Should Old Acquaintance Be Forgot

Although I started this blog more than eight years ago, it lay largely dormant for most of this period and this has been my first full calendar year of (somewhat) regular posting. The experience has been consistently rewarding but occasionally exhausting. As the year draws to a close I'd like to acknowledge my debt to a few of the individuals whose writing I have enjoyed and learned from over the past twelve months, and to reflect upon some of the main ideas that have been explored in these pages.

Macroeconomic Resilience began the year as an anonymous blog but was subsequently revealed to be the creation of Ashwin Parameswaran, whose ecological perspective on behavior and markets is very close to my own. Every post of his is worth reading in full, but there is one on the trade-off between resilience and stability that remains an absolute favorite of mine.

Steve Randy Waldman's posts on interfluidity are generally so compelling and self-contained that there is usually very little left to add. I have been especially appreciative of a sequence of recent posts in which he argues that technocratic arguments, regardless of their merits, are unlikely to be persuasive if they are not consonant with our moral intuitions. It is the neglect of this important point that has so many commentators wondering why a policy that allegedly saved the financial system from collapse at negligible cost to the taxpayer is so deeply unpopular.

Along similar lines, Yves Smith on naked capitalism has been relentless in her criticism of TARP (and the unseemly self-congratulation of its architects) on the grounds that superior alternatives were available at the time. While there is plenty of room for debate on these points, it's a conversation that must be had, and one that has to consider the impact of the policy on the distribution of financial practices, as well as the outrage generated when moral intuitions are offended. It is essential that Yves (and her guests) continue to challenge the emerging academic consensus on the policy.

One of the defining events of the year for me was the flash crash of May 6. Contrary to initial media reports, this was not the result of a fat finger or computer glitch -- it was the consequence of interacting trading strategies, most of which involved algorithmically implemented rapid responses to incoming market data for very short holding periods. In understanding the mechanics of the crash I benefited from comments posted by RT Leuchtkafer in response to an SEC concept release. One of these was published three weeks before the crash and turned out to be remarkably prescient.

Viewed in isolation, the crash might be considered fairly inconsequential, and a recurrence could probably be prevented by implementing rule changes such as trading halts followed by call auctions. But the crash ought not to be viewed in isolation. Like the proverbial canary in a coalmine, it's importance lies in what it reveals about the manner in which trading strategies interact to produce major departures of prices from fundamentals from time to time. These more routine departures take longer to build and correct, are difficult to identify in real time, and leave their mark in the form of value and momentum effects, volatility clustering, and the fat tails of return distributions.

This view of speculative asset markets as a behavioral ecosystem in which the composition of stategies is a key determinant of market stability has also been advanced by David Merkel on The Aleph Blog. David's sequence of posts on what he calls "the rules" is well worth reading, and it was in response to his tenth rule that I wrote my first post on trading strategies and market efficiency. That was just a couple of weeks before the flash crash occurred and brought these ideas suddenly to life.

I am convinced that the non-fundamental volatility induced by the trading process has major effects on portfolio choice, risk-bearing, capital allocation, job creation and economic growth. Some possible mechanisms through which such effects can arise have been explored by David Weild and Edward Kim, and I thank David for bringing this work to my attention. I am also grateful to Terry Flanagan of Markets Media Magazine for an invitation to attend their Global Markets Summit where I witnessed a fascinating and combative debate on the broader economic effects of exchange-traded funds.

On the issue of market efficiency I have tangled with Scott Sumner on multiple occasions. But his anniversary post on The Money Illusion really struck a chord with me. Scott has a talent for making complex ideas intelligible, and an ability to maintain a clear distinction between a model and the empirical phenomenon that it is designed to explain. His vision of the economy is coherent and he is a formidable intellectual adversary. His post made me even more optimistic about the ability of blogs to shape economic discourse in constructive ways.

My window to the world of economics and finance blogs is Economist's View. Mark Thoma somehow manages to be both comprehensive and highly selective in his choice of links, virtually all of which are worth following. But more importantly, his site is a wonderful clearinghouse for open debate on economic methodology, especially in relation to macroeconomics. His post on the dynamics of learning (featuring a video presentation by George Evans) was especially memorable, as was Brad DeLong's diagrammatic discussion of the topic.

Despite the recent flowering of behavioral and experimental economics, I believe that the level of methodological homogeneity in our profession is stifling. But the time may finally be ripe for the introduction of agent-based computational models into mainstream discourse. A problem with simulation-based approaches is that there are no commonly accepted criteria on the basis of which the robustness of any given set of results may be evaluated. This will change once there is an outstanding article in a leading journal that sets a standard that others can then adopt. Where will it come from? Based on my reading of ongoing work by Geanakoplos and Farmer, I suspect that it may emerge from this recently funded initiative at the Santa Fe Institute. That would be nice to see.

Although my posts here have dealt largely with economics and finance, I also have a deep personal interest in social identity and group inequality, especially in the American context. On this set of issues I have found no voice more incisive than that of Ta-Nehisi Coates, whose freshness of perspective and formidable powers of expression I find breathtaking. His post on Robert E. Lee was one of several spectacular pieces this year, and prompted me to respond with my own thoughts on cultural ancestry. Related themes have been explored in a series of fascinating dialogues between Glenn Loury and John McWhorter.

Finally, I am thankful for the numerous extraordinary comments that have been left here, many by individuals who manage superb blogs of their own. Joao Farinha on economic development, Barkley Rosser on bubbles and agent-based models, Kid Dynamite on the flash crash, Economics of Contempt on TARP, Nick Rowe on learning, Adam P on equilibrium, Andrew Gelman on dynamic graphs, 123 on exchange traded funds, Andrew Oh-Willeke on private equity and cultural founder effects, and JKH on maturity diversification come immediately to mind, but there are many, many others.

I could go on, in a futile attempt to acknowledge all those who have influenced me and taken the time and trouble to respond either in comments here or on their own blogs. But this post has to end before the calendar year does, and this seems as good a time to stop as any.

A very Happy New Year to you all.