Thursday 22 May 2014

The Map and The Territory - Alan Greenspan Book

The latest issue of the Central Banking Journal includes my review of the latest book from Alan Greenspan.  It is an interesting book with insights about economics and about the man.  You can read the review here or below.

Book review of ‘The Map and The Territory. Risk, Human Nature and the Future of Forecasting’ by Alan Greenspan, Allen Lane, 2013

‘The Map and the Territory’ is an enigmatic title for a book written by a former Chairman of the US Federal Reserve, which also seeks to cover ‘risk, human nature and the future of forecasting’.  I set out to review the book thinking how long it will take me to understand the rationale for the title. 

The introduction made an impression.  A reasonable acknowledgement that economic forecasting failed in the lead up to the crisis and of the need “to understand how we all got it so wrong”.  I use the word ‘reasonable’ judiciously.  Given the author’s position as Chairman of the US Federal Reserve before the crisis, I was not expecting an acknowledgement that the Fed or the US authorities fell asleep under Greenspan’s watch so “we all got it so wrong” – my emphasis.   Equally, I am not sure if other central bankers have acknowledged that much.  The assessment is usually about bankers going bonkers. 

One of the issues that Greenspan tackles in the book is the extent to which it is appropriate to rely on rationality assumptions for forecasting economic behaviour.   One of the challenges that Greenspan identifies for forecasters is that behavioural responses are unlikely to be symmetric.  For example, the collapse of asset prices would be sharp and, probably, deep while recovery would be gradual.  Overall, Greenspan concludes that economic behaviour is not random and that most economic choices are stable over the long run.  In his own words, ‘we are driven by a whole array of propensities ... but, ultimately, our intuitions are subject to reasoned confirmation.’

This does not mean that errors would not occur.  Greenspan singles out the secular underestimation of tail risks based on the last quarter century of observations.   As for the ability to eradicate those propensities that can give rise to the tail risks, Greenspan dryly note that ‘there was no irrational exuberance in the Soviet Union and none in today’s North Korea’.

It is difficult not to read the book seeking to understand the man – the musician, the economist (or is he a forecaster), the businessman and the economic technician.   Greenspan uses the term economist and forecaster in ways that seem fully synonyms.  I can only wonder how many people in his position would see things that way.  Typically, I guess they don’t but I found it an honest recognition of the main economic role of leading a central bank. 

For Greenspan, there is also small gap between the forecaster and the businessman.  His business, Townsend-Greenspan & Co, was industry forecasting so he had to delve into the details of markets such as oil, natural gas, coal, pharmaceuticals.  I remember learning about price elasticity of demand and about the challenge of estimating it.  As I recall it, the example that Samuelson’s textbook mentioned was the elasticity of the global demand for oil.  Here is someone who saw that challenge from the first row.  Greenspan admits getting his estimates about the oil consumption after the rapid escalation of oil prices in 1973 off the mark.

The interest in the detail of the economic forecaster is evident through the book.  There is a fair amount of slicing and dicing of US statistics to understand the underlying reality.  I was particularly interested on (I believe) his development of an indicator of a time series of maturity of GDP and his use to measure the degree of risk aversion in the economy.  Another example that caught my attention was the use of patent data to measure productivity.  The examples could be particularly useful to any Central Bank analyst looking for innovative ways to analyse the economy.

In terms of banking regulation, Greenspan acknowledges – not surprisingly – that regulatory capital requirements were too low before the crisis.   His analysis suggests an increase of regulatory capital from 10% before the crisis in terms of book value to 13% and 14% in 2015.  Greenspan is also clear that designating banks as “systemic” is simply enhancing their ability to fund themselves at a lower cost.  Greenspan quotes IMF estimates of 40 to 80 basis points funding advantage, which, as he also points out, is a significant advantage in a competitive financial market.

The books also looks beyond financial regulation to wider economic issues around productivity and the rise of entitlements culture, which makes for an interesting reading.  I would recommend it to post-graduates that want to develop an appreciation of the breadth of economic thinking and analytical skills that can be accumulated over a lifetime, even if you do not necessarily share every idea or conclusion.

As I completed reading the book, I still had not found an explanation for the rationale of the ‘map and the territory’.  I had a few hypotheses but nothing.  I was worried that I might have missed something fundamental about the book.   I was reassured to find references to maps in the inside cover of the book. 

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