While Brad provided an advanced copy, Dean and Paul presented their paper with Greg Mankiw providing his comments courtesy of Donald Luskin who for some reason thinks Mankiw devastated the paper by Baker-DeLong-Krugman (BDK). Max Sawicky provides another perspective on the Gunfight at the Brookings Corral as does Brad.
Greg might have given a citation to Andrew Samwick for this:
If the dividend yield is approximately irrelevant, as Modigliani and Miller tell us, then it is easy to imagine that it could undergo a major change in the years to come. Looking ahead, it seems plausible to me that dividend payouts broadly construed could rise significantly. If we are about to experience a period of slower economic growth because of demographic change, then firms might well have fewer profitable investment opportunities and, as a result, may decide to pay out a larger percentage of their earnings.
At one point, I had mused that perhaps Andrew had a point here. But there’s a small problem with this line of reasoning – in particular my numerical example. The price-earnings ratio is invariant to the growth rate only in the special case where it happens to be the inverse of the return to capital. A price-earnings ratio equal to 20 would be consistent with returns equal to 5% not 6.5%. Of might Greg be conceding the argument that stock valuations will one day crash:
I would guess that, in their hearts, the authors of this paper agree with me about this. To see if I am right, I would like them to answer the following question: Suppose that next week, the stock market falls by 50 percent, so dividend and earnings yields double. Would Baker, DeLong, and Krugman suddenly be in favor of President Bush’s proposal for Social Security reform? I suspect they would not. If I am right, this suggests that while the paper raises some interesting questions about the future of assets returns, as far as the debate over Social Security goes, it is largely a non sequitur.
If the market is indeed suffering from irrational exuberance, what is the rush to get household portfolios into overvalued stocks? Actually, I don’t think Greg is saying this as he closes with the notion that the risk-return debates are a side show. But here he is being unfair to BDK. If he is really agreeing with the Barro-Becker no free lunch proposition (as I do), then his real complaint should be with the Cato crowd that convinced George W. Bush there is some free lunch or the Club for Growth crowd led by Donald Luskin who are basing their case for privatization on this non sequitur. Speaking of our favorite April’s Fool, more here.
Update: Bibamus also notes that Mankiw’s no free lunch proposition contradicts George Bush and Donald Luskin’s snakeoil salesmanship pitch.