broaddus during the May 1997 FOMC meeting. For a more recent version, see David Beckworth, “Inflation Targeting.” 38. The debate over the costs and merits of inflation targeting continues until the time of writing, but there is evidence that central banks should target the stability of growth and asset prices rather than the stability of inflation when confronted by a supply shock.