The equity premium and the Economists Voice

by John Quiggin on September 17, 2005

The Economists’ Voice is one of the more interesting (at least to me) ventures in academic publishing on the Internet. The aim is to provide analysis of economic issues from leading economists, something that has been sorely lacking in recent years[1]. It’s intended to contain deeper analysis than is found on the Op-Ed page of the Wall Street Journal or New York Times, but to be of comparable general interest. Unfortunately, it’s not free but you can get guest access to read particular articles.

Simon Grant and I have an article on the implications of the equity premium, an issue that’s been discussed in various ways on this and other blogs.

Here’s the abstract:

Simon Grant and John Quiggin argue that taking the equity premium seriously—-the well-known fact that the average annual historical return of stocks is seven times that of government bonds and other debt-—has many implications, the most robust of which is that recessions are extremely costly even if they don’t lower average consumption and that macroeconomic stabilization policies are more important than has been thought.

We also show that, to the extent that the equity premium is due to various kinds of capital market failure, it provides a rationale for public ownership of some business enterprises and for a rate of return on public investment close to the real bond rate.

fn1. Paul Krugman is an exception, but an isolated one. Thirty years ago, leaders of the profession like Samuelson and Friedman routinely wrote for newspapers and for periodicals like Time and Newsweek.

{ 1 trackback }

Tim Worstall
09.19.05 at 2:23 am

{ 10 comments }

1

Matt Weiner 09.17.05 at 4:23 pm

Note that “Samuelson” is Paul, not Robert (correct?)

2

dsquared 09.17.05 at 5:31 pm

By the way, casual readers, JQ is too modest to say it, but this is a real coup for the Economists’ Voice. Grant and Quiggin on the equity risk premium is an article that any high-end technical journal would have been pleased to have publishedm and the fact that it’s ended up in popular form in this journal is something that the non-economist ordinary business reader ought to be pretty damn pleased with.

3

Kieran Healy 09.17.05 at 5:39 pm

an article that any high-end technical journal would have been pleased to have published

Perhaps sometime around 2009, from what I understand of the review pipeline at major economics journals.

4

Maynard Handley 09.17.05 at 9:49 pm

“the well-known fact that the average annual historical return of stocks is seven times that of government bonds and other debt”

I don’t want to be snarky here, just specific. Is this well-known fact not a fact about US stocks in the 20th century? Does this really generalize to the rest of the world? Is it true of Britain? Europe? Japan? Emerging markets?

5

Delicious Pundit 09.17.05 at 10:50 pm

It’s intended to contain deeper analysis than is found on the Op-Ed page of the Wall Street Journal

So many jokes could go here! Some pitches off the top of my head:

…but then, a used Starbucks “The Way I See It” cup contains deeper analysis than is found on the Op-Ed page of the Wall Street Journal.

…while still blaming everything on crypto-Marxist community college professors.

…but we spilled something on our “News Corporation Heritage Foundation Talking Points presented by Alcoa,” so we had to think of something on our own.

6

John Quiggin 09.18.05 at 1:33 am

Maynard, the equity premium is pretty robust, applying (AFAIK) to all stock markets with a sufficiently long history to allow estimation. Certainly it’s not confined to the US.

7

David Kane 09.18.05 at 9:24 pm

dsquared (who I hestitate to tangle with) claims that “Grant and Quiggin on the equity risk premium is an article that any high-end technical journal would have been pleased to have published.”

Untrue! High-end technical journals (by which I assume you mean things like AER, QJE, JPE and so on) do not publish these sorts of pieces (unless authored by Nobel laureates). No math. No modeling. No statistics.

Which is a shame, of course.

8

paul 09.19.05 at 8:45 am

As an example of economists talking to other economists who have all read the relevant literature, it’s a fine paper (and interesting in its results). If the authors are trying to reach interested non-economists, they should unpack all of the causal chains leading to their conclusions in significantly greater detail. After three or four readings, I still trying to puzzle out basic issues such as what it means for the equity premium to be real — does it mean that the implied risk aversion arises rationally or that the market failure comes from an otherwise necessary evolution of market institutions? Does it mean that people who stick with either stocks or bonds for the long term are simply irrational in their valuations? Are the effects of various policy measures being gauged in real dollars or against imputed utility functions? If these questions don’t matter, why don’t they matter?

The economists who wrote for the public back in the age of giants and dinosaurs took pains to make their arguments as accessible as possible, but that doesn’t seem to be the case here. I guess I’m just not the target audience.

9

dave heasman 09.19.05 at 9:01 am

This bit of the intro : –
“the well-known fact that the average annual historical return of stocks is seven times that of government bonds and other debt” woke me up.

Is this really true? Seven times?
Over a long historical period?
I guess there are a lot of Government Bonds that have crap returns and are just hidden fraud – the UK WWII War Loan f’rexample – but surely the overall return on all Govt bonds & debt is about/over 3%?
Is the overall rate of return on all stocks really 20% or so? Over a long period? Seems incredible, or I’m missing something obvious.

10

John Quiggin 09.19.05 at 5:53 pm

For those interested, there’s a longer and more technical survey of the equity premium literature here.

In response to Paul, the aim was to get the main points across in less than 2000 words, which meant cutting out responses to a lot of your questions. I’m sorry if you found the result opaque, though the questions you raise suggest that you got at least something out of it.

Dave, the historical average real rate of return to short-term bonds has been about 1 per cent.

Comments on this entry are closed.