Friday, July 23, 2010

Financial reform thoughts

I have none but others have so I thought I'd put them here. In my spare time I think I'd like to follow up on how the enacted reforms reflect what lawmakers (or lobbyists) think are the most important causes of the financial crisis:

1. Mark Thoma's roundup: I'd summarize his thoughts as that the law doesn't go far enough.
a) Consumer protection agency addresses the fraud issue, I think.
b) Exchange for derivatives addresses the lack of transparency/securitization issue.
c) Resolution authority doesn't really address a cause but just allows a better clean-up procedure.
d) TBTF isn't addressed at all though Mark thinks it should.
e) Proprietary trading, capital requirements, leverage limits are not really addressed or are too weak. (i.e. the compromise version of the Volcker rule)
f) Credit rating agencies appear to have been given a pass.
g) Executive pay is also not addressed. A clawback would have been interesting.

2. This article (HT: MR) on the derivatives exchange was interesting:

As the U.S. Senate recently debated a major financial reform bill in which the credit default swap, a kind of derivative, played a significant part, Senators Carl Levin (D-MI) and Jeff Merkley (D-OR) proposed an amendment to that bill that would have banned banks from proprietary trading. There were a lot of high-rolling bankers who did not want that amendment to pass, because it would have messed up their plans to repatriate foreign profits into the United States, untaxed, by trading in derivatives on their own accounts. The clearinghouse ICE Trust U.S. forms a central part of these plans.

What is ICE Trust U.S., and who owns it? ICE US Holding Co., which was established in 2008 as the parent of ICE Trust U.S., is located in the Cayman Islands. Yet none of the owners of ICE US Holding Co. are based in the Caymans. IntercontinentalExchange, Inc., which owns 50 percent of ICE US Holding, is headquartered in Atlanta, Georgia. Among the other owners of the Caymans company are Citigroup, Goldman Sachs, J.P. Morgan, Merrill Lynch and Morgan Stanley, which are headquartered in New York. Bank of America, which now owns Merrill Lynch, is based in Charlotte, North Carolina. Deutsche Bank (Frankfurt) and both UBS and Credit Suisse (Zurich) are also part owners.

... ICE US Holding Company L.P., Cayman Islands, which owns ICE Trust U.S., is “a blocking company” used to prevent the foreign subsidiary from being deemed as loaning margin to a “U.S. person” (namely, ICE Trust U.S.). “They are loaning the money to a Cayman Islands person”, he said. This means that banks can keep their profits abroad and untaxed, but still use them to trade on a U.S. exchange, making investments in U.S. credit default swaps while not paying tax on the collateral placed on the exchange. It’s precisely what Section 956 was designed to prevent.

... University of Michigan Law School professor Reuven Avi-Yonah, who frequently testifies as an expert witness on tax issues in congressional hearings, said the ICE structure ought to be examined by the public, even if it is legal. “Not only do we have an entity in a tax haven, but it’s also an entity with no substance, which is really a killer combination.” A former corporate lawyer, Avi-Yonah told me, “I am not sure the IRS would reject it, but that doesn’t mean it’s okay; Congress should take a look.”

This whole thing strikes me as hypocritical (approved by the Fed! no less - they're not going to win any friends here, me thinks), especially since there are all these proposals to prevent tax abuses.

3. John Cassidy on the evolution of the Volcker Rule (which led to the watered down version):

“There is a great amount of ambiguity about how the bill will evolve in practice,” Raghuram Rajan, a University of Chicago professor who was one of the few economists to warn about the risks of a financial blowup, told me. “It has tremendous promise, but also tremendous scope for disappointment.”

... Many independent analysts agreed, arguing that Bear and Lehman had been destroyed by excessive borrowing and by their sunny view of the subprime-mortgage market. Their proprietary-trading desks had not been the problem. Benn Steil, an economist at the Council on Foreign Relations, told me that, if bank deposit insurance didn’t exist, he would consider an investment with Goldman’s prop-trading desk safer than one with a Midwestern bank that would turn around and lend it to local businesses. If Volcker’s recommendations had been in effect before 2008, Steil said, “the crisis would have unfolded precisely as it did.”

Volcker countered that the Treasury’s approach risked exacerbating the likelihood of future bailouts. In proposing to grant the biggest financial firms special legal status as “Tier 1 financial holding companies,” the Treasury came close to designating them as too big to fail, thereby encouraging them to take more risks.

... Yet a larger question remains: Will the reform package be sufficient to prevent future bailouts? Among economists, there is considerable skepticism about the Volcker rule. “If you have the incentive to take risks, there are so many ways that you can do it, and banning one specific activity is not very useful,” Raghuram Rajan said. “If I am a bank and I want to load up on risk, I can give loans to walking wrecks, and that will give me all the risk I want.” In fact, prohibiting banks from proprietary trading could “give you false confidence that they are not taking risks when they are.”

... Volcker may have won the intellectual debate, but, as he readily concedes, the practical challenge lies ahead. Two years from now, when the Volcker rule goes into effect, some firms may well try to skirt it, by, for example, placing big proprietary bets and trying to define them as something else. Without the legislative purity that Volcker was hoping for, enforcing his rule will be difficult, and will rely on many of the same regulators who did such a poor job the last time around, particularly those at the Fed. If the Obama Administration had been able to force the banks to hold a lot more capital in perpetuity, this would not matter very much: a financial system with low leverage can survive the occasional implosion. But international negotiations on a new set of capital requirements are going slowly, and there is no assurance that they will yield meaningful results. If they don’t, once the next credit boom gets going, leverage ratios will start rising again.

In this area, as in many others, the Dodd-Frank Bill is at most a useful beginning. As Volcker told me, it doesn’t really deal with a number of issues that contributed to the crisis, such as extravagant Wall Street compensation practices, misleading accounting, and incompetent credit rating. Ultimately, it also leaves open the question of what would happen if one of the biggest financial firms got into the same sort of trouble that brought down Bear Stearns and A.I.G. As a legal matter, the federal government could now euthanize such a firm instead of bailing it out. But is the threat of closure credible? If in five years Goldman, say, were to suffer a catastrophic trading loss, then, regardless of whether it had given up its banking license, the Treasury and the Fed would come under great pressure to save the firm.

Is utility unbounded from below

This assumption is usually made in game theoretic versions of contract theory. If utility is unbounded from below agents play a game repeatedly then there is some path in which behavior can be enforced so that incentive compatibility holds. I may have phrased this incorrectly - it's been a while since I've looked at game theory.

Basically, all it says is that we can enforce good behavior with sufficient threats. On the flip side, one would also think that if faced with the possibility of dying, we would make a decision to preserve our lives. In equilibrium, with perfect knowledge and perfect rationality then workplace safety would not be an issue. Of course, we don't have perfect knowledge or perfect rationality so regulation is required. But can regulation perform better than a worker's private knowledge of workplace issues?

This post is basically in response to this NYT article on workers' concerns aboard the Deepwater Horizon before it blew up:

A confidential survey of workers on the Deepwater Horizon in the weeks before the oil rig exploded showed that many of them were concerned about safety practices and feared reprisals if they reported mistakes or other problems.

In the survey, commissioned by the rig’s owner, Transocean, workers said that company plans were not carried out properly and that they “often saw unsafe behaviors on the rig.”

Some workers also voiced concerns about poor equipment reliability, “which they believed was as a result of drilling priorities taking precedence over planned maintenance,” according to the survey, one of two Transocean reports obtained by The New York Times.

Tuesday, July 20, 2010

Children, marriage and divorce

Again from the New York Magazine:

... couples probably pay the dearest price of all. Healthy relationships definitely make people happier. But children adversely affect relationships. As Thomas Bradbury, a father of two and professor of psychology at UCLA, likes to say: “Being in a good relationship is a risk factor for becoming a parent.” He directs me to one of the more inspired studies in the field, by psychologists Lauren Papp and E. Mark Cummings. They asked 100 long-married couples to spend two weeks meticulously documenting their disagreements. Nearly 40 percent of them were about their kids.

If wanting children causes marriage, does having children cause divorce?

Sovereign defaults

In a post of what happens if things go really badly, I was surprised to see that the Asian economies that have a 5-year cumulative default probability (whatever this is supposed to be) of 10 percent or greater: Indonesia, Thailand, South Korea.

What I dislike about the graph is the following: Is there really a difference between 11 and 11.4 percent probability? Assuming that the model is estimated, where are the standard errors?

Another "feature" of these default models is the timing. When stuff happens we always wonder, why now? Why not last month? Why not yesterday? In many cases, it is the case that really nothing much has happened between the time economists say that these countries are in danger of defaulting and when it happens, e.g. Greece.

My guess is that there is some inattention or lack of focus by "people". You know the ones I'm talking about - they're constantly in crisis mode, switching their attention from one to another. When all is well, they're really not doing much. Then something is due e.g. a loan payment and they switch their attention to it and suddenly things aren't all that rosy and boom! Then when they're done fanning that one fire they decide to see what else they can torch and before you can say contagion, you're right smack in the middle of it.

I'd guess that if we looked at all the crises in history, very few have happened on holidays or during the summer vacations.

Unintended consequences?

1. I've never been a big believer of this but I can't make up my mind after this article:

In the surrounding steep valleys, hundreds of defunct silver and gold mines pock the slopes with log-framed portals and piles of waste rock. When water flows over the exposed, mineral-laden rock in and around the mines, it dissolves zinc, cadmium, lead, and other metals. The contaminated water, sometimes becoming acidic enough to burn skin, then dumps into nearby streams. So-called acid mine drainage, most of it from abandoned boom-time relics, pollutes an estimated 12,000 miles of streams throughout the West—about 40 percent of western waterways. ...

... But as these volunteers prepare to tackle the main source of the pollution, the mines themselves, they face an unexpected obstacle—the Clean Water Act. Under federal law, anyone wanting to clean up water flowing from a hard-rock mine must bring it up to the act’s stringent water-quality standards and take responsibility for containing the pollution—forever. Would-be do-gooders become the legal “operators” of abandoned mines like those near Silverton, and therefore liable for their condition.

2. Should FOIA apply to journalists?

... does the press always get to decide whose secrets trump? What bothers me most about the cult of the source is the press’s insistence on its right to ignore due process of law and refuse to reveal sources even after the issue has been fully litigated. Fine: appeal it up to the Supreme Court if you want, but in a democracy with an (all but) uncorrupted judiciary, if you ultimately lose, you should obey the law as it is, not as you would like it to be.

The Malaysian Connection

I had known about the letter from Malaysia in the anthrax case, recounted very well here and about Stephen Hatfill. What I hadn't known was this titbit:

His girlfriend was Malaysian-born—and a hoax package had been sent from Malaysia to a Microsoft office in Nevada.

The article does not explain how the subsequent suspect Bruce Edward Ivins managed to mail a package from Malaysia though I suspect these kinds of things are easily done.

The article was enjoyable though it was hard not to see why the FBI considered Hatfill a suspect (unless he was being set-up - I may be watching too much TV). In the end, this is a tale of how we can all buckle when the weight of one organization (not just the government) comes down on us.

China and Africa

A preface excerpted from The Atlantic:

“Statistics are hard to come by, but China is probably the biggest single investor in Africa,” said Martyn Davies, the director of the China Africa Network at the University of Pretoria. “They are the biggest builders of infrastructure. They are the biggest lenders to Africa, and China-Africa trade has just pushed past $100 billion annually.”

Davies calls the Chinese boom “a phenomenal success story for Africa,” and sees it continuing indefinitely. “Africa is the source of at least one-third of the world’s commodities”—commodities China will need, as its manufacturing economy continues to grow—“and once you’ve understood that, you understand China’s determination to build roads, ports, and railroads all over Africa.”

Davies is not alone in his enthusiasm. “No country has made as big an impact on the political, economic and social fabric of Africa as China has since the turn of the millennium,” writes Dambisa Moyo, a London-based economist, in her influential book,
Dead Aid: Why Aid Is Not Working and How There Is a Better Way for Africa. Moyo, a 40-year-old Zambian who has worked as an investment banker for Goldman Sachs and as a consultant for the World Bank, believes that foreign aid is a curse that has crippled and corrupted Africa—and that China offers a way out of the mess the West has made.

Some additional links:

1. Via Chris Blattman
2. Foreign Affairs:

Why would the Chinese government push some of its labor- and energy-intensive industries to move to special economic zones in Africa, even as the U.S. Congress bans the U.S. Agency for International Development from financing any activities that could relocate the jobs of Americans overseas? Because Chinese planners want industrialists at home to move up the value chain. Polluting industries such as leather tanneries and metal smelters are no longer tolerated in many Chinese cities.

3. The Atlantic (interesting throughout):

Many Chinese agricultural initiatives are shrouded in mystery. In 2006, for instance, China offered a $2 billion soft loan to Mozambique for a project to dam the Zambezi River Valley, amid some of the continent’s most fertile soils. The following year, Chinese and Mozambican officials reportedly signed a memorandum of understanding allowing 3,000 Chinese settlers to begin farming in the area. But following a local uproar, Mozambique’s government denied all reports of the plan, and little has been heard of it since. ...

... The stop-and-go quality of major Chinese farming deals and the strong feelings that they’ve produced suggest that the honeymoon between the Chinese and Africans may not last long. During the course of my trip, land issues seemed to bring out the ugliest biases in the people I spoke to. “If you gave this land to Chinese people to work it, this place would be rich overnight,” said one Chinese woman immigrant, a middle-aged trader in southern Congo: “They’re too lazy, these Africans.” Many Africans, for their part, were intensely wary of Chinese immigration; Daniel told me that this was a particularly raw issue among many of his friends. Conspiracy theories echoed frequently. In Dar, for instance, rumors had spread that the new national sports stadium was part of a secret deal to grant land to Chinese farmers in Tanzania.

... Many Chinese fortune seekers had hired African work gangs to dig for copper, sometimes even in Lubumbashi’s red-clay streets. “They were profiteers and speculators,” said one local businessman. “Congo got nothing from them.” Most of them dug “no more than 20 feet deep, which requires no investment at all.” The government belatedly tried to reassert control, requiring all those who mined copper to smelt it as well, and to make more-substantial investments in equipment, in order to generate more jobs and tax revenue and to make the industry more sustainable. In response, small operators scrambled to build small, inefficient furnaces. In 2008, as prices tumbled from $9,000 a ton to a low of $3,500, the makeshift smelters closed down and the Chinese owners fled, leaving their Congolese workers unpaid and the landscape littered with industrial refuse.

Why Washington is the way it is

According to Jeff Goldberg:

In some places (though not in the District of Columbia, where I also live) it is legal to reserve a parking spot using lawn furniture until the streets are cleared. I once would have agreed that this is an unfriendly practice, but this winter’s storms convinced me otherwise. I live in a special area of Washington that was established by the federal government as a reservation for former employees of Ralph Nader, and while my neighbors are thoughtful people who support our local NPR affiliate and believe that War Is Not the Answer, they’re not very good at shoveling snow. This may be because, as liberals, they believe that street-clearing is the job of the government. Or because they think that mechanical snowblowers cause global warming. ...

Orthodontics and obesity

K1 needs (?) expanders. This much we found out a month ago. The orthodontist also recommended the removal of 2 canines to facilitate the permanent teeth that were coming out.

There were two things we could have done, both of which I would have wanted to avoid.
1. Get a second opinion.
2. Go with the recommendation.

I don't see how either option can contribute to the reduction in health care costs (assuming dental is part of health care). Neither my spouse nor I had braces or orthondists and neither of us have perfect teeth and our feelings were - so what? But I had read an account of how at age 47 she decided to get braces and how her teeth bugged her through most of her life and really, who wants this for their kids.

So we went with #2. We went ahead with the extraction - not too bad - $290, and the expanders will cost $4000 over possibly 2 years or less (before braces). We're not quite sure how much of it insurance actually covers (yet) but one small contribution to the cost of escalating health care would be to remove insurance coverage of orthodontics except for injurious cases (e.g. plastic surgery for burn victims). It would certainly make us think harder about orthodontics.

Yet, with all the rising costs of obesity, as recounted by Mark Ambinder, the benefits of bariatric surgery is still unknown and hence not covered by insurance.

In the half century since surgeons began performing bariatric procedures, the surgery’s mortality rate has declined to half of 1 percent, and its long-term success rate—people who keep at least 50 percent of their excess body weight off for several years—has become exceptional. For reasons clinicians still don’t quite understand, the surgery seems to cure diabetes, sometimes instantly. The surgery does not work for everyone: some people who endure it will essentially regrow their stomachs and gain back the weight. Though the rate of minor complications can exceed 30 percent, the incidence of more-severe complications is less than 3 percent. But the procedure is still an equalizing force: for a honeymoon period, about six months to a year after surgery, it allows you to resist the environmental and physical pressures that intensify appetite and food addiction.

...For young adults who cross a certain weight threshold, bariatric surgery can be an effective preventive step. Its incidence among all adults doubled over six years, to 220,000 surgeries in 2008. And it seems to be increasingly prevalent among obese teenagers: one study suggests that from 2000 to 2003, the number of teens resorting to the procedure tripled. But it’s major surgery, and specialists aren’t comfortable doing it as a preventive measure. Moreover, many insurance companies (including mine) refuse to pay the $30,000 cost, reasoning that any economic benefit they would recoup is years down the road.

Data deluge or why data is not information

This series looks like it could shape up to be another Pulitzer for WaPo.

Some random thoughts:
1. Workers with marginal productivity of zero.
2. Why has there not been a greater fiscal stimulus?
3. This gallery shows that the government has almost everything 24 and NCIS has, yet the data deluge is tremendous.
4. The paradox of more data is that there is less information which is why I'm not so worried about privacy when it is in the hands of the government. In private hands with private incentives and goals on the other hand .... So, its the private contractors, analysts, and anyone with a private agenda.
5. #4 cries out for a super-super computer that will tell us all it knows (and run the world).
6. In all software or data projects decreasing returns to scale is the norm.

Inflation or deflation

The Economist asks a simple question (and given that I had made a portfolio reallocation decision based on my answer - and perhaps a wrong answer at that) I was interested in seeing what the participants of the forum had to say.

1. Ricardo Caballoro, MIT: On average (across the world), inflation is not and will not be a concern for quite a while.
2. Arminio Fraga, Gavea Investimentos: In the near term, the excess capacity found in most advanced economies pushes prices down. But central banks know how to pump up aggregate demand and fix this, it is just a matter of time. So deflation is not a lasting threat.
3. Stephen Roach, Morgan Stanley: ... as I look out over the next five years, I see a good case for both another whiff of deflation only to be followed by an outbreak of accelerating inflation. The sequencing is key. I worry that fears of deflation will lead to yet another spate of policy blunders that could ultimately set the stage for meaningful deterioration on the inflation front.
4. Gilles St. Paul, CEPR: As long as the recession continues, the risk of inflation is small. However, the scenario of a return to high inflation as we exit the crisis should not be dismissed, for a number of reasons.
5. Adam Posen, IIE: Most macroeconomists instinctively believe that deflation is bad, and we certainly can generate a list of reasons why that should be so.
6. Stephen King, HSBC: The Western world is in danger of following in Japan’s deflationary footsteps.
7. Scott Sumner, Brandeis: I believe that the US and Europe are unlikely to experience outright deflation in the foreseeable future.
8. John Makin, Caxton Associates: Deflation is currently a greater threat to the world economy than inflation.
9. Tom Gallagher, ISI: ... neither inflation nor deflation is the base case, the arguments against inflation are stronger, so I worry more about deflation.

Some answers were more straightforward than others. (I excluded Brad DeLong only because his response wasn't easy to excerpt but he definitely falls in the deflation camp.) Except for Stephen Roach, no one really gave a time frame (Roach says 5 years). And some economists tend to couch their responses with more caveats than others - perhaps this is an inate ability of economists to cover our asses.

Here is Jim Hamilton (which sounds extremely crisp and clear to my ears):

For the last year and a half my assessment has been that the near-term pressures on the U.S. economy were deflationary, while long-term fundamentals involve significant inflation risks. It's time for a look at the data that have come in over the last 6 months, and time to say that I still see things exactly the same way.

... I often hear the idea expressed that all the money that the Federal Reserve has created through its various responses to to the financial crisis has to produce inflation. With the exception of the assets the Fed acquired through the
AIG deal, which aren't going anywhere, most of the other special facilities the Fed implemented in the fall of 2008 have been wound down, replaced with long-term holdings of mortgage-backed securities and agency debt.

... The source of my concern about long-run inflation comes not from the expansion of the Fed's balance sheet, but instead from worries about the ability of the U.S. government to fund its fiscal expenditures and debt-servicing obligations as we get another 5 or 10 years down the current path. Just as many analysts have had trouble seeing how Greece can reasonably be expected over the near term to move to primary surpluses sufficient to meet its growing debt servicing costs, I have similar problems squaring the numbers for the U.S. looking a little farther ahead.

... I am definitely not among those calling for current budget cuts-- that would only aggravate our immediate employment challenges. But I do think now would be an excellent time for fiscal reforms that make the long-run math look substantially more responsible. Examples include raising the eligibiity age for Social Security and Medicare, increasing the Medicare copay, budget reform to bring earmarks under control, a plan to ease the government out of responsibiity for implicitly or explicitly guaranteeing U.S. mortgage debt, and reforms at the state and local government level to bring their long-run pension liabilities under control.

Menzie Chinn Follows up with some more graphs (and he is also in the deflation camp). Subsequently, Jim Hamilton lists some ideas as to how to fight deflation.

And from Mark Thoma, the Feds may have a schizophrenic view perhaps due to salty and fresh economists:
Atlanta Fed:
Since last October, the consumer price index (CPI) has gone up an annualized 0.7 percent. On an ex-food and energy basis, the number is a little lower, at 0.5 percent. And the Cleveland Fed's trimmed-mean and median CPIs, at 0.7 percent and 0.2 percent, respectively, also put the recent trend in consumer prices in pretty low territory.

While the Richmond Fed:
The recent spate of weaker economic data doesn’t mean the U.S. recovery is faltering, and the Federal Reserve continues to get closer to the time when it will need to raise interest rates... Lacker believes, like many other Fed officials, that the economy doesn’t yet need fresh support from the Fed.

which drew the following comment from Mark Thoma:
What's he afraid of? Inflation?

Some labor market puzzles

I had opined that I thought that macro economic models need to address the labor market rather than the product market and I'm wondering if these puzzles are really product market related or just labor market anomalies.

Keep in mind, we have had a recovery in output, but not in employment. That means a smaller number of laborers are working, but we are producing as much as before. As a simple first cut, how should we measure the marginal product of those now laid-off workers? I would start with the number zero. If a restored level of output wouldn't count as evidence for the zero marginal product hypothesis, what would? If I ran a business, fired ten people, and output didn't go down, might I start by asking whether those people produced anything useful?

It is true that the ceteris are not paribus, But the observed changes if anything favor the hypothesis of zero marginal product. There has been no major technological breakthrough in the meantime. If anything, there has been bad monetary policy and a dose of regulatory uncertainty. And yet again we can produce just as much without those workers. Think of "labor hoarding" yet without...the hoarding.

You might cite oligopoly models and argue that the workers can produce something, but firms won't hire them because they don't want to expand output, due to lack of demand. That doesn't seem to explain that output has recovered and that profits are high. And since there is plenty of corporate cash, it is hard to claim that liquidity constraints are preventing the reemployment of those workers.

... In general, which hypotheses predict lots more short-term unemployment among the less educated, but among the long-term unemployed, a disproportionately high degree of older, more educated people? This stylized fact seems to point toward search and recalculation ideas, with some zero marginal products tossed in. Do aggregate demand theories yield that same data-matching prediction? I don't see it, at least not without being paired with a theory of concomitant real shocks.

My question here is what is "real" about shocks? Are we back to exogenous technological shocks again? I hope not.

Stay in stocks?

So says Jeremy Siegel as my quarterly 401(k) report tells me that I just lost $10K over the last quarter. On the personal front, my decision to reallocate from stocks to TIPS isn't paying off that well either.

For the current quarter, it seems that neither stocks nor bonds are really delivering any returns. This is the quandary that money managers face as they chase higher returns - so when the next 'big thing' comes along they plunge into it. The dot-com crash was followed by herding into MBS. What's the next big thing?

As fiscal stimulus stalls, it may become apparent that the government will need to spend more and spend directly - shove ready or not. One possibility is infrastructure investment and who knows, perhaps we really need it. And it's not just the Americas that infrastructure investment is being touted. Example, here.

Over-active voice

The passive voice seems to have fallen out of favor over the years and I don't really know why.
When I was in school, the passive voice was encouraged among other reasons, it conveyed the humbleness of the writer. These days, the passive voice has even carried over to scientific and technical writing.

For instance, it is also advocated here (note the use of passive voice is to sound less accusatory). It is also encouraged here for the following reasons:

We find an overabundance of the passive voice in sentences created by self-protective business interests, magniloquent educators, and bombastic military writers (who must get weary of this accusation), who use the passive voice to avoid responsibility for actions taken. Thus "Cigarette ads were designed to appeal especially to children" places the burden on the ads — as opposed to "We designed the cigarette ads to appeal especially to children," in which "we" accepts responsibility. At a White House press briefing we might hear that "The President was advised that certain members of Congress were being audited" rather than "The Head of the Internal Revenue service advised the President that her agency was auditing certain members of Congress" because the passive construction avoids responsibility for advising and for auditing.

Yet, the active voice when used can lead to criticism such as this where Tyler Cowen is apparently reprimanding John Taylor for his over-use of I in Taylor's memoir Global Financial Warriors. My theory is that the rise of the use of the active voice coincides with the rise of the Internet, reality TV and in essence the ME generation.

Fifty percent inflation?

Geez, was in the Mickey D's recently after an extremely long hiatus (probably over 2 years) and just noticed that the hash browns that used to go for $1 for 2 is now $1 for 1. Is it just in DC and/or did this just happen and I'm just clueless?

Saturday, July 17, 2010

Why I hate libraries

Well, after a long time, it has happened again. Ugh! It's also the very first time I'm borrowing from the DC library too. Yuck, because it seems like such a great library system.

Update (7/19): So I decided to take matters into my own hands and went to the library today to hunt for it. The reason I decided to do this was because the library system kept sending me e-mails that the book was due. I spoke to a librarian and she said that the system shouldn't be doing that since I had reported the book returned and that they had put a search out for it.

In any case, I found the book - on the shelf - and handed it to the librarian.

Friday, July 16, 2010

Was it all a bubble?

Was all of the price increase a bubble? The price chart is from Zillow and all other charts are from Calculated Risk via Econbrowser.

I ask this because occasionally, I come across comments regarding auto sales and home sales such as the following:

"The seasonally unadjusted number of light vehicles sold in June was below the values for May or March and about the same as April. We still seem closer to the bottom than the top."

"Housing continues to lurch up and down with the expiration of tax credits. New home sales and pending home sales were both at record lows for May, while mortgage purchasing applications were near a 13-year low."

US Zillow Home Value Index

If I assume that at least some of the house price increase was due to fundamentals, for instance, up to 2003, and the rest was due to a bubble, then the above charts tell a different story than if we are trying to get our consumption back to its peak. Given that there was a consumption binge, do we really want the levels to go back to what they were in 2007? Given that there is now and excess supply of new homes, should we really expect sales of new homes to drive the economy and that mortgage applicatons and sales to return to pre-crash (or even pre-2003) levels? Assuming that consumers were highly in debt in order to buy cars, should we allow auto sales to return to their "normal" levels?


This mornings tremor shook me out of my sleep. Now I can safely say I've experienced a mild earthquake and it left me slightly queasy.

Judging by the number of earthquakes this year versus other years, e.g. 2009, it's hard to say if its been a more active year or not even though in my mind it feels like it has.

It would be interesting to see if there are any patterns via spatial and temporal autocorrelations - I'm familiar with autocorrelations in time series, less so spatial and don't even know if we can combine both.

Thursday, July 15, 2010

Causes of financial crisis

This opinion by Raghu Rajan places the blame on skill biased technological change and increased inequality leading to a policy to increase homeownership among low and moderate income as a way to close this gap as the root cause of the crisis. This is a merely a deft way of blaming Fannie and Freddie and the CRA (Community Reinvestment Act).

The CRA and Freddie and Fannie has its passionate (?) defenders, among them:
1. Menzie Chinn,
2. Paul Krugman,
3. Mark Thoma

BTW, Jim Hamilton thinks that GSEs did play a role, albeit not the principal role.

I am thinking of playing a game:
These are as many factors that I could think of that can be the cause of the financial crisis (in no particular order, and I'll update the list as I think of more):

1. Greed (aka rational utility maximizing investment bankers and investors)
2. Lack of regulation and oversight
3. Complexity of securities
4. Media spreading rumors
5. Eliot Spitzer - his removal of Greenberg from AIG coincided with AIG insuring CDS
6. Dr Doom aka Nouriel Roubini, Meredith Whitney, or any or all bearish financial analysts, bloggers and commentators
7. Monetary policy - interest rates were too long for too long and then started rising too quickly triggering defaults
8. Herd behavior among bankers and investors
9. Over-optimisim among bankers and investors
10. Fannie Mae/Freddie Mac and policy to increase homeownership aka Community Reinvestment Act
11. Interconnectedness of financial system
12. Rating agencies
13. Short sellers
14. Securitization
15. Mortgage fraud
16. Inequality caused by skill biased technical change (SBTC)
17. Globalization/free trade possibly causing SBTC
18. And just for the heck of it, global warming.
19. Animal spirits.
20. Financial models & over-reliance on models
21. Moore's law and increase in computing power
22. Mark to market
23. Too big to fail/Moral hazard
24. Pay for performance and the economists who designed lavish pay packages of investment bankers.
25. Leverage
26. Proprietary trading

The name of the game is "causality jenga". We have these factors or building blocks of the crisis on one side and then there is the crisis on the other and for this purpose we can just define crisis as the events of the fall of 2007 beginning with the failure of Bear Stearns. If we start pulling out these building blocks (factors) we would ask ourselves, would the event still happen?

And as we do this, I think analysts need to ask themselves the chain of events that led to the crisis. In other words, a mechanism. Rajan has laid one out above which I think is incomplete. In the parlance of some other social sciences, we need to think clearly about what factors are 'primal' and what others are 'mediators'. If the chain can be broken somewhere could the crisis have been averted?

Or perhaps we can start by identifying necessary and sufficinet conditions. Or perhaps this is asking too much of economists.

Econometric Models

This post really annoyed me (emphasis mine):

The ARRA, the fiscal stimulus act passed last year, gave the Council of Economic Advisers an impossible job: measuring how many jobs the act created. Here is the CEA's latest attempt. As far as I can tell, there are two kinds of evidence here.

First, there are model simulations. That is, the CEA took a conventional Keynesian-style macroeconomic model and used those set of equations to estimate the effect the stimulus should have had. Essentially, the model offers an estimate of the policy's effect, conditional on the model being a correct description of the world. But notice that this exercise is not really a measurement based on what actually occurred. Rather, the exercise is premised on the belief that the model is true, so no matter how bad the economy got, the inference is that it would have been even worse without the stimulus. Why? Because that is what the model says. The validity of the model itself is never questioned. (Moreover, the fact that other organizations simulating similar models come to similar conclusions is no evidence about the validity of the model's simulations. It only tells you the CEA staff did not commit egregious programming errors when running their computer simulations.)

This criticism is vacuous in the following sense:
1. It is valid not just for this model, but any econometric model.
2. It is valid also for any DSGE models that assume exogenous 'deep' parameters.
3. It is essentially valid for any econometric model that uses instrumental variables or 'fancy' causal type analysis. (Can any one say valid instruments?)
4. Any model is only as good as its assumptions.

The following is just an off-the-cuff remark and I'll probably get into trouble for this: No one really is convinced by any econometric or statistical evidence especially if it is a one-off study. We are only convinced if we already believe in the first place and in this case, the author has already discounted the effects of ARRA (before any evidence was even presented) and therefore dismisses this evidence as unconvincing.

Even if I were agnostic about the effects of the stimulus, this one study would really do nothing to convince me that it is effective. Different models, using different assumptions (robustness is what some may call it) really is the key to trying to persuade. After all, models (econometric or otherwise) really are rhetoric in disguise.

Wednesday, July 14, 2010

The mathematization of medicine

The wisdom of this in the field of economics has been debated and is perhaps also debatable. But what about medicine? I am not in a position to judge how useful nor am I in a position to say how widespread and popular it is but I came across the following

From Cardiovascular Mathematics by Luca Formaggia, Alfio Quarteroni, and Alessandro Veneziani (Eds.). The following is from Chapter 2

Some gems from Robert Hall

This interview has been blogged about elsewhere but I wanted to save the bits that I found interesting:
[on automatic recession dating]:
Actually, long ago, in the 1980s, we sponsored a project that informally, unofficially put out a recession probability index that Jim Stock and Mark Watson prepared. It didn’t work very well in the 1991 recession, so they stopped doing it after that.

And it didn’t work for fairly typical reasons. That was the first recession that wasn’t accompanied by a decline in productivity, so it looked somewhat different. So their historical relationships weren’t as stable as they hoped.

That’s one of the main reasons why automatic rules haven’t worked. People have done research on the machine approach for years. In fact, when I was a graduate student and took a computer science course, my project was to write software that would automate this. So it’s not a new idea. But it’s never worked very well.

Region: It would have missed the 1981 recession if we’d used the two negative GDP quarters rule.

Hall: You mean 1980.

Region: Right, 1980.

Hall: 1981 was no problem. The 1980 recession was just one quarter. And people have said that the 1980 recession was actually just sort of a prelude to the ’81 recession. We say no, but it’s been said.

Region: It seems it’s more of an art than a science then. Hall: It’s a classification problem that the world seems to want an answer to, but it has a shifting structure, and dealing with the shifting structure is the issue. We try very hard to achieve historical continuity.

We don’t doubt for a second—and I don’t think anyone else does either—that we know when there’s a recession. In all the data we look at, certainly in the period when we’ve had reliable data, which is since World War II, there’s never been an episode that’s somewhere halfway between a recession and a nonrecession. Every recession has been clear. And they all see unemployment shoot up and typically see GDP decline.

We do face issues though. With the most recent revisions of GDP, the 2001 recession essentially doesn’t exist. It was a flattening, but as emphasized on our Web site, there are issues of depth, duration and dispersion, but there was neither depth nor duration in what happened in ’01. By the alternative measure of total output, real gross national income, the 2001 recession is quite apparent.To me, it’s not an issue because that’s just looking at GDP. If we look at employment, as I did in a 2007 Brookings paper on the “Modern Recession,”—by “modern recession” I mean one in which productivity rises…

[on the state of macroeconomics]
Region: The past few years seem to have brought about a crisis of confidence in the economics profession, with critics suggesting that macroeconomics has failed in some fundamental way. It’s a topic addressed by [Minneapolis Fed President] Narayana Kocherlakota in our Annual Report this year. Do you agree that the macro profession failed the nation during the financial crisis?

Hall: I don’t. There are two parts to the issue. First, did macroeconomists fail to understand that a highly levered financial system based in large part on real-estate debt was vulnerable to a decline in real-estate prices? No way. Many of us pointed out the danger of thinly capitalized banks. We had enthusiastically backed the idea of prompt corrective action in bank regulation, so that banks would be recapitalized well before they became dangerously close to collapse. We watched in frustration as the regulators failed to take that action, even though they had promised they would.

Second, did macroeconomists fail to understand that financial collapse would result in deep recession? Not at all. A complete analysis of that exact issue appears in an extremely well-known and respected chapter in the Handbook of Macroeconomics in 1999, written by Ben Bernanke, Mark Gertler and Simon Gilchrist. Depletion of the capital of financial institutions raises financial frictions to levels that distinctly impede economic activity. In particular, credit-dependent spending on plant, equipment, inventories, housing and consumer durables collapses. That chapter is an excellent guide to the depth of the current recession.

I would have liked him to have answered the question: How should the government response? Although he does talk a little about fiscal policy in the beginning of the interview, I did not think that he adequately responded to how the fiscal stimulus should have been structured (he says in the interview that too little of it went into increasing aggregate demand directly) and whether monetary policy would have been prefered i.e. he did not answer Kocherlakota's claim that economists were not able to provide a play book to respond to the crisis.

When is aggregate demand high

This question puzzled me: If aggregate demand is so low, why are profits so high?
If I remember what's left of my economic knowledge correctly, aggregate demand is simply C+I+G (in a closed economy) and this in turn equals Y or GDP.

So is Tyler asking why are profits so high when output is so low? This doesn't really make sense and I decided that it has to be the output gap that is high (that makes aggregate demand low).

From FRED the picture for corporate profits:

And from FRBSF a picture of the output gap (I wish these folks would make their data available for download):

The questions I would have are (and bearing in mind that output gap measures can be vastly different, e.g. see here for example):

1. Is the cyclical component of profits pro- or counter-cyclical to the output gap?
2. Same question vis-a-vis unemployment and profits.

Sticky expectations or just cheap

In an old post I thought that perhaps I had sticky expectations or that I was just cheap. But Nick Rowe explains that it is possible that I am not alone - that via comments by Richard Serlin, that consumers expect prices to be stable.

One of the arguments against sticky prices is that there are no microfoundations for this. Yet economists make all kinds of unrealistic assumptions all the time - sometimes with very little foundation - that agents are rational and utility maximizing or that preferences are Cobb Douglas or when it suits them, preferences are non-separable. Sometimes technology is Cobb-Douglas and sometimes it is CES again depending on which paper you are reading. These assumptions are all over the place and there is really no one set of assumptions that are made for all papers.

The argument for sticky prices posted above is that consumers do not like prices that change frequently. One of the hard things about economic modeling especially in dynamic models is the real world equivalent of a "period". In a model with 50 periods and prices that change every period can be considered "too frequent". The real world equivalent is usually a "quarter" or perhaps even a "month" - so are price changes every quarter really too frequent? Shoe prices that fluctuate every month I would consider to be too frequent, but if the price changes every quarter I can possibly deal with that.

One month ago, the price of a case of 18-pack Horizon Organic milk was $13.49 at our Giant grocery store nearby. Two weeks ago it was $13.99 and a few days ago it was $14.49. Is this too frequent? Again, it depends on the good as some papers have shown. (See yesterday's post and the links therein for references.) It also depends on whether these price changes will stick - i.e. is it worth my time to drive 10 or 20 minutes somewhere else to get it cheaper (or to find out that it is the same price!) Morever, where firms have the leeway to substitute for cheaper inputs or smaller portions (e.g. restaurants) they will do so.

To summarize, prices are sticky and models that explore price stickiness are a part of the development of economic knowledge. How important is this stickiness I am undecided. I am also unconviced that there is sufficient work done on the frequency of price changes and the possibility of substitutions - and I think it is because the data is not easy to come by. It is also not clear how consumers respond to price changes of various goods. In other words, a research agenda and hopefully enough grants to sustain a whole generation of economists.

Tuesday, July 13, 2010

If an old model is wrong, does a new model make it right?

I enjoyed this article:

... We almost never directly observe what is going on beneath the surface of 70 percent of the planet, and yet US fishing rules and regulations demand that scientists predict how many fish are in a given sea.

So scientists and fishermen and everyone else rely on computer models that mimic what is known about fish. Into the models goes information like size, age, growth rate, how many fish will die of natural mortality (predation, disease, moving away from the area) and how many are taken in the fishery.

Lobsters lack body parts like ear bones that help to reveal the age of other species; as a result, modelers use lobster size instead. But even size can be misleading, because lobster growth rates also vary with temperature: the warmer the water, the faster they grow. And since most lobsters move around throughout the year and over the course of their lives, their growth rate does not stay the same.

Variable growth rates can have surprising effects. According to Dr. Yong Chen, a fisheries scientist at the School of Marine Sciences at the University of Maine, the lobsters that grow into the size that can be legally harvested during any given year can include individuals born over a seven-year time span. In other words, the lobster on your plate could be four years old and the one on your friend's plate could be eleven years old, even if they are both one-pound lobsters that were caught in the same trap.

These facts complicate computer models. Throughout the 1990s and early 2000s, the National Marine Fisheries Service model consistently underestimated the number of lobsters in the sea, and therefore overestimated the percentage being caught in the fishery each year, leading federal scientists to believe that overfishing was occurring in the Maine lobster industry. Yet year after year, catches went up and research surveys recorded higher and higher numbers of lobsters. Clearly the model wasn't working.

Fast forward to 2008: The Atlantic States Marine Fisheries Commission and the National Marine Fisheries Service officially adopted a completely new model that estimated the lobster population as "not overfished."

This transformation occurred largely thanks to the talent and tenacity of Dr. Yong Chen.

According to Chen, there are four main areas where his model improved on the prior version. "We included the inshore trawl data from Maine and other state surveys, in addition to federal survey data; we had better catch data to work with than before; we had more realistic biology built into our virtual lobsters; and we used a statistical approach that incorporates margins of error in our inputs (this approach uses Bayesian statistics)," he said.

But how do we know that the new model is right versus less wrong?

Canadian mortgage market

I was shocked, shocked! to learn that Canadians cannot get 30-year mortgages. I was even more shocked, shocked! to learn that the typical mortgage is 5-years. Who can afford to live in Canada? I shrieked!

The average house price as of January 2010 in Toronto - $409K, and in Ottawa - $324K. Other sources for prices are here and here (which reports a national average as of 05/2010 of $346K, Toronto $446K, Ottawa $334K.)

A 5-year mortgage at 6% for a loan amount of $300,000 is about $5,000 per month. The average montly income of a computer programmer is about $3,000 per month (not so different from a carpenter!) in 2005 dollars (and I'm assuming before tax). Even with 2 incomes so that the montly household income reaches $8000K before tax, I find it hard to believe that Canadians can afford to own a home in Canada. (Assuming a 30% tax rate, that would he a HH income of $4,200.)

Sticky price models

I've been trying to make some sense out of the arguments for and against sticky price models. First, Stephen Williamson rants about how he was betrayed by Kocherlakota:

... the Narayana I knew would have thought the worldview represented in standard Keynesian economics was hopelessly naive. ... Woodford's view of the world is not coherent, and it certainly isn't a normative theory - the Taylor rule has never been shown to be an optimal response to anything. Also forget the "positive analysis." One would think that New Keynesians would be thoroughly embarrassed by the financial crisis, which obviously has nothing to do with sticky prices, and left them at a loss for policy prescriptions. ...

... First, there is nothing new in New Keynesian economics, which is successful in good part because it is completely unobjectionable to (i.e. the same as) Old Keynesian economics. Some people might tell you that it's forward looking price-setting that makes the difference, but I don't buy it. Second, New Keynesian economics leaves me empty. There is nothing "important" going on there.

A more reasoned argument is made by David Andolfatto:

... the data show sticky prices and the NK [New Keynesian] model has sticky prices. So what is there to argue? In fact, something very important: Do not confuse measurement with theory. The sticky price hypothesis is a theory; i.e., a proposed mechanism designed to interpret the data. And while the theory arguably has some empirical support, it is not as strong as one is generally led to believe. Sticky price models calibrated to match the observed average duration of price changes (just over one quarter) imply relatively benign consequences. Things get uglier when trying to match model predictions to microdata; see Klenow 2003. These considerations have led some economist to explore other avenues of "stickiness;" e.g., the "sticky information" models posited by Mankiw and Reis (QJE 2002).

...What accounts for the enduring popularity of sticky price models? I'm not sure, but here are some possibilities. First, they do the least violence to the comfort of Walras and Marshall. Second, they imply that money is non-neutral; something that central bankers are particularly fond of believing in. And third, they appear to rationalize (legitimize) interest rate policies like the Taylor rule.

... I have a hard time taking the sticky price hypothesis seriously. The theory literally implies that if prices were fully flexible, many of the worst properties of recessions would be avoided. There would be no liquidity traps, no financial crises, and no lost decades. Conversely, if prices are sticky (in the theoretical sense), simple government policies, like raising the long-run inflation rate or expanding government spending, can evidently restore something close to economic nirvana when the economy is in a liquidity trap. More than one prominent econblogger appears wedded to this view. I remain skeptical of such easy fixes.

Nick Rowe responds:

One of the jobs that economists are supposed to be doing, and have been doing for the last couple of centuries, is to explain prices. To assume prices are fixed is not to explain them; it's to refuse to explain them. We aren't doing our job. It is only a little better to assume prices are "sticky", which means imperfectly flexible, so they adjust only slowly from one equilibrium to another. We don't explain why they are sticky; we just assume it. For example, the Calvo model of the Phillips curve, that underlies most New Keynesian macroeconomic models, simply assumes that firms face a fixed probability d per period of being "allowed" to change price.

... if I hate the assumption so much, why am I still a sticky price macroeconomist?

First, because when I go to the supermarket, what I see and what I do seems to fit my macroeconomic model pretty well.

... A Marshallian economy has many markets, one for each of the non-money goods, where that good is exchanged for money. A Walrasian economy has one big centralised market, where all goods are exchanged simultaneously for all other goods. Sticky-price macroeconomics is Marshallian, in that sense, and definitely not Walrasian. By ignoring the possibility of a market in which labour is exchanged directly for output, sticky-price macroeconomists are implicitly assuming a monetary exchange economy. Barter is ruled out. Recessions are inherently a monetary exchange phenomenon in these models. Recessions are caused by a shortage of money - an excess demand for the medium of exchange. ...

A model of recessions that says they are caused by an excess demand for the medium of exchange seems right to me. I think I see more resort to home production, barter, and private monies during a recession, and I do see more incentive for people to do so. We see proxies for excess supply generally increase: sellers need more effort to sell; buyers need less effort to buy. The prices that do seem more flexible, because we see them rise and fall daily, tend to fall. It looks right.

Unfortunately for me, I am not familiar with the literature and the discussion pretty much left me flummoxed especially the part where Nick Rowe introduced me to the literature that states that if output is demand determined then wage stickiness does not matter but price stickiness does.

To me, all the action is in the labor market. RBC models had problems with it (matching the moments of hours) and it is the labor market where economists tend to focus on in terms of gauging the health of the economy. The key assumption as the post points out is if output is demand determined and I don't really know how crucial this assumption is. Firms produce what they produce and then 'let the markets decide'. There is constant labor reallocation within and between industries as demand for differentiated products fluctuate.

Suppose I start a new firm to crank out some new cereal and start by producing 500,000 units and set the price at $10. I hire some labor to do the job and pay them $5 per hour. If the product is not selling well I may lower the price and either cut back on number of workers or pay them less. If the product does well then I may hold the price constant and either hire more workers or have them work more hours. If a recession hits and I'm in the first situation where the product is not doing so well then whether prices or wages are sticky or not really doesn't matter - I will just shut down and all the workers are out of a job. If I am in the second situation I may cut back on labor or lower the price of the product. If wages were not sticky I may pay them less. If prices were not sticky I may lower the price. It's not clear to me what firms would do. Sticky prices need to be explained in this situation. And I do see that it is more plausible that workers and firms can come to some agreement so that wages are flexible. So perhaps, Nick Rowe is right after all - that it is the product market that matters which in turn affects the labor market.

The question of whether monetary or fiscal policy works better in the situation where the firm continues operation is to ask the question what does the policy maker want to achieve? Is it that the firm does not lay off workers or cut back on production hours? If this is the case then perhaps there is a role for fiscal policy by stimulating demand for my product. What about monetary policy? Does lower interest rates help the firm or the worker? Yes, if we can borrow to smooth production or consumption (at least to tide us over) until the recession is over but this sounds less effective somehow.

Mark Thoma summarizes some evidence which I have yet to digest.

What's unsatisfying about e-books

At least what I find unsatisfying:

1. The feel of pages, the smell of the paper.
2. I can't share it (or can I?) without breaking DRM laws.
3. I can't resell it.
4. I can't give it away.

Monday, July 12, 2010

Future of American jobs

Are we looking here at A Future of Lousy Jobs? The current recession its effect on employment has economists looking harder at this question. In a previous post, Raghu Rajan speculated that labor reallocation would not be easy. The future of jobs has also been in recent blog posts due to an essay by Andy Grove and is also discussed by Rajiv Sethi.

I am mainly reacting Economists View and welcome Tim Duy to the heretics club:

... very right minded economist and policymaker knows unequivocally that free trade is good, and to even question that assumption makes one an ignorant heretic who has never heard of Smoot-Hawley. ...I grow increasingly convinced that the disappointing economic outcomes of the last decade are the culmination of decades of industrial neglect. That economists have dismissed industrial decline with a story of high value knowledge-based workers, a story with specific relevance to the tech boom of the 1990s but that is now defunct. And I am increasingly convinced that these trends have been largely dismissed by the economics community because acknowledging them would cast doubt on value of free trade, failing to recognize that currency manipulation was turning free trade into a zero-sum game. In short, I have become a heretic.

I would point out only that the size effect of Smoot-Hawley on the Great Depression is not a settled question. (MR doesn't share Andy Grove's concerns however.)

But how can we take a bad job and make it better? What we are really concerned about is the possibility that the hollowing out of blue-collar manufacturing jobs and the stagnant wages associated with these jobs and in the service sector are leading to a future where workers are trapped in the lower rungs with little mobility. As the previous link mentions:

... the blue-collar jobs we pine for were not always good jobs: we made them good jobs. ... Some of this was due to the power of unions. Most of it was because of the enormous improvements in productivity wrought by improved technologies and management techniques.

However, as Tim Duy points out, the growth in wages has lagged behind the growth in productivity:

... productivity growth is supposed to yield improved economic outcomes via higher real wages. Yet ... labor's share of output has been steadily decreasing since the early 1980s. This downward trend was interrupted by gains evident during the tech bubble of the mid-1990s. Apparently, only during that brief, shining moment of generational technological change did the productivity story work as we believe it should, at least since the early 1980's.

Here are some more heretical views:
1. Turn the government into the union by raising the minumum wage and or making health benefits mandatory. (I realize that this is indeed HERETICAL! that should drive most economists into a hair tearing frenzy!)
2. Mandate that "low-wage jobs" e.g. hamburger flippers, cashiers, grocery baggers, etc. be reserved solely for part-timers i.e. those who are looking to supplement their income such as students, retirees or home-makers with some time on their hands. These jobs will be exempt from the minimum wage. (I also realize the incentives that are inherent in the regulation of job categories, i.e. the pressure to make one job category exempt will also lead to pressures to make other jobs exempt).

In the best possible world, the invisible hand works best but we don't often know very well how long it takes to work and how it distributes the gains and losses as it goes to its phase of creative destruction.

Parsing monetary vs fiscal policy

In this well-written post, Raghu Rajan argues that this is not the time to raise interest rates but at the same time argues that interest rates should also rise lest they result in speculative growth. However, I had a hard time parsing his arguments without resorting to some cutting and pasting to link together his argument.

Of course, some who are convinced that the Fed contributed to the recent crisis by keeping real interest rates negative too long in the period 2002 to 2004 would wonder if stimulus “consistent with the past” is appropriate. Has the Fed, like the Bourbons, learnt nothing and forgotten nothing?

... What many people forget is that interest rates are also a price, and shape not only the level of economic activity but also the allocation of resources and the relative wealth of buyers and sellers of financial savings. A sustained period of ultra-low interest rates will favor the segments of the economy that took us into the crisis – housing, durable goods like cars, and finance. And it will encourage households to borrow and spend rather than save.

... None of this is to say that the Fed should jack up interest rates quickly without adequate warning, or to extremely high levels. There are trade-offs here, between short-term growth and long-term misallocation of resources, between reducing risk aversion and inducing excessive risk taking, between reviving hard-hit sectors and encouraging repeated bad behavior. On balance though, if and when the jitters about Europe recede, it would be prudent for the Federal Reserve to start paving the way towards positive real interest rates.

Aha! So he is arguing that interest rates should rise. But what about fiscal policy?

Even while I think monetary policy is too a blunt tool, there may well be some role for fiscal policy. There is a humanitarian need to extend benefits to the unemployed.

Yes, but no.

I don't disagree with what he is saying but it doesn't say a heck of a lot about what we should do NOW. His arguments about labor reallocation however may point to some painful adjustments ahead:

If households are going to want fewer houses, industries such as construction will have to shrink (as should the financial sector that channeled the easy credit). A significant number of jobs will disappear permanently, and workers who know how to build houses or to sell them will have to learn new skills if they can. Put differently, the productive capacity of the economy has shrunk. Resources have to be reallocated into new sectors so that any recovery is robust, and not simply a resumption of the old unsustainable binge. The United States economy has to find new pathways for growth. And this will not necessarily be facilitated by ultra-low interest rates.

Behavior and rationality

In a very interesting post on the winners curse, Rajiv Sethi describes the following based on Thaler:

The winner's curse is a concept that was first discussed in the literature by three Atlantic Richfield engineers, Capen, Clapp, and Campbell (1971). The idea is simple. Suppose many oil companies are interested in purchasing the drilling rights to a particular parcel of land. Let's assume that the rights are worth the same amount to all bidders, that is, the auction is what is called a common value auction. Further, suppose that each bidding firm obtains an estimate of the value of the rights from its experts. Assume that the estimates are unbiased, so the mean of the estimates is equal to the common value of the tract. What is likely to happen in the auction? Given the difficulty of estimating the amount of oil in a given location, the estimates of the experts will vary substantially, some far too high and some too low. Even if companies bid somewhat less than the estimate their expert provided, the firms whose experts provided high estimates will tend to bid more than the firms whose experts guessed lower... If this happens, the winner of the auction is likely to be a loser.

In Thaler's description, the winner's curse arises despite the fact that bidder estimates are unbiased: their valuations are correct on average, even though the winning bid happens to come from someone with excessively optimistic expectations. Someone familiar with this phenomenon would therefore never conclude that all bidders are excessively optimistic simply by observing the fact that winning bidders tend to wish that they had lost.

Sethi then goes on to argue that the reason for the crisis is not so much behavioral but can be seen as a rational response to ecological factors. He claims that there is herding due to what other firms/actors are doing rather than interdependent preferences (or cognitive limitations) as quoted by Kindleberger:

Overestimation of profits comes from euphoria, affects firms engaged in the production and distributive processes, and requires no explanation. Excessive gearing arises from cash requirements that are low relative both to the prevailing price of a good or asset and to possible changes in its price. It means buying on margin, or by installments, under circumstances in which one can sell the asset and transfer with it the obligation to make future payments. As firms or households see others making profits from speculative purchases and resales, they tend to follow: "Monkey see, monkey do." In my talks about financial crisis over the last decades, I have polished one line that always gets a nervous laugh: "There is nothing so disturbing to one’s well-being and judgment as to see a friend get rich."

My only thought to all this was: If agents are rational can they also be optimistic (or pessimistic)? I would tend to argue that optimism is a cognitive or behavioral trait rather than part of rationality. Some previous thoughts here.

Assessment gap

K1 got her results from a standardized test over the summer. She did pretty well. One thing that surprised me about the report was the following:

In one sub-test she was in the 72 percentile when normed against "Independent schools" which I read as private schools. But when normed against the national norm (which I read as including public schools) she was in the 95 percentile. This tells me that the gap between the achievement of private and public school students is pretty large - larger than I had expected - which was no more than 10 percent at the 50-75 percentile range.

Saturday, July 10, 2010

Power update

After two incidents of losing power within a week, we experienced another (albeit short) one today for about 15 minutes. The temprature was in the 70s with a slight drizzle. When we ventured out later, parts of Bethesda were still out. If this doesn't scream ineptitude, incompetence and a lousy power grid I don't know what does.

Thursday, July 8, 2010

Parenting should not be all (or mostly) work

This article pretty much nails it:

She’s referring to the recent documentary that compares the lives of four newborns—one in Japan, one in Namibia, one in Mongolia, and one in the United States (San Francisco). “I don’t mean to idealize the lives of the Namibian women,” she says. “But it was hard not to notice how calm they were. They were beading their children’s ankles and decorating them with sienna, clearly enjoying just sitting and playing with them, and we’re here often thinking of all of this stuff as labor.”

This is especially true in middle- and upper-income families, which are far more apt than their working-class counterparts to see their children as projects to be perfected. (Children of women with bachelor degrees spend almost five hours on “organized activities” per week, as opposed to children of high-school dropouts, who spend two.) Annette Lareau, the sociologist who coined the term “concerted cultivation” to describe the aggressive nurturing of economically advantaged children, puts it this way: “Middle-class parents spend much more time talking to children, answering questions with questions, and treating each child’s thought as a special contribution. And this is very tiring work.” Yet it’s work few parents feel that they can in good conscience neglect, says Lareau, “lest they put their children at risk by not giving them every advantage.”

I overheard a conversation this morning at the check out register of Whole Foods. One of the clerks said she was the oldest of 8. I'd be willing to argue that raising 2 kids today takes more time and effort than raising 8 kids 20 years ago (especially middle and upper class).

But what do I make of this:

Martin Seligman, the positive-psychology pioneer who is, famously, not a natural optimist, has always taken the view that happiness is best defined in the ancient Greek sense: leading a productive, purposeful life. And the way we take stock of that life, in the end, isn’t by how much fun we had, but what we did with it. (Seligman has seven children.)

Why do they say that economists know the price of everything

and the value of nothing? MR provides an example:

One thing that does annoy me is the claim that these urinals "save" 40,000 thousand gallons of water a year. Water is not an endangered species. With local exceptions, water is a renewable resource and in plentiful supply. At the average U.S. price, you can buy 40,000 gallons of water for about $80.

Of course, as noted in the comments, water is subsidized but perhaps put succinctly is the following:

1. Government subsidizes water because of interest-group politics (for the benefit of farmers),
2. Government tries to mandates use of water-saving equipment to try to avoid waste created by #1.
3. Government reverses self and forbids use of equipment in #2 because of interest-group politics (for the benefit of plumbers).

Another source of discussion is perhaps from the Scientific American.

How economists argue

Mankiw's post gives the best example (emphasis mine):

I am pretty sure Paul would not find this line of argument persuasive. As far as I can tell from reading his commentary over the years, he does not believe that the distortionary effects of taxes are particularly large and so they do not figure much into his policy analysis. But many other economists (and I suspect many stimulus-skeptics like the tea-partiers) believe that taxes have significant incentive effects and can prevent the economy from reaching its full potential. Their argument seems logically coherent, even if it relies on a different set of parameter values for the relevant elasticities than Paul believes to be true.

Beliefs, beliefs, beliefs. Damn the evidence - or even better, argue that the evidence is wrong, mismeasured, or inaccurate.

Third world infrastructure

In Washington, DC. This is essentially how I would characterize the recent power outages due to "high" temperatures. From WAPO:

Outages continue: Thousands in D.C. area without power as firms work on repairs
The oppressive heat -- and now humidity -- that descended on the Washington region has spurred near-record demands for electricity. Power companies are working to repair outages caused by the spike in demand as area residents reach for thermostats.

Blah, blah, blah.

Having lived in Malaysia and visited Bangkok - countries sometimes characterized by Americans as Third World and never having experienced any power outages due to "high" temperatures I would characterize this recent "outbreak" and its response as pathetic.

Lack of capacity is not a convincing argument for the outages. Our neighborhood experienced its first this summer on July 4th for about 3 hours and then on July 7th at about 6 pm for about 13 hours. The outage affected maybe one square block - this does not sound like lack of capacity but perhaps a lack of investment in equipment to balance load.

Pathetic, pathetic, pathetic.

Monday, July 5, 2010

Austerians versus Stimulians

Krugman's prose is inspired:

Much of what Serious People believe rests on prejudices, not analysis. And these prejudices are subject to fads and fashions. ... For the last few months, I and others have watched, with amazement and horror, the emergence of a consensus in policy circles in favor of immediate fiscal austerity. That is, somehow it has become conventional wisdom that now is the time to slash spending, despite the fact that the world’s major economies remain deeply depressed. ... This conventional wisdom isn’t based on either evidence or careful analysis. Instead, it rests on what we might charitably call sheer speculation, and less charitably call figments of the policy elite’s imagination...

When the IMF proposed austerity way back in the Asian crisis it was roundly ridiculed. Yet, why has there been concensus on austerity? A more straightforward statement would be that Austerity is stupid but stimulus is dangerous and we're between a rock and a hard place. Will Ireland's preemptive austerity provide any future lessons?

Despite counter-examples (HT: MR) to how contractions can cause expansions, the weight of evidence appear to be on Krugman's side:
... every few months we’re told that the bond vigilantes have arrived, and we must impose austerity now now now to appease them. Three months ago, a slight uptick in long-term interest rates was greeted with near hysteria...Since then, long-term rates have plunged again. Far from fleeing U.S. government debt, investors evidently see it as their safest bet in a stumbling economy. Yet the advocates of austerity still assure us that bond vigilantes will attack...

What’s the evidence for the belief that fiscal contraction is actually expansionary, because it improves confidence? (By the way, this is precisely the doctrine expounded by Herbert Hoover in 1932.) Well, there have been historical cases of spending cuts and tax increases followed by economic growth. But as far as I can tell, every one of those examples proves, on closer examination, to be a case in which the negative effects of austerity were offset by other factors, factors not likely to be relevant today. For example, Ireland’s era of austerity-with-growth in the 1980s depended on a drastic move from trade deficit to trade surplus, which isn’t a strategy everyone can pursue at the same time.

And current examples of austerity are anything but encouraging. Ireland has been a good soldier in this crisis, grimly implementing savage spending cuts. Its reward has been a Depression-level slump — and financial markets continue to treat it as a serious default risk. Other good soldiers, like Latvia and Estonia, have done even worse — and all three nations have, believe it or not, had worse slumps in output and employment than Iceland, which was forced by the sheer scale of its financial crisis to adopt less orthodox policies.

Trade and wages

After looking over Krugman's Trade and Wages Reconsidered the only thought that struck me was this:

How do we reconcile the data with static general equilibrium models when the data generating process is neither static nor in equilibrium at the time it is recorded?

I had expected a paper which would have stated the following:
In the following model, volume of trade is endogenous. If the elasticity of substitution between skilled and unskilled labor is y and the volume of trade exceeds a, then wage inequality will be b.

I imagine such a proposition is out there somewhere but I'm not a follower of trade theory enough to go out looking for it and perhaps I should.