Sunday, June 09, 2013

Weekend Papers: Parts I and II (skittish bond markets and phone records) by Jared Bernstein
More on Skittish Markets: Check out the figures in this piece on another dimension of skittish markets as per my commentary earlier in the week: tanking bond prices. As bond yields begin to rise—because the must, they should, and they will—their price moves inversely. But it’s striking how sharply they’ve turned. 
The broader economic lesson here is one of my favorites because it’s one of the most interesting aspects of relationships between economic variables: non-stable elasticities. 
Economists often cite elasticities–how one variable moves relative to another–as if they’re etched in stone: an A% increase in unemployment leads to a B% decrease in inflation; an X% increase in the minimum wage leads to a Y% change in employment (with “Y” tiny, but that’s another story); a R% increase in bond yields triggers an S% decline in bond prices. But B, Y, and S are not fixed! The change with underlying conditions, demographics, policy, and more. 
The large elasticity documented in the article—the movement in bond prices with respect their yields—is especially large at turning points, and is even further amped up by the length of time that bond rates have been so historically low. 
So I humbly submit that you keep this lesson in mind: if a price or an interest rate or some other important economic variable has been where it is for a long time—and in financial markets a long time isn’t necessarily that long—and it starts to change course, or even people think it’s about to change course, be prepared for a much larger response in related variables than you were expecting.

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