Wednesday, April 24, 2013

"Time doesn’t run backwards."

This is the best put-down I think I've ever seen, of "expectations" in economics. From Steve Roth:

... cause really does almost always precede effect. Time doesn’t run backwards. (Unless you believe, like many economists, that people, populations: 1. form both confident and accurate expectations about future macro variables, 2. fully understand the present implications of those expectations, and 3. act “rationally” — as a Platonic economist would — based on that understanding.)

But while I'm on the subject of expectations, I want to round up some excerpts from Maynard. From The General Theory, Chapter 5: Expectation as Determining Output and Employment:
ALL production is for the purpose of ultimately satisfying a consumer. Time usually elapses, however — and sometimes much time — between the incurring of costs by the producer (with the consumer in view) and the purchase of the output by the ultimate consumer. Meanwhile the entrepreneur (including both the producer and the investor in this description) has to form the best expectations he can as to what the consumers will be prepared to pay when he is ready to supply them (directly or indirectly) after the elapse of what may be a lengthy period; and he has no choice but to be guided by these expectations, if he is to produce at all by processes which occupy time.

... It is upon these various expectations that the amount of employment which the firms offer will depend. The actually realised results of the production and sale of output will only be relevant to employment in so far as they cause a modification of subsequent expectations...

It would be too complicated to work out the expectations de novo whenever a productive process was being started; and it would, moreover, be a waste of time since a large part of the circumstances usually continue substantially unchanged from one day to the next. Accordingly it is sensible for producers to base their expectations on the assumption that the most recently realised results will continue, except in so far as there are definite reasons for expecting a change.

So the rule is that expectations are based on existing conditions (or "recent results").

For the world's economists, everything depends on expectations. For me, expectations depend on the results we're getting now.

Which come first? Easy. Results come first. Results set the standard.

Graph #1: US Real GDP Growth Rate Since 1975

See that high spot there, that big peak just before 1985? That was expectations. That's what we got from electing Ronald Reagan. Everybody had great expectations.

But it didn't last. Look at the graph. Everything since 1985 stinks.

// update, 4:03 AM

By coincidence, Marcus yesterday showed this graph,

Graph #2, Source: Marcus Nunes

He pointed out the low spot in it, and wrote:

I wonder if the July 1932 ‘bottom’ is associated with FDR´s nomination acceptance speech on July 2, 1932.

Yes to that. I think that's how "expectations" works. You get a great surge of optimism or pessimism that cannot last long. Cannot last, because it's based on expectations rather than on economic fundamentals like cost. You get a trend anomaly and that's about it.

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