John Cochrane: evaluation

Transcript context

…Here’s a question from a reader. To paraphrase, “Finance was really exciting in the ’70s and ’80s. There was CAPM, Black–Scholes, prospect theory, et cetera, but what big exciting things have happened since? Where should we be looking for the next great innovation in finance?” I love this. You and I are now old enough to remember that every age thinks of the previous age as the great golden era. I have a story. Bob Lucas told the story that in the late ’60s and ’70s, when he and his buddies were developing rational expectations and getting all the stuff that got the Nobel prizes at Chicago, they felt awful because all the hot attention was going to MIT and Harvard and what people were doing there. They felt like they were out in the wilderness, and they were, of course, looking back at — this was in the ’80s — they were looking back. “That is a great golden age.” And now the ’80s, “Oh, it’s so boring here now.” Of course, now we look back at the ’80s as a great golden age. There’s always this golden age of the past. What’s going on now in finance, I find fascinating. I’m the kid of a historian, so I have always a broad aspect. I think of what our children will understand that we don’t understand yet and all the puzzles out there to be learned about them. It fills me both with excitement and dread that I don’t have enough hours in the day to work on them. I mentioned one. Why is there so much trading? Here’s a fundamental question we don’t know about asset markets. What happened in the last 10 years has been, I think, really deep. The field of finance turned from what I was doing — macro-finance versus the behavioralists who want to put psychological imperfections at the heart of everything. That faded, and an immense amount of effort went into the plumbing of finance. They call it institutional finance. The plumbing failed in 2008, so we learned a tremendous amount about the plumbing and about liquidity and about all the ways in which asset markets don’t look like the simple models, as you mentioned. What’s wrong with interest rates in Brazil? Well, rather than look to habits of everybody or to psychological imperfections of everybody, what people are looking to now is, who’s active in currency markets, and how our banks are active, and how do their balance sheets look? And the facts are just astounding. It does look like when there’s a lot of demand, prices go up. That shouldn’t be in financial markets. People putting in a bunch of orders shouldn’t drive the prices up. There’re these facts about trading and volume and the prices and flows. The institutional finance — that’s the exciting thing that just happened, and now we have a great new data point in front of us. Any scientific field feels chaotic in the moment, but I still think it’s an exciting place to be. This is the hardcore podcast, so we’re going to plunge right into the fiscal theory of price level and inflation. In your forthcoming manuscript, you summarized it as follows in one sentence: “The fiscal theory says that the price level adjusts so that the real value of a nominal debt is equal to the present value of primary surpluses.” Is that still true? If on average, g is greater than r, namely, the growth rate of the economy is higher than real interest rates, the government has to pay on its debt?…

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