frobbing markets

Market volality provides information about a market. In just the same way as you learn what a gizmo does by applying different input to it, so you piece together the shape of a market by watching what happens under different circumstances. A market could seem utterly stable, until a little volatility reveals that it had always been at the edge of a precipice.

Tyler Cowen sees this in the fate of USian symphony orchestras after the financial crisis. The financial crisis pulled out much of their institutional support, thus showing how shallow was their backing. This caused secondary effects:

The initial negative shock of the crisis, among its other effects, caused donors and potential donors to see that support for these projects was weaker than they thought. Many of these donors are now less than keen to keep pouring money into losing endeavors. An unraveling process has set in. It’s not just the negative wealth effect, but new information has been revealed about popularity and sustainability of the underlying venture. Neither monetary nor fiscal stimulus will prove any kind of easy cure for these institutions or, potentially, for these jobs.

There is a well-known literature in finance about how trading, combined with the possibility of sudden price dips, causes market participants to learn the shape of the market demand curve and thus revalue the appropriate overall level of prices. The mere act of trading can generate market volatility. This kind of insight is not yet sufficiently appreciated in macroeconomics. The financial crisis caused us to see that many market institutions were on shakier ground than we had thought.

This is analogous to the ‘tipping-point’ understanding of political protest. Marches aren’t themselves important. But they show the strength of support, and so can win you the support of actors hedging their bets. So the time to march (leaving aside movement-building reasons) is when you believe that your support is greater than generally understood

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