What have economists learned in the last year?

Here is my latest New York Times column, on four things that we have learned over the last year.  Here is the opening:

Harry S. Truman once said he wanted to talk to a one-armed economist, “so that the guy
could never make a statement and then say: ‘on the other hand.’ ” Yet
economic knowledge continues to progress in unexpected ways. Here are a
few of the things we learned in the last 12 months…

But to continue the lunchtime debate with some of my colleagues, the piece ends as follows:

Knowledge is a wonderful thing, but sometimes simply knowing what we
don’t know is a form of understanding. So beware the one-armed
economist; sometimes a good economist could use two or even three arms
or more.

I would make one modification to the tone of the piece: A number of days elapsed between the final draft and publication; I now estimate the probability of a recession higher than the rhetoric of this piece might to some people indicate.


Nice article. I do have one question though.

In the article you write, "Economists hadn’t known whether digitization would help or hurt music markets; many thought that greater exposure to music and the ease of online access might lead people to buy more. But in 2007 the outcome became clear: people tend to buy their favorite song from an album, online, rather than buy the whole album."

How is it that this "hurts music markets"? If buyers are better off by more than sellers lose isn't this an improvement in economic efficiency? I'm not savvy enough to actually crunch through the numbers, but it seems like it's quite plausible that there might be an improvement in efficiency.

I'd be interested in more of your thoughts on this. Thanks!

Very nice piece, Tyler. Your calm tone creates a sense (well-deserved, I think) that your reliance on data is not selective. Honest, sound use of data is an unusual offering for NYT readers, most of whom may not be economically literate enough to tell the difference.

I think you could have made more of the obvious collusion in the mortgage market. To say it is simply fraud is to imply that it was principally borrower fraud.

Fact is that declining mortgage standards went hand in hand with securitization. When loans were to be bundled and sold things got sloppy.

I don't think "stated income" loans were an option when I bought 20 years ago. I needed all my pay stubs, and for my first purchase (even with 20% down) a co-signer.

So fraud, sure. But from borrower up through securitizer (and rating service) perhaps.

Of course with a moment to reflect, what which I got so maudlin about isn't actually dead, just rarer, which would have only boosted my ego and self-image as someone who enjoyed stuff a little off the beaten path, sneering at those who collect platinum albums while extolling "hidden" gold-selling gems.
The same goes for restaurants. At a Korean restaurant about a year back I had some really tasty, spicy sausage soup, but I doubt I would have enjoyed it as much if first the waitress and then a cook from the kitchen hadn't tried to dissuade me from ordering it.

tom s.: Isn't it equally likely to have been greed (or at least an eyes-bigger-than-stomach phenomena)? How many people buy a house out of desperation; don't the desperate rent?

I don't know anyone in our lunchtime debates who would disagree with you on the value of knowing what we don't know. But how many hands does that really take?

I too raise an eyebrow at the term "predatory borrowing." It suggests that the innocent lenders were taken advantage of by wily borrowers. It's a bit of a stretch to believe that a lender was shocked, shocked to discover that borrowers were lying about their income when the lenders themselves called the loans "liar loans."

odograph: I agree there was significant fraud from the mortgage issuer up, but I don't think your pattern of declining loan standards is all that strongly connected to such fraud, and I think such upper-level fraud was likely a relatively small proportion of the problem. (And "but but on the fourth hand," I do realize that there's other evidence you didn't mention; e.g., if somehow you haven't already found the blog _Calculated Risk_ you'll probably find it interesting.)

One of the instabilities "in free markets" (in some circles) or "in human society" (at GMU:-) seems to be that many people learn from experience considerably faster than they really should. I finished my Ph. D. thesis on path integral Monte Carlo simulations at a time when the boom in mortgage-based securities was relatively young but already a recognizable post-physics career path, and I was not the only quantum mechanic (though, I think, the only chemist) to audit the pricing-derivative-securities class that year. I was left with a strong impression of Rube Goldberg shakiness (no great foresight there, I pretty consistently err on the side of bearishness), so unless after I left the field the fraudsters succeeded in hunting down the offending source materials and burning them, I think the fundamental risks should have remained well known.

And I really don't think one needs to appeal to fraud to understand the general pattern of what happened at the issuer level and further up the food chain (and what showed up at the homeowner end as low standards). Even when the fundamental difficulties are fully appreciated, the compensating advantages of doing the transactions can be so compelling that a lot of volume probably made fundamental sense: risky can still be worthwhile. But then, once people around you start making a lot of money on something for a few years, it is oh so tempting to learn from experience faster than you should. And lesson number one, often, is that it's a safe way to make money. Then once you learn that, it becomes temptingly logical to reason that things which people considered far too marginal before must be only moderately risky because after all they're only moderately more risky than what you have learned is safe...

Of course, it's also tempting to cut corners by fooling other people. But in any race between people fooling themselves and people fooling other people, people fooling themselves tend to have a natural advantage.

Thus for the dominant theme, I wouldn't choose fraud, but more like a replay of the 1987 overexuberance with building mighty castles of derivatives atop a foundation of (much too nearly) fundamentally-just-a-Gaussian statistical models of price changes: not fraud so much as the temptation to push one's ideas well beyond the limits where the risk makes sense. There might well have been an obscene amount of fraud in absolute terms --- any nonzero proportion of trillion dollar mistakes tends to be an absurdly large amount of money. But I'd be surprised if the sums lost to fraud rival those lost to the usual imbalance of fear and greed.

Just to nitpick, Harry Truman's middle name is just "S," --it's not an initial and shouldn't be followed by a period.

re: "Music company profits may not recover until other hardware manufacturers compete more successfully with Apple, which is selling songs very cheaply, knowing that the music will fuel demand for iPods."

Cheaply compared to what? There's an unjustified value judgement here that a digital song should cost more than $.99 retail. But why? It seems like a lot for a low-quality digital file, where the vendor doesn't even provide backups for you.

Amazon is also selling music for .99 cents a song. Are they underpricing it as well?

To my knowledge, Apple makes very little on digital music sales, somewhere in the general vicinity of recouping its costs. I believe most labels get in the ballpark of 65 cents out of the 99 Apple charges, which seems pretty good compared to the old record store system. Apple is making its money off the hardware.

When the music hardware business gets more competitive, do we really expect the labels to get more out of online music? Hardware prices go down, likely depressing hardware profits. Does this motivate the hardware manufacturers to raise music prices or pay out more to the labels? I would argue no - "low" music prices will likely continue to be a competitive necessity for Apple, Microsoft, Real, etc.

So I don't think a more competitive HW market really helps. The labels need to get better product and better promotion. If they could figure out a way to make more money off burned CDs, that wouldn't hurt either. Maybe lobby for a higher tax on blank CDs?

Tyler is ambitious---"probablity of recession". We are in a recession big guy--flat wages, decreasing spending, foreclosures, credit card defaults. Guess the clowns at the BLS have done such a great job of flimflaming the data
that even Tyler thinks a recession is yet to occur. So how bad does it have to get for you to call a recession?

Foreclosures and credit card defaults are the result of unwise borrowing and lending, and they're not the same as a recession. Neither are flat wages and decreased spending, as long as GDP doesn't go down two quarters in a row. If you want to argue that GDP figures don't capture some level of economic pain, fine. But there's not much point in redefining economic terms to try to make your argument.

Prof. Cowen,

I enjoyed your piece. I am particularly interested in teenagers copying CDs they borrow from one another. When I was in high school in the early 1990s, we did the same thing using cassette tapes. For every CD or tape I purchased, I borrowed another 10 from friends and copied them. This was back when we all had a cassette players in our cars. Most boom boxes came with dual-cassette tapes for this purpose. Many boom boxes also made it easy to "tape" a CD. Blank tapes were cheap, and made great stocking stuffers around the holidays.

Are today's teenagers really doing something new by copying and burning CDs? It seems like this is an old phenomenon with a new technology.

Returning ... "low of quality?" I wonder what I meant by that.

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