A conversation with Tyler Cowen

Conversation with Tyler podcast interview. Perhaps predictably, the most challenging interview / podcast I've ever done. Video here and embed below

Update:

My comments on efficient markets and active management provoked a lot of email.

I mentioned Jonathan Berk, and should have mentioned his coauthors Rick Green and Jules Van Binsbergen, on how active management can persist even though investors don't make any money on it. The basic idea is really clever: A manager has 5% alpha skill on $10 milllion, i.e. he can earn $500k, but the skill does not scale. So he earns 5%, charges 1% fee, investors get 4%. Investors see his great performance and rush in. Now he has $50 million assets under management. He still earns $500k. He charges 1% fee, and investors get zero alpha. It’s equilibrium – if investors leave, alpha to investors goes up again, and they return. Investors are earning the same zero alpha they get on the index so why not. And that’s about what we see. Fees persist in equilibrium, fees are equal to alpha on average, alpha post fees are about zero, flows follow performance. The seminal paper is "Mutual Fund Flows and Performance in Rational Markets" Jonathan B. Berk, Richard C. Green Journal of Political Economy 2004 112 1269-1295 and a series following, here . It's not a perfect theory, but the glass is nearer full than empty, and it's a lovely supply and demand starting place to understand an industry that persists for decades.

More generally, the average fund earns no alpha, almost guaranteed by free entry. The trouble is distinguishing the good ones from the bad ones, on ex-ante characteristics. The filters used by academics are pretty weak -- past returns, ratings, education of principals etc. On the other hand, now we just move it all up to the meta-game. Picking managers is no different than picking stocks. Skill on skill, alpha on alpha, fees on fees...

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Brazilian Inflation

This marvelous plot comes from an interesting article, The Monetary and Fiscal History of Brazil, 1960-2016 by Joao Ayres, Marcio Garcia, Diogo A. Guillén, and Patrick J. Kehoe. The article is part of the Becker-Friedman Institute Project , complete with a big and now easily available data collection effort, and forthcoming book . If you want a deep historical and economic analysis of fiscal and monetary interactions, this is an amazing resource. And it summarizes historical episodes that North Americans just might want to know more about soon! (HT Ricardo Reis who pointed it out in a great discussion last week, that I will post as soon as it's available.) To me the graph is at first blush a reminder that inflation can stop on a dime, despite sticky prices, seemingly adaptive or sticky expectations, Phillips curves, and so forth. Brazil seems to have had 6 Tom Sargent "end of inflations" episodes in 10 years! (Reminder: Tom showed that inflation can end very quickly i...

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