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Random walk

Impossible to predict the next step. EFFICIENT MARKET THEORY says that the PRICES of many financial ASSETS, such as SHARES, follow a random walk. In other words, there is no way of knowing whether the next change in the price will be up or down, or by how much it will rise or fall. The reason is that in an efficient market, all the INFORMATION that would allow an investor to predict the next price move is already reflected in the current price. This belief has led some economists to argue that investors cannot consistently outperform the market. But some economists argue that asset prices are predictable (they follow a non-random walk) and that markets are not efficient.

Rate of return

A way to measure economic success, albeit one that can be manipulated quite easily. It is calculated by expressing the economic gain (usually PROFIT) as a percentage of the CAPITAL used to produce it. Deciding what number to use for profit is rarely simple. Likewise, totalling up how much capital was used can be tricky, especially if it is expanded to include INTANGIBLE ASSETS and HUMAN CAPITAL. When FIRMS are evaluating a project to decide whether to go ahead with it, they estimate the project's expected rate of return and compare it with their COST OF CAPITAL. (See NET PRESENT VALUE and DISCOUNT RATE.)

Rate of return regulation

An approach to REGULATION often used for a PUBLIC UTILITY to stop it exploiting MONOPOLY power. A public utility is forbidden to earn above a certain RATE OF RETURN decided by the regulator. In practice, this often encourages the utility to be inefficient, slow to innovate and quick to spend money on such things as big offices and executive jets, to keep down its PROFIT and thus the rate of return. Contrast with PRICE REGULATION.

Ratings

A guide to the riskiness of a FINANCIAL INSTRUMENT provided by a ratings agency, such as Moody's, Standard and Poor's and Fitch IBCA. These measures of CREDIT quality are mostly offered on marketable GOVERNMENT and corporate DEBT. A triple-A or A++ rating represents a low risk of DEFAULT; a C or D rating an extreme risk of, or actual, default. Debt PRICES and YIELDS often (but not always) reflect these ratings. A triple-A BOND has a low yield. High-yielding bonds, also known as junk bonds, usually have a rating that suggests a high risk of default.

A series of financial market crises from the mid-1990s onwards led to growing debate about the reliability of ratings, and whether they were slow to give warning of impending trouble. After the Enron debacle, which again the ratings agencies had failed to predict, some critics argued that the big three agencies had formed a cosy oligopoly and that encouraging more competition was the way to improve ratings.

Recession

Broadly speaking, a period of slow or negative economic GROWTH, usually accompanied by rising UNEMPLOYMENT. Economists have two more precise definitions of a recession. The first, which can be hard to prove, is when an economy is growing at less than its long-term trend rate of growth and has spare CAPACITY. The second is two consecutive quarters of falling GDP.

Regulatory capture

Gamekeeper turns poacher or, at least, helps poacher. The theory of regulatory capture was set out by Richard Posner, an economist and lawyer at the University of Chicago, who argued that “REGULATION is not about the public interest at all, but is a process, by which interest groups seek to promote their private interest ... Over time, regulatory agencies come to be dominated by the industries regulated.” Most economists are less extreme, arguing that regulation often does good but is always at RISK of being captured by the regulated firms.

Rent

Confusingly, rent has two different meanings for economists. The first is the commonplace definition: the INCOME from hiring out LAND or other durable goods. The second, also known as economic rent, is a measure of MARKET POWER: the difference between what a FACTOR OF PRODUCTION is paid and how much it would need to be paid to remain in its current use. A soccer star may be paid $50,000 a week to play for his team when he would be willing to turn out for only $10,000, so his economic rent is $40,000 a week. In PERFECT COMPETITION, there are no economic rents, as new FIRMS enter a market and compete until PRICES fall and all rent is eliminated. Reducing rent does not change production decisions, so economic rent can be taxed without any adverse impact on the real economy, assuming that it really is rent.