“There is one aspect of MMT that I have some sympathy with: the idea that what we spend money on is far more important than how we finance it.” — Cliff Asness
Amid resurgent and protracted inflation, much of the bloom, similar to it has been, is resulting from the rose of Modern Monetary Theory (MMT). The Federal Reserve raised rates of interest by 75 basis points (bps) on September 21, marking just the newest step in its tightening cycle. With August CPI numbers showing inflation at 8.3%, further rate hikes are hardly off the table. These developments weren’t foreseeable in October 2021, when the discussion took place within the Equity Risk Premium Forum; Nevertheless, perspectives on MMT and lots of other topics are shared by Rob ArnottCliff Asness, Mary Ida Compton, William N. Goetzmann, Roger G. Ibbotson, Antti Ilmanen, Martin Leibowitz, Rajnish Mehra, Jeremy Siegeland Laurence B. Siegel are still relevant.
Her assessment of MMT was ambivalent at best. Arnott explained that MMT policies shouldn’t have nearly the redistributive effect expected by their proponents, but simply make the wealthy richer.
From there, panelists reflected on their 10-year predictions Forum 2011 for the realized equity risk premium (ERP). All of their forecasts significantly underestimated the actual number.
Before the forum ended, they returned to the character of ERP and whether it is definitely a “risk premium.” Ibbotson suggests: “One possibility would be that stocks are perceived as much riskier than they are,” while Jeremy Siegel theorizes: “It could be the explanation of Tversky-Kahneman loss aversion.” . . People react asymmetrically to losses and gains.”
Below is a flippantly edited transcript of the ultimate a part of their discussion.
Roger G. Ibbotson: Does anyone here have an opinion, a positive opinion, about MMT? It appears that the federal government and the Fed have actually taken control. Does anyone think there may be anything positive about this?
Rob Arnott: We at Research Affiliates have a draft paper that Chris Brightman wrote a 12 months ago and he didn’t publish it because he was afraid of upsetting clients in the midst of the COVID pandemic. The paper shows that there’s a direct connection between deficits and company profits. That means a trillion dollars in deficit spending is related to a trillion dollars in additional corporate profits over the following 4 years. This relationship has a theoretical basis that will take too long to look at in additional detail. In any case, because of this for those who pursue MMT, you might be enriching the people you supposedly wish to “milk” with the intent of enriching the poor and dealing class.
Laurence Siegel: I feel most of us knew this. We just couldn’t prove it. I would really like to read Chris’ essay.
Cliff Asness: That has been the decision on quantitative easing for 10 years now. Let me say something about MMT. There is one aspect of MMT that appeals to me: the concept that what we spend money on is much more essential than how we finance it. The one good point about MMT that they do not emphasize enough is that this: If the federal government did loads less and raised zero tax rates in order that there was a giant deficit, the libertarian in me would think that is a superb world. And if the federal government spent a whole lot of money and funded it entirely through taxes, I would think that is a nasty world. I feel MMT makes that difference. Then I make every political decision that goes against them.
Arnott: The level of taxation will not be the tax we pay. It’s the cash we spend. Because every part that’s spent either comes from tax revenue or is withdrawn from the capital markets through deficits and increasing debts. In each cases the cash is withdrawn from the private sector. So spending determines the actual tax rate and is what’s troubling a few $3-5 trillion deficit.
Remembering past predictions
Rajnish Mehra: Larry, after the last forum in 2011 you sent an email with everyone’s stock premium forecast.
L. Siegel: It was an email with all of the forecasts from 2001 in order that we could compare our then current (2011) forecasts with the old (2001). I actually have no record of the 2011 forecasts. Sorry. But I remember Brett Hammond giving a chat at Q Group in 2011 where he said that each one the forecasts for 2011 were very near 4%.
Ibbotson: I missed the last forum resulting from a snowstorm, but I feel the markets exceeded almost everyone’s expectations.
L. Siegel: They definitely did.
Ibbotson: So it doesn’t matter what we said. Whatever the predictions, the market performed higher. The one who had the best estimated value won.
Jeremy Siegel: And I might say, by the way in which, that bonds have done loads higher than anyone predicted. Both stocks and bonds have outperformed expectations over the past 10 years.
Martin Leibowitz: My recollection – I could possibly be improper and you’ll correct me on that, Larry – was that the numbers ranged from a risk premium of 0% to about 6%, with a mean of three.5% to 4%. It’s very interesting how these predictions correlate with most of the numbers we’re throwing around today, and that there are very different explanations for the way we got there.
L. Siegel: Marty, those were the predictions within the 2001 forum, the primary one. In the 2011 forum, the estimates were all very near 4%.
If you take a look at the forecasts from 2001 (20 years ago), Rob’s lowest forecast was and it was zero. But these weren’t 20-year forecasts; they were 10-year forecasts. The highest prediction was from Ivo Welch, but the best prediction amongst those present today was Roger’s. Congratulations, Roger.
Ibbotson: Whoever was highest won. There was nothing particularly prescient about my prediction. We must also reiterate that these were 10-year forecasts made 20 years ago. Apparently Larry doesn’t have the 2011 forecasts handy.
L. Siegel: No, I won’t try this. I’m sorry.
J. Siegel: I forgot what mine was. Was mine 4.5% or 5%? I forget.
L. Siegel: Jeremy, yours was 3 to 4%.
Leibowitz: What was Rogers?
L. Siegel: 5%.
Leibowitz: That was the best?
L. Siegel: Ivo Welch gave 6% to 7%.
Antti Ilmanen: Have we stated what the term of the bond is?
L. Siegel: A ten 12 months bond.
J. Siegel: What is the proper answer?
Mary Ida Compton: Do you mean what actually happened?
J. Siegel: How high was the realized equity risk premium over the past 10 years and the way high was the realized premium over the past 20 years?
Compton: I actually have the 10-year numbers here. For the ten years ended September 2021, the S&P 500 returned 16.63% annually. Long Treasuries returned 4.39%.
L. Siegel: Therefore, the realized 10-year equity risk premium from September 30, 2011 to September 30, 2021 was 1.1663/1.0439 – 1 = 11.73%.
In the 20 years from September 30, 2001 to September 30, 2021 it was 1.0951/1.0644 – 1 = 2.88%.
The latter is a reasonably small margin over bonds, and even the strongest forecaster wouldn’t have won. But we didn’t ask for a 20-year forecast in 2001, so there isn’t a winner and no loser.
Ibbotson: I assume I didn’t win.
L. Siegel: Actually, you won, Roger, because Ivo Welch is not here. For the years 2001 to 2011, you had the best forecast of the people here, and the actual return was much higher than the best forecast.
Aceness: My forecast for next time is one basis point above the best forecast.
Afterthoughts: Good news and bad news
Ibbotson: Before we conclude, I would really like to handle Rajnish’s comment that the equity premium will not be a premium. I’m attempting to take into consideration what the rewards is likely to be for. One possibility is that stocks are perceived as much riskier than they really are. Is that a possibility?
L. Siegel: Yes, that could be a possibility.
Ibbotson: Or is there a extremely extreme tail risk that folks are pricing in?
J. Siegel: It could possibly be the Tversky-Kahneman loss aversion explanation. It is a behavioral explanation for why there may be such a high risk premium. People react asymmetrically to losses and gains.
Compton: TRUE.
William N. Goetzmann: My theory is that all of us hear bad news and are continually bombarded with fears concerning the end of the world. We know that these emotions really worry people before stock market crashes.
There is a whole lot of evidence for this. In an article I’m working on with Bob Shiller, we take a look at earthquakes within the region where people make their market forecasts. They change into more pessimistic and consider that there shall be a crash after they learn that there was an area earthquake. So I feel this problem is behavioral and never necessarily easy to model.
J. Siegel: But you are also saying that we have been bombarded with bad news for 150 years?
Götzmann: I feel probably the most recent period is probably the most extreme example. Over the last decade, people have been talking concerning the market, and the market has been doing pretty much.
Compton: People love stuff like that; they cling to it. It’s within the media, it’s on social media, it’s within the newspapers. Remember the Y2K problem? Was that crazy or what? I do know individuals who liquidated their stock portfolios because they were afraid of the Y2K problem.
J. Siegel: You speak about being bombarded with negativity over the past decade. You write an article with Bob Shiller, whose CAPE ratio is the very reason individuals are bombarded with negative news. The CAPE ratio was on the quilt of the magazine twice.
Götzmann: Jeremy, I actually have a story to inform you. One time I used to be on the bus for one in every of those National Bureau of Economic Research conferences on behavioral finance, and Bob Shiller and Dick Thaler were each on the bus. One of them said, “I’m 100% in stocks.” And the opposite one says, “I’m 100% out.”
And they each had great theories supporting their decision, right? So what should I do?
L. Siegel: And they each have Nobel Prizes, in order that they must each be right. On that note, I would really like to shut as we’re running out of time and I would really like to thank our 11 extremely distinguished speakers in addition to everyone else who helped organize this forum to make this possible. Have a pleasant afternoon.
If you enjoyed this post, do not forget to subscribe.
Image courtesy of cogdogblog concerning the Creative Commons Attribution 2.0 generic License. Circumcised.
