The importance of expectations

I often argue that current NGDP depends heavily on future expected NGDP. That’s also a prediction of modern New Keynesian macro models. However, this generalization is less true during the current Covid pandemic, as current output is artificially depressed by social distancing.

But even social distancing cannot stop asset markets from looking ahead. The current price of assets such as houses is roughly equal to the 12-month future expected price (a bit lower due to trend inflation.)

Consider the recent boom in house prices, occurring despite a severe recession with 10 million fewer jobs than a year ago:

Home prices surged the most on the record in the third quarter, according to a report Tuesday from the Federal Housing Finance Agency.

With record-low mortgage rates fueling demand for housing, prices jumped 3.1% compared to the prior quarter. That was the biggest gain in records dating to 1991, according to FHFA.

Compared to 2019, prices were up 7.8% in the three months through September, the biggest jump since 2006.

What’s going on here?  I’d point to three factors:

1.  An expectation that the Covid pandemic will be over within 12 months, probably even sooner, due to the many vaccines being developed.

2.  A long run downward trend in interest rates that began in the early 1980s and shows no sign of ending.

3.  Increasingly strict land use rules, motivated by “NIMBY” attitudes among the public.

Because the first point is fairly obvious, let me focus on the other two.  We don’t know all the reasons why interest rates are trending lower, although demographics are probably one factor.  Population growth in slowing, and interest rates fell first in places like Japan, where population growth slowed earlier than in the US.

(I suspect that our economy’s shift in emphasis from building things to creating ideas also plays a role.)

But the second reason (lower interest rates) would not normally be enough, for “never reason from a price change” reasons. In a well functioning economy, higher housing prices should lead to more new construction.  Anticipation of these increases in production would limit the price increase.  That used to happen in the mid-20th century, when it was fairly easy to build houses in America.  In recent decades, however, it’s become harder and harder to build new homes, in more and more cities.  Thus we will increasingly resemble places like the UK, Hong Kong, Canada, Australia and New Zealand, where house prices have reached a permanently high plateau (in real terms) due to strict building limits.

There are also lessons for monetary policy.  Just as expectations of high post-pandemic house prices create high house prices today, expansionary monetary policy that boosts expected future NGDP can boost NGDP right now.  Indeed this is basically the argument for average inflation targeting–create future inflation expectations to raise current inflation.  Bullish expectations can’t work miracles (for output) when a real shock like Covid causes people to hunker down, but in a normal recession the expectations channels is by far the most important part of stabilization policy–Nick Rowe likes to say it’s about 99% of monetary policy.


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Why is bitcoin at $18,000?

We can all admit now that it isn’t a bubble, right?  Of course you still might think the current price is too high, as returns are a (near) random walk. This WSJ article ably surveys the current landscape.  I put the least stock on “inflation hedge” arguments, and the most on ordinary factors such as […]

The post Why is bitcoin at $18,000? appeared first on Marginal REVOLUTION.

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Life-Years Lost: The Quantity and The Quality

A few weeks ago, the NYT reported that “The Coronavirus Has Claimed 2.5 Million Years of Potential Life.” If you read the original study, you’ll discover one crucial caveat: The authors’s calculations assume that COVID victims would have had the standard life expectancy for Americans of their age.  They freely admit that this is unrealistic and inflates their estimate:

The SARS-CoV-2 virus is known to infect and replicate in many different tissues and exacerbates problems in several organ systems including the kidney, liver, heart, lungs and brain (Lu et al., 2020; Chandrashekar et al., 2020). Any individual with problems in these systems or the immune system is likely to be more vulnerable to SARS-CoV-2 infection and suffer more severe outcomes as has been demonstrated for immune deficiencies (Bastard et al., 2020). In addition, other health states qualifying as pre-existing conditions, such as obesity, hypertension, chronic kidney disease and diabetes are known comorbidity factors for COVID-19 (see CDC co-morbidity tables and references therein; and these cohorts of individuals have a shorter than average predicted life span. Deaths due to complications with pre-existing comorbid conditions would artificially increase the person-years lost in these calculations but are difficult to quantitate in this current analysis.

The authors argue that fixing this problem would only modestly cut their estimates.  I’m not convinced, but I’d rather focus on a much bigger issue: Taking quality of life into account, how many life-years has the reaction to COVID destroyed?  To see what I’m getting at, ask yourself: “Suppose you could either live a year of life in the COVID era, or X months under normal conditions.  What’s the value of X?”  Given the enormous social disruption and dire social isolation that most people have endured, X=10 months seems like a conservative estimate.  For what it’s worth, this Twitter poll agrees*:

So what?  Well, we’ve now endured 8 months of COVID life.  If that’s worth only 5/6ths as much as normal time, the average American has now lost 4/3rds of a month.  Multiplying that by the total American population of 330M, the total loss comes to about 37 million years of life.  That’s about 15 times the reported estimate of the direct cost of COVID.

Casual readers will be tempted to declare that the cure has been much worse than the disease.  The right cost-benefit comparison, however, is not to weigh the cost of prevention against the harm endured.  The right cost-benefit comparison is to weigh the cost of prevention against the harm prevented.  You have to ask yourself: If normal life had continued unabated since March, how many additional life-years would have been lost?  I can believe that the number would have been double what we observed, even though no country on Earth has done so poorly.  With effort, I can imagine that the number would have been triple what we observed.  There’s a tiny chance it could have been five times worse.  But fifteen times?  No way.

Upshot: The total cost of all COVID prevention has very likely exceeded the total benefit of all COVID prevention.

Before you panic, note these key caveats:

1. This does not imply that zero COVID prevention was optimal.  The lesson is merely that we went much too far.

2. Prevention includes both private and government efforts.  The main lesson of the data is not merely that government overreacted, but that people overreacted.

3. As I’ve argued before, the initial costs of government action were moderate, because private individuals reacted strongly on their own.  Over time, however, government’s share of the burden has increased because private individuals’ have a strong tendency to lose patience and return to normalcy.

4. If a vaccine suddenly became available today, my calculations for the story so far would still hold.  Behavioral changes prevent deaths day-by-day.  They also drain life of much of its meaning day-by-day.


At this point, you could protest, “Hey Bryan, I thought you weren’t a utilitarian.”  So what if the cost of COVID prevention greatly exceeds the value of life saved?  My answer, to repeat, is that I have a strong moral presumption in favor of human liberty.  So while I respect individuals’ rights to overreact to moderate risks, I oppose any act of government that does not pass a cost-benefit test with flying colors.

And no, I don’t think that an asymptomatic person who walks down the street unmasked is “aggressing” against passersby in any meaningful way.

* You could object that my Twitter followers are self-selected to regard COVID prevention costs as high.  In point of fact, they consider the personal costs markedly less serious than the average costs:


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Chart of the WeekHow a Collective Infrastructure Push Will Boost Global Growth

By IMFBlog With vaccines around the corner, there is increased hope that the pandemic could soon be under better control. That said, the need for cooperative efforts to work toward a better future has never been greater. Priority areas relate to the need to produce and distribute vaccines globally, tackle climate change, and bolster the […]

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