Housing boom in Auckland – repeat of US housing market collapse?

On New Zealand’s TVONE last night the current affairs programme “Sunday” ran a segment on the booming property market in Auckland. There were some interesting interviews with real estate people plus economists – namely BNZ Chief Economist Tony Alexander and New Zealand Institute of Economic Research (NZIER) Principal Economist Shamubeel Eaqub. The economists were a lot more rational in their thoughts as to buying a house – for example:

* Have you actually done the sums?
* Can you afford to repay the mortgage if there is a 3% interest rate increase?
* We could see a US style housing collapse.
* Auctions are a good example of buying on emotion with all the hype.

Loads of behavioural economics in the programme. You should be able to see the following:

Herding – People tend to follow the herd, especially information is uncertain, incomplete, and asymmetric (some people are more informed than others).

Relative Positioning – is a concern people have regrading their own economic and social status relative to other people.

Overconfidence – is a belief, fed by emotions, that you can predict movements better than you actually can. When you’re overconfident, you’re not as smart as you think you are.

Institutional Failure – Investment decisions that can be bad for society but good for the individual can be a product of the institutional environment. If decision makers face little or no downside risk when making very risky decisions, they’ll take those risks.

Here is the link to the programme – “Sunday – Going, Going, Going”

It is the algorithms that outsmart humans not machines.

Whilst away on hockey tour in Malaysia I was able to avail myself of the ‘The Straits Times’ newspaper which is published in Singapore. One article that particularly caught my attention was that concerning the creativity of algorithms. Most are oblivious to their creativity yet highly sophisticated algorithms have created music based on the works of great artists but in a style that is personalised and therefore indicative of you the individual. They are also replacing writers – Professor Phil Parker of the Insead Business School in Paris has published more than a million reports on Amazon in just a couple of years. Using a proprietary algorithm that produces a report in 10 – 20 minutes instead of about 4 weeks. The algorithm pulls information from the web, performs econometric analyses, creates tables, formats the report and publishes it as a Word document. Professor Parker has also developed algorithms to produce poems, videos and video games.

Algo Trading
Although we could question the efficacy of algorithms on intangible dimensions such as “soul’ and “depth”, one area where they trounce human beings is stock trading. With up to 75% of trades on Wall Street done using computer programmes it is no wonder that algorithms execute trade at lightening speed and carry out numerous transactions every second. On the NYSE the average round-trip transaction time is 600 microseconds. To put into perspective if you blinked it takes you 300 milliseconds to complete the action – during that time NYSE executed 500 trades. This desire to improve efficiency in the market has led to extremely low costs of trading and very high stock liquidity. However it has also produced huge swings in stock prices. On 6th May 2010 – know as the ‘Flash Crash’ – the DJIA fell 9% in minutes but then recovered most of that loss in the subsequent few minutes.

The landscape of society was always made up by this uneasy relationship between nature and man. But now there is this third co-evolutionary force – Algorithms – and we will have to understand them as nature and in a way they are. Kevin Slavin Ted Talk

Behavioural Economics: Prospect Theory

One of the first topics in the Behavioural Economics course that I am teaching is Prospect Theory. Of critical importance to behavioural economists is the fact that people are frequently subject to cognitive illusions (errors in understanding reality based on how information is presented or framed and how our brain processes information) causing errors and biases in decision making. Moreover these events are typically not one-time occurrences: People fail to learn appropriately from their mistakes, which is a product of not abiding by conventional economics behaviour norms. Nobel Laureate Daniel Kahneman and Amos Tversky referred to this as errors and biases approach. Prospect theory was developed as descriptive theory of certain aspects of average decision-making behaviour. Conventional economics can’t describe, explain, or predict choice behaviour. Emotions are a key driver of a person’s behaviour. People have been shown to be loss averse, generally appearing to dislike losing something roughly twice as much as they like gaining it. Such a phenomenon has been shown in a number of experimental studies in a broad range of contexts. Loss aversion can be explained by prospect theory , which states that an individual’s value function (whether for money or otherwise) is concave for gains but convex for losses. In other words, people are more sensitive to losses compared to gains of similar magnitude.

This is illustrated in the graph. The reference point in the diagram is the current position of the individual concerned. Gains and losses are evaluated with reference to this neutral reference point. The value function takes an asymmetric S-shape because marginal value (or sensitivity) declines as absolute gains and losses increase in size. A dollar lost more than outweighs a dollar gained. In conventional economics, gains and losses are treated equally – a dollar lost simply cancels out a dollar gained.

Relative Income

Many people pay special attention to reference points when income or wealth increases or decreases. What counts isn’t total income or wealth but the relative changes in income and wealth – this is why the negative and positive dimensions of the value function are drawn from a reference point. In conventional economics, what people are most concerned about is the endpoint or total amount of income or wealth. But from the perspective of prospect theory, many people are happier if their income increase by 10% from a lower level of income than 2% from a much higher level of income. If my income goes up by 10% from $1,000 to $1,100, I’ll be happier than if my income goes up 2% from $10,000 to $10,200. Of course in conventional economics, your emotions don’t introduce concerns about reference points that may override your desire to increase your absolute level of income.

Behavioural Economics: Pirates anchor ransom price

A lot of behavioural economics textbooks look at the role of anchoring in our decision making processes. The anchoring effect is a type of framing where the appraisal of options is affected by an original starting value (or anchor). This is despite the anchor being arbitrarily chosen. For example, when asked to value the same property after being given different anchor values, real estate agents gave valuations that were significantly correlated with the arbitrary anchors provided.

With regards to the seizures of ships by Somali pirates, economists have had a particular interest in the negotiations that have taken place especially as the market has been generally free of government intervention. Research has shown that by sending consistent (cheap-talk) signals about their type (“sophisticated pirate” / “poor owner”), each side hopes to negotiate a better outcome but have reason to speed up the negotiation process:

Pirate - the hostages (and themselves) need to be fed
Crew – cargo might be perishable and the vessel is not in use therefore not making money.

However higher past ransoms are positively associated with subsequent ransom amounts – higher ransom amounts pass on a negative externality on future victims. This finding has policy implications for governments considering becoming involved in ransom negotiations. For instance, under political pressure to recover hostages, the Spanish government paid 1.2 million USD in 2008 for release of the Playa del Bakio, more than twice the previous record amount for a fishing vessel – source: Barrgh-gaining with Somali Pirates, 2012 by Olaf J. de Groot, Matthew D. Rablen and Anja Shortland. Therefore a floor price (see graph) has been set for future negotiations and it is a point of anchoring for the the pirates. Also from this paper is a graph (see below) that shows the duration of hijack and the ransom paid in US$m – there is a lack of correlation although the authors suggest that there is insufficient observations in this analysis.

The authors of the paper conclude by saying:

ransoms might be lowered by making rich ship-owners more patient by, for instance, by governments providing emergency loan guarantees to cover the running cost of the hijack, or compensating ship-owners for loss of hire, while offering
significant financial compensation to the crew.

Introduction to Behavioural Economics – Mind over Money

Here is a great documentary on behavioural economics from PBS – features Richard Thaler – University of Chicago and co-author of Nudge, Gary Becker Univerisity of Chicago, Jennifer Lerner – Harvard – social psychologist. The main model of consumer behaviour assumes that we never buy anything until we’ve calculated the impact on, for example, our retirement fund, and we’re so good at maths we use interest rates to compute our pleasure, over time, after buying something.

At the centre of all the rational models lies an unflinching belief in free markets. The idea is to keep regulation and government interference to a minimum, in both the every day consumer market and in the giant money markets of Wall Street. Rational economists believe that the increase in wealth, worldwide, over the last 30 years, is a triumph for free markets.

With the GFC, the rift in economics widens between the rationalists and the behaviouralists. So which side is right? Are we rational about money, or do our emotions and psychology play a much bigger role than previously realized?

The programme features loads of experiments:
$20 auction. People bid for the $20 but the second highest bidder receives nothing and pays the amount of the losing bid. See what happens.

Answer this question
a) Would you prefer $100 in a year’s time or $102 in a year one day?
b) Would you prefer $100 right now or $102 tomorrow?

Conventional v Behavioural Economics

Teaching a behavioural economics course this year and I came across an explanation of conventional and behavioural economics by Morris Altman – University of Victoria, Wellington, NZ. Will post other material from the course.

Behavioural Finance – what is it?

As with behavioural economics the conventional view of finance assumes that markets are efficient and that the price of shares, bonds and other financial instruments are a reflection of the fundamental economic values that they represent. Behavioural finance is all about understanding why and how financial markets are inefficient. If there is a difference between the market price of a share or bond and its fundamental value then in conventional economics no one can make money in financial markets by exploiting the difference.

Why are financial markets not efficient?

In an efficient financial market, share and bond prices move up and down according to the information about changes in the real economy. However this information must be accurate and unbiased and if there are errors people should be able to identify them. Additionally this information should be updated regularly so only the objective information affects people’s decision-making – Bayseian Updating.

Bayseian Updating – this refers to people who are willing and able to modify their beliefs based on new, objective information. However in their decision-making, rationality of individuals is limited by the information they have and people don’t always know what good or objective information on the financial markets actually looks like.

Random Walk Hypothesis

This refers to the idea that financial asset price movements follow a random walk. This was made famous by Burton Malkiel who wrote “A Random Walk Down Wall Street”. He argued that past movements in asset prices don’t provide the information required to predict future prices. Basically you can’t get rich by beating the market although by selling advice to those who believe you can beat the market might earn you a high salary.

Some behavioural economists largely support this perspective that financial asset prices largely follow a random walk. Consequently using simple heuristics (enabling someone to work something out for themselves) as an investment strategy is an intelligent move. Other behavioural economists, such as Robert Shiller, state that there is easy money to be made on stock markets by smart investors which implies, along with bubbles, that financial markets are inefficient. This assumes that you can make money from market inefficiencies and the past can predict the future. Shiller argues that people can’t predict day-to-day changes in stock prices but it doesn’t mean that smart investors can predict nothing at all.

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The above is a brief extract from an article published in this month’s econoMAX – click below to subscribe to econoMAX the online magazine of Tutor2u. Each month there are 8 articles of around 600 words on current economic issues.

econoMAX

Measuring Wellbeing

This has become popular with a lot of governments worldwide especially in the UK and USA. Late last year I attended a conference at the University of Waikato and Professor Les Oxley took a session entitled

“Is GDP an appropriate measure of wellbeing?
….. and is anything else better?”

Traditionally we have used Gross Domestic Product as it measures:
- The total value of final goods and services produced in the economy
- The total of incomes earned in producing that output
The final purchases by households, business, and government by summing consumption, investment, government spending, and net exports

Historically origins of GDP

In the 1930′s, in response to the information gap revealed by the Great Depression, Simon Kuznets developed a set of national income accounts.

In the 1940′s, World War II planning needs were the impetus for the development of product or expenditure estimates (gross national product); by the mid-1940′s, the accounts had evolved into a consolidated set of income and product accounts, providing an integrated birds-eye view of the economy.

In the late 1950′s and early 1960′s, interest in stimulating economic growth and in the sources of growth led to the development of official input-output tables· In the late 1960′s and 1970′s, accelerating inflation prompted the development of improved measures of prices and inflation- adjusted output.

However there are negatives to GDP as a measurement which was outlined by President Kennedy in 1968.

“The Gross National Product counts special locks for our doors and the jails for those who break them … the destruction of the redwood and the loss of our natural wonder in chaotic sprawl … Yet (it) does not allow for the health of our children, the quality of their education, or the joy of their play … the beauty of our poetry or the strength of our marriages … it measures everything, in short, except that which makes life worthwhile.” President Kennedy 1968

Les Oxley produced a comparison of wellbeing between the USA and France – Are GDP and other measures highly correlated?

Conclusions:

* GDP was not designed to measure wellbeing, especially at the individual level
* We continue to use it because we can measure it quite easily and use it for comparisons over time and space
* BUT it can mislead and potentially lead to mismanagement
* There are alternatives to complement GDP
* The complements are not freaky or the realm of weirdos in and out of economics – they are becoming more mainstream and the problems of using GDP for purposes for which it was not intended are becoming public
* Some of the best minds are trying to shift us away from SOLE use of GDP as an INDIRECT measure of wellbeing

I am off to the beach again for a few days – back again on 19th January.

Nudging in the UK

Here is a BBC HARDtalk interview with Richard Thaler – co-author of the book ‘Nudge’.

Stop smoking, eat less, exercise more, pay your taxes on time. So many things governments want us to do; so hard to get us to do them. HARDtalk’s Shaun Ley speaks to behavioural economist Richard Thaler who thinks he has the answer. It’s called ‘nudge’ theory, but it’s not just an academic idea. Britain’s Prime Minister is so impressed, he’s set up a whole ‘nudge unit’ in the heart of his government. If you live in Britain, you may unwittingly already be part of a nudge experiment. So is the nudge guru teaching those in power how to encourage us to live better; or helping politicians to control us?

A2 Economics – Inflation Revision

With the Cambridge A2 exam on Wednesday here are some revision notes on inflation and a diagram that I have found useful. As well as cost-push and demand-pull inflation remember:

Inflationary Expectations

In recent years more attention has been paid to the psychological effects which rising prices have on people’s behaviour. The various groups which make up the economy, acting in their own self-interest, will actually cause inflation to rise faster than otherwise would be the case if they believe rising prices are set to continue.

Workers, who have tended to get wage rises to ‘catch up’ with previous price increases, will attempt to gain a little extra compensate them for the expected further inflation, especially if they cannot negotiate wage increases for another year. Consumers, in belief that prices will keep rising, buy now to beat the price rises, but this extra buying adds to demand pressures on prices. In a country such as New Zealand’s before the 1990′s, with the absence of competition in many sectors of the economy, this behaviour reinforces inflationary pressures. ‘Breaking the inflationary cycle’ is an important part of permanently reducing inflation. If people believe prices will remain stable, they won’t, for example, buy land and property as a speculation to protect themselves.

Kilkenomics 2012 – Economics (comedy) Festival

Here is a promotional video for the recent Kilkenomics festival in Kilkenny Ireland. It brings together top economists and comedians to discuss the perils of the world economy – the debt crisis, the euro, quantitative easing, the environment etc. The clip below shows some of the highlights from last year’s festival – very amusing. Includes Jeffrey Sachs of the Earth Institute Columbia University, Fintan O’Toole author of Ship of Fools and Enough is Enough, Will Hutton of The Guardian and a range of comedians.

Lower taxes don’t necessarily help those on higher incomes

Robert Frank, author of the Economic Naturalist and The Darwin Economy, wrote a piece in the New York Times on the influence money has on determining the outcome of political decisions. Wealthy donors to political causes will want to make sure that policies implemented by the authorities will mean lower taxes for them and less regulation for their businesses. As their income goes up this will only increase the monetary contribution they can give to demand greater favours.

This invariably leads to greater inequality and eventually may become so acute that even those politicians who have large funding from the corporate sector won’t succeed against opponents who seek major reforms. However, lower tax rates can have both positive and negative impacts on wealthy donors:

Positive - lower taxes mean greater disposable income and more consumption in the private sector.
Negative – budget deficits and the reduced quality and quantity of public services e.g. roads, schools, hospitals etc.

Those on higher incomes have been insulated from the declining quality of public sector goods and services by being able to pay for the equivalent in the private sector – schools, hospitals etc. But with a declining middle class it might be harder to recruit productive workers in addition to a reduction in demand for goods and services. Furthermore there are consequences of poor public goods/services that cut across the inequality of income and affect everyone:

* poor roads, bridges and general infrastructure
* electricity shortages/ blackouts (remember ENRON in California)
* effects of reduced investment in nuclear power that could be detrimental to safety

Scenario – 2 Societies with differing degrees of government and private spending

Frank asks which country would be happier? As improvements to cars are quite costly above a certain value and can be viewed as only minor, most people think that the BMW drivers are better off, not to mention safer. Furthermore the BMW drivers are less likely to feel deprived as societies don’t often mingle.

Frank concludes by saying:

So if regulation promotes a safer, cleaner environment whose benefits exceed those broadly shared costs, everyone – even the business owner – is ahead in the long run.

Behavioural Finance: Saving for tomorrow, tomorrow

Here is a very good TED talk from Shlomo Benartzi. It’s easy to imagine saving money next week, but how about right now? Generally, we want to spend it. Economist Shlomo Benartzi says this is one of the biggest obstacles to saving enough for retirement, and asks: How do we turn this behavioural challenge into a behavioural solution?

Shlomo Benartzi uses behavioural economics to study how and why we plan well for the future (or fail to), and uses that to develop new programs to encourage saving for retirement.

Neuroeconomics – consumption experiences

An article in the recent Eco@Otago publication, from the University of Otago in New Zealand, showed how the changing properties of a product which are unrelated to its natural characteristics can affect people’s satisfaction.

Beer with vinegar in it

Dan Ariely (of “Predictably Irrational” fame) and others carried out research in 2006 where they offered patrons at a bar two types of beer:

1. A common brew
2. A common brew with a few drops of balsamic vinegar.

They divided the testers into 3 groups:

1. They had no information about the beers’ ingredients – “blind”
2. They were told which beer had vinegar in it before tasting both – “before”
3. They were told which beer had vinegar in it after tasting both – “after”

If knowing about the vinegar has no impact on preference then the outcome of tastes tests should be the same across all groups. If knowledge about vinegar influences tastes then the results from the blind group should differ between the “before” and “after” groups. The study showed that revealing the vinegar in the brew did affect the satisfaction only if the tasters were told “before” they tried the beer. Therefore, expectations changed the satisfaction that tasters received from their drinks.

Coke or Pepsi?

A similar experiment explored the cultural influences on satisfaction. It involved a taste test with Coke and Pepsi, two similar products but each have their own cult following. This study conducted ‘functional magnetic resonance imaging’ (fMRI) while participants were tasting to identify the effect consumption of each drink had on brain function.

Participants revealed which drink they perferred and were then subject to either blind taste tests OR taste tests with information about which cola they consumed. Consumers who preferred Coke experienced greater brain activity in the prefrontal cortex, hippocampus and midbrain when they were drinking it – versus when tehy did not know it was the brand they tasted. Therefore knowledge of brand can actually produce a physical response during consumption.

Does a higher price = more satisfaction?

A similar experiment showed how economic decision-making is affected by price and satisfaction. In this study participants performed blind taste tests with fMRI scanning for 5 different types of wine. They also conducted taste tests after revealing the prices of the wines to the participants to see if their preferences depended on cost. There were two innovative elements of this study:

1. There were actually only 3 wines – two of the wines were re-administered to the participants but were assigned different prices before doing so.
2. The fMRI focused on the area of the brain believed responsible for satisfaction – the medial orbitofrontal cortex (mOFC).

Taste tests revealed that subjects exhibited more activity in the mOFC when they tasted highly-priced wine versus the same wine with a lower price tag. Therefore more expensive wines regardless of their composition led to the following:

Expected higher quality wine = higher price = physically generated enhanced experience.

Purchasing decisions are more complex than traditional textbooks describe and what goods are perceived to be has a significant influence.

Economics games for the classroom

Following on from Geoff Riley’s blog post (see below) on the Tutor2u site here are the games that he was alluding to.

In this blog I am reprising an article produced by our good friend Mark Johnston from New Zealand in an early edition of the now discontinued Latte Magazine(2007). I am doing so because I know that many colleagues are interested in trying some experimental games with their students for example when teaching game theory, behavioural economics and the provision of public goods.

Click the link for the games in pdf format from the Latte Magazine
winter07-economicsgames

Here is another that I have used recently on Oligopolies.
Oligopoly Game

Open University – 60 second adventures in economics

Here is a series of 6 cartoons from the Open University about economic concepts – I got this link from Mo Tanweer of Oundle School in the UK. They are very well done and make for good revision with the forthcoming exams. Below is one on The Invisible Hand. To view all 6 click on the link -
Open University 60 second adventures in economics.

Behavioural Economics: How to regulate the rate of alcohol consumption.

The Economist wrote a piece on the influence that the type of glass has on how fast you drink. Research by Angela Attwood of the University of Bristol has shown that the shape of a beer glass can regulate how quickly someone does drink. The experiment was done with 160 undergraduates – 80 men and 80 women – and they were asked to do one of four things.

1. Drink beer out of a straight glass
2. Drink beer out of a flute (a glass whose sides curve outward towards the rim)
3. Drink lemonade out of a straight glass
4. Drink lemonade out of a flute.

To complicate matters some glasses were half-full and others full. In order to acquire accurate research data the students were not told what the experiment was hoping to conclude but were led to believe that they were taking a language test after being shown various films. What the researchers were hoping to find out was how quickly the participants drank the 4 drinks. The time it took to consume the four drinks were as follows:

The full straight glass of beer – 11 minutes
The full flute glass of beer – 7 minutes
The full straight glass of lemondade – 7minutes
The full flute glass of lemonade – 7 minutes

The assumption from this experiment is that a beer drinker wishing to monitor how much he/she are drinking during the night uses the volume reamining in the glass with reference to the halfway mark. A curved-sided glass makes that judgment difficult and most volunteers thought the half-way mark in the flute was lower than its true value, and if a volunteer had drunk from such a glass originally, the degree of misestimation correlated with how fast he had drunk. If a glass is half-full to start with, however, this reference point is lost from the beginning. So the shape of the beer glass can affect how fast beer is drunk. Health campaigners and breweries might have differing opinions on what is the best shaped glass to serve beer.

Euro Crisis – is it the Ultimatum Game all over again?

Jame Surowiecki in the recent edition of The New Yorker likened the euro zone crisis to the fairness trap. With Greek politicians looking at renegotiating its aid package and austerity measures, the German government has indicated that they are running out of patience and money to lend to Greece. Policymakers have talked about a Greek exit from the Euro – Grexit – which would mean they would default on their debts and no longer be part of the Euro currency.

As many economists have pointed out when economies go through a recessionary or contractionary phase their exchange rate starts to depreciate. This makes exports more competitive and imports cheaper which ultimately helps growth. However for Greece to leave the Euro it would destroy vast amounts of capital as well as costly for the rest of Europe. Greece owes almost half a trillion euros and containing the damage would mean the recapitalisation of banks, continent-wde deposit insurance and more aid to Portugal, Spain, and Italy. However it seems that this would be a much more expensive option than Greece staying in the euro zone.

Rationally there should be some sort of compromise with maybe a relaxing of austerity measures and giving Greece a bit more time to bring about some serious structural reforms especially to its tax system. However according to Surowiecki Europe isn’t arguing just about what the most sensible economic policy is but what is fair.

The Germans see it as unfair that they have to bailout Greece especially as the Greeks have continued to live beyond their means – how did they afford to host the Olympic games in 2004? Borrow more money? Why should the Germans be obliging when there is no meaningful reform in Greece?

From a Greek perspective it is equally unfair that for them to suffer years of slim government budgets and high unemployment in order to repay foreign banks and richer northern neighbours.

This fous on fairnes could prove disastrous – remember the Ultimatum Game.

The Ultimatum Game by Werner Goth 1982
In this game somebody offers John £100 under the condition that he shares it with Sarah. The two of them cannot ex- change information and John can make a single offer of how to split the sum. Sarah, who is aware of the amount at stake, can say yes or no. If her answer is yes, the deal goes ahead. If her answer is no, neither John or Sarah gets anything. In both cases, the game is over and will not be repeated. You may not be surprised to learn that two thirds of offers are between 40 and 50 percent.

From research carried out (Karl Sigmund et al.), only four in 100 people offer less than 20 percent. Proposing such a small amount is risky, because it might be rejected. More than half of all responders reject offers that are less than 20 percent.

However, why should anyone reject an offer as “too small”? The only rational option for a selfish individual is to accept any offer, as £1 is better than nothing. A selfish proposer who is sure that the responder is also selfish will therefore make the smallest possible offer and keep the rest.

This game-theory analysis, which assumes that people are selfish and rational, tells you that the proposer should offer the smallest possible share and the responder should accept it. But this is not how most people play the game.

The fairness problem is exacerbated by the fact that our definition of what counts as fair typically reflects what the economists Linda Babcock and George Loewenstein call a “self-serving bias”. This is even more pronounced when both parties feel they are not part of the same community – known as “Social Distance”. For instance:

1. The Greeks’ resentment of austerity might be attenuated by the recognition of how much money Germany has already paid and how much damage was done by rampant Greek tax dodging.

2. The Germans might acknowledge that their devotion to low inflation makes it much harder for struggling economies like Greece to start growing again.

The pervasive rhetoric that frames the conflict in terms of national stereotypes is the following:

Hardworking, frugal Germans v frivolous, corrupt Greeks
Tightfisted, imperialistic Germans v freewheeling, independent Greeks

This makes it all the more difficult to reach a reasonable compromise.

Chelsea win Champions League – Petr Cech picks the correct side everytime

With the disapointment of the 2008 Champions League Final behind them, Chelsea can finally claim to be the best team in Europe. As in 2008 it was decided by another penalty shoot but this time Chelsea were the victors. As always I am particularly interested in the peanlty shoot out and the strategies, if any, that are implemented by both the penalty taker and the goalkeeper.

The situation that kickers face in a penalty kick is a simultaneous-move game where they have three alternative strategies: shooting right, left, or centre. Similarly the goalkeeper also has three alternative strategies: dive to the right, dive to the left or remaining in the centre of the goal. In defining the sides of the goal researchers use the “natural side” of the kicker (which is the goalkeeper’s right, if the kicker is right-footed, and the goalkeeper’s left, if the kicker is left-footed) and the “opposite side”. Labeled like that, the strategies of both kicker and goalkeeper will be to choose the natural side of the kicker (NS), the centre (C) or the opposite side (OS).

From data compiled by Spanish economist Ignacio Palacios-Huerta he calculated the proportion of successful penalty kicks. Below is a table that shows the success rate of penalty takers when they went to their natural side and opposite side when the goalkeeper went his natural side and opposite side. Notice that when the kicker went NS and goalkeeper OS the success rates was 95% – the remaining 5% missed the target. Similarly when the kicker went OS and goalkeeper went NS – 8% missed the target.

Here is data on the peanlty kicks from last Sunday’s Champions League final

 

 

 

 

 

 

 

 

 

Notice that Chelsea keeper Petr Cech went the correct way for all penalties (including the one taken during normal time) – seemingly on the plane over he studied all Bayern penalties since 2007. He said it took nearly 2 hours – did he have a strategy?

Also Chelsea penalty takers favoured the natural side whilst Bayern the opposite side. Below is the shoot out once again.

Social Inequality and the Great Contraction

Till van Treeck in the Guardian talks about higher inequality and easy access to credit being a reason for consumers to borrow beyond their means. There is mention of Rgahuram Rajan’s book “Fault Lines” which argues that lower and middle-class consumers in the US have saved less and borrowed more in order to increase their real incomes. This obviously kept aggregate demand and employment high but meant there was a huge amount of debt which contributed to the financial crisis of 2009-10. Rajan criticises the textbook theory of consumption as he believes that there is a link between income inequality and overall private consumption. Most would tend to agree with this statement as consumers tend not to be rational about their long-term income.

In 1996, Alan Greenspan, then chairman of the Federal Reserve Bank, noted in response to growing concerns about rising inequality that “wellbeing is determined by things people consume [and] disparities in consumption … do not appear to have widened nearly as much as income disparities”. In a similar vein, Fabrizio Perri and Dirk Krueger suggested in an influential scholarly article published in 2006 that “consumers could, and in fact did, make stronger use of credit markets exactly when they needed to (starting in the mid-1970s), in order to insulate consumption from bigger income fluctuations”.

Recent research has shown that the rise in inequality over the last few decades has been due to many households living beyond their means and being attracted into suspect credit they couldn’t pay back.

Bring back Keynes!

Keynesian economists believe that consumers care about their consumption relative to others as an indication of their social status. Therefore the further you get behind in your ability to purchase goods and services – in relation to others – the more pressure there is for you to borrow money.

Similarly, the basic Keynesian insight that middle-class incomes need to grow in line with productivity in order to sustain robust aggregate demand appears today more relevant than ever.

In the US the increase in inequality has meant that household have worked longer hours, saved less, and borrowed more in order to maintain a social status. Till van Treeck alludes to the fact that the dominant textbook economic theories of consumption look almost as toxic as some of the credit products that ultimately caused the crisis.