Economic news: do we get too much of it?
Ian Macfarlane AC, noted economist and former Governor of the Reserve Bank of Australia, delivered the 2011 Mosman Address last Friday.
Following is an edited transcript of his talk:
Tonight I hope to answer two questions and make one historical observation as follows;
- Do our media concentrate too much on economic news, and do they do so more than in other countries?
- Does it make us happier and better able to do our jobs and invest our savings?
- And finally I want to move to the opposite end of the spectrum and discuss some really important long run developments that we tend to overlook.
Do we get too much economic news?
People with jobs like I had have always been at the receiving end of a lot of economic information, most often from official sources like the Australian Bureau of Statistics, but increasingly now from private providers of survey information. Over the past couple of decades the general public has also been inundated with this type of information.
The newspapers and magazines are full of economic news, television news is saturated with it, there are special radio and television programs devoted to it. This is a world-wide phenomenon, and you can turn on a television set in a hotel in the US, Europe or Asia and hear someone holding forth on the latest movement in exchange rates, share prices or bond yields.
While it is a world-wide phenomenon, it is more pronounced in newspaper coverage in Australia than elsewhere. I have often heard foreign visitors or new arrivals express surprise at how much economic coverage there is in Australian papers, particularly on the front page.
We did a comparison at the Reserve Bank a few years ago of how much coverage central bank monetary policy decisions received in three countries – Australia, the US and the UK (the latter two being the two financial centres of the world). We looked at three comparable newspapers in each country; the Financial Times, the Times and the Independent in the UK; the Wall Street Journal, the New York Times and the Washington Post in the US; and the Financial Review, the Australian and the Sydney Morning Herald in Australia.
We added the number of articles in these papers in the three days surrounding two successive monthly monetary policy meetings. Our findings were as follows;
- In the US, 35 articles;
- In the UK, 46 articles;
- In Australia, 131 articles.
Then we looked at how many of these articles were on the front page. The results;
- In the US, 1 article
- In the UK, 1 article
- In Australia, 14 articles.
Why is there so much more coverage in Australia than elsewhere? One explanation I have heard is that there is not as much other news to report.
We are not an international power or trouble spot, we are not engaged in major wars, we do not have racial riots, civil insurrections, or sectarian violence, and the private lives of our politicians are not as lurid as British one (or a recent American president). So instead our newspapers are taken up with recent figures on employment, interest rates, the CPI or the Budget.
With the media competing so strongly against each other, there is inevitably a bias towards sensationalism. While Australia has a few experienced and thoughtful economic commentators who are world class, it also has a multitude of eager beavers who are mainly concerned with tomorrow’s headlines. They try to extract the maximum amount of coverage out of each ephemeral piece of news – monthly or even daily figures are invested with a significance well beyond their actual information content.
Interest rates do not merely rise, they ”soar”, the exchange rate “dives” or “plunges”, Budgets “blow-out”. The reader is left with the impression of constant action and turmoil. The recurring television image is of people in dealing rooms or on the floors of futures exchanges shouting at each other.
Another feature is the tendency to concentrate on pessimistic news. It is the nature of all journalism – not just economic – that its practitioners seek to expose a disaster or a conspiracy. No one ever wins a prize in journalism by pointing out that things are proceeding relatively smoothly and uneventfully, hence the tendency to find bad news, mistakes in policy and to label every minor glitch as a crisis (the most over-worked word in journalism).
At the margin I believe all this news tends to make us less confident, less secure and less happy than if we had less of it.
Does it make us better at doing our jobs or investing our savings?
The normal first response would be to say of course it must. More information must be better than less, that is what the whole information revolution is about. It is hard to argue with this point of view in terms of most of the decisions we make in everyday life. Certainly a broad range of information is better than a narrower one. But is more frequent information about a particular thing better than less frequent information?
Is it possible that if we are inundated with more information than we need, we may not be able, as the old saying goes, to see the wood for the trees? Or another way of saying this is that we may be on top of the detail but lose perspective, or as T.S.Eliot said rather more eloquently:
Where is the life we have lost in living?
Where is the wisdom we have lost in knowledge?
Where is the knowledge we have lost in information?I am not sure what the first line means, but the latter two are pretty clear.
Another reason we should question the value of frequent information is that it is subject to a distortion known as the “narrative fallacy”. This is the need to be able to tell a story as to why a movement in an economic variable occurred, even if it is a very short-term movement. Every day the exchange rate changes, so does the share price index, and every day you will be told why they changed, i.e. what caused them to rise or fall even if they only moved by a few tenths of one percent. Do we really know the reasons behind these small daily moves, or do we just make up a story because we can’t bear to say that we don’t know why they moved? It is often just random noise, but we can’t say that. Similarly, each movement in a monthly statistic such as retail sales, employment or business confidence has to be explained by some other economic or political development, although in many cases the movement is just due to sampling error. Incidentally, not only do we think we can explain past events that we can’t, but we also think we can forecast future ones that we can’t, but that is another story for another day.
I want to now turn to the question of whether more frequent information enables us to become better decision makers, in particular whether it makes us better or worse investors. Let me start by mentioning that several financial advisor I worked with told me that, among their clients, those that spent the most time tracking daily movements in their portfolio did worse on average than those who reviewed theirs’ less frequently. This is, of course, only hearsay, but it sounded plausible to me for several reasons.
It has been established from a lot of experimental research that most people exhibit “loss aversion” That is they experience more unhappiness from losing $100 than they gain in happiness from acquiring $100 (approximately twice as much according to the evidence). So the more often they are made aware of a loss the more unhappy they become. If the stock market rises by 6 per cent per annum, that, plus dividends is a reasonable return and should not be a cause of unhappiness. But given the variability of daily movements, on average about 47 per cent of days the market would fall, and on 53 per cent it would rise. Since we experience more unhappiness from the falls than happiness from the rises, this daily flow of information would result in a net fall in happiness. If we reviewed the market on a monthly basis, there would be a smaller proportion of losses, and a larger proportion of gains, so we would be happier.What this shows is that more frequent information makes us less happy, but it does not necessarily mean we become worse investors.
However there is a body of research in behavioural finance conducted by experimental psychologists that shows that it also makes us worse investors. This is because we tend to suffer from myopia (reading too much into short-term movements) and loss aversion (already described). This research concluded that ”investors who got the most frequent feedback (and thus the most information) took the least risk and thus earned the least money.” This is very serious research. Economists usually don’t like being lectured to by psychologists, but the two who conducted this research – Kahneman and Tversky were the only two non-economists ever to win the Nobel Prize in Economics (unfortunately the latter died before he could receive it). These experiments are done with real people and real money, and I will give a brief summary of how they worked.
In the experiment the subjects are able to invest in two asset classes – one, which we may call equities, which has a higher average return, but more short-term variability, and one, which we may call bonds, which has lower return and lower variability. The investors in the experiment who receive daily information avoid short term losses by buying more bonds and less equities than those who receive monthly or quarterly information, and so as a result earn a lower return over the long run.
A similar finding results even if the subjects are confined to investing in equities. Those who receive daily information are inclined to act on it and over- trade. The resulting increase in transaction costs lowers their return relative to those who receive less frequent information.
So I think we can conclude that too much information, or more correctly, too frequent receipt of economic and financial information, reduces the recipients happiness and leads them to make inferior investment decisions.
What of the Long-run?
I would now like to shift away from the problems of the short-run to look at some really long run changes – changes that take decades, generations or centuries. This is mainly of historical interest as it is probably impossible for a fund manager to make money out of such changes.
Have you ever wondered how it was possible a century ago for so many magnificent homesteads to be built in rural Australia (the National Trust has produced several excellent books on subject). Why were some farmers a century ago able to build these mansions? The answer is that the price of wool was so high that the owner of a sheep station could afford to build a mansion and to staff it with servants.
It turns out that changes in the prices of what we produce can explain a lot about how economies and countries evolve. The example I gave above is a relatively small development; there are other much bigger ones that almost defy comprehension.
- In 1667, under the Treaty of Breda, the Dutch government gave up their claim on Manhattan to the English in order to retain the island of Run (how many people know where that is – it is in Indonesia). I am sure they would like to reverse the swap now if the could. Why did they prefer the island of Run? Because it was the world’s main source of nutmeg, which was highly-prized in Europe and extremely expensive. (I wonder how many of you have consumed nutmeg in the last week – you can buy a hundred grams at Woolies for $2.40).
- In the late eighteenth century France had only enough armed forces to protect one of its two major possessions in the Americas. It had to choose between Canada and Haiti. It chose Haiti. Why? Because the price of sugar was so high that more wealth could be extracted from Haiti than the whole of Canada. I am sure they would choose differently today
I don’t know whether Napoleon was involved in that decision – maybe he was. He certainly was responsible for what today seems an extremely unprofitable decision – the Louisiana Purchase of 1803. Under this transaction France sold to the United States a large tract of land west of the Mississippi, which doubled the size of the US. The price of $15 million was cheap, even by the standards of the time. (It probably didn’t have any nutmeg or sugar).
What is the significance of this sort of long run development for Australia? We touched on it before when we observed the magnificent rural homesteads of the late nineteenth century. Unfortunately that type of wealth did not last.
From about 1900, the trend of prices for what we exported – mainly agricultural and mineral products either fell, or at least did not rise as fast as the prices of the goods we imported – mainly manufactures. This was because the supply of agricultural and mineral products could easily be expanded by bringing new areas on stream or by raising productivity. In economic parlance, Australia experienced a trend fall in its terms of trade, and this made the country less wealthy than it otherwise would have been.
Now as we all know from our daily papers, that has all changed. The terms of trade have risen to an all time high, the mining sector is booming and agriculture is looking up. Is this just a cyclical event, or has something more fundamental changed that means it is more permanent. A famous investor said the four most dangerous words in investing are “it’s different this time”. Is he right and we should expect to return to the old pattern, or is it different now?
Well I think it really is different now. The long decline in the terms of trade ended in about 1985, and a hesitant upward trend commenced. Then, over the past half dozen years, notwithstanding the financial crisis, the terms of trade have gone through the roof. Why has the downward trend of eighty years been so comprehensively reversed. Essentially it is because of the emergence of the developing countries as a major economic force. First it was Taiwan, Korea, Hong Kong and Singapore, then Malaysia, Thailand and Indonesia. And finally the big one – China, followed by India. Now it is the price of manufactured goods which are falling as it is easy to expand their supply by bringing into production the massive rural populations of China and India. This simultaneously provides us with cheap manufactured goods and increases the demand for our exports as inputs into the manufacturing process.
Of course, it could all fall apart, but I don’t think that is likely. It is relatively easy for countries to keep growth going when starting from a low base and being able to adopt technology that has already been invented by others. Besides a world where China and India play a major role is not really new: it is a return to earlier times. Until the industrial revolution in the late 1700s, China and India accounted for most of the worlds GDP, and their incomes per head were similar to those in western Europe. Looking back in a hundred years’ time, we may view the 1800s and the 1900s as an aberration when some countries with relatively small populations in Europe and North America outpaced their larger rivals for a time.
Where does all this leave Australia? In a very favourable position I would say. It doesn’t mean that we won’t see some future falls in export prices – that is almost inevitable – but on average they should still be high by historical standards. It also doesn’t mean that the current expansion will continue indefinitely – the business cycle will re-assert itself at some point. But, by the standards of other developed countries, we will remain in a favourable position.
But I want to conclude by reminding you that it is still possible to squander a favourable position if the wrong policies are followed. Argentina is a classic example of this as it had about the same income per head as Australia a hundred years ago, but is now only half of ours.
I am reasonably confident we won’t make their mistakes, but I note that in the past, the Australian political process has handled adversity well, but prosperity badly. We now have to learn how to put in place the policies that will enable us to realize the prosperity that our place in the world opens up to us.
