OCTOBER 2 2009

Andrew K. Rose, Mark M. Spiegel, Fed SF: Predicting Crises, Part II: Did Anything Matter (to Everybody)? The enormity of the current financial collapse raises the question whether the crisis could have been predicted. This Letter examines research suggesting that early warning models would not have accurately predicted the relative severity of the current crisis across countries, casting doubt on the ability of such models to forecast similar crises in the future.

Urban Jermann, Vincenzo Quadrini, VoxEU: Paying more attention to financial shocks. The financial crisis has made it clear that macroeconomic models need to allocate a more prominent role to financial frictions. This column provides a framework where the financial sector can be the “source” of business cycle fluctuations. The model suggests that credit shocks have played an important role in all major recessions experienced by the US economy during the last two and a half decades.

Robert J. Barro, Charles J. Redlick, NBER: Macroeconomic Effects from Government Purchases and Taxes. For U.S. annual data that include WWII, the estimated multiplier for defense spending is 0.6-0.7 at the median unemployment rate. There is some evidence that this multiplier rises with the extent of economic slack and reaches 1.0 when the unemployment rate is around 12%. Multipliers for non-defense purchases cannot be reliably estimated because of the lack of good instruments. For samples that begin in 1950, increases in average marginal income-tax rates (measured by a newly constructed time series) have a significantly negative effect on real GDP. Increases in taxes seem to reduce real GDP with mainly a one-year lag due to income effects and mostly a two-year lag due to substitution (tax-rate) effects. Since the defense-spending multiplier is typically less than one, greater spending tends to crowd out other components of GDP. The largest effects are on private investment, but non-defense purchases and net exports tend also to fall. The response of private consumer expenditure differs insignificantly from zero.

Ethan Ilzetzki, Enrique G. Mendoza, Carlos A. Vegh: How big are fiscal multipliers? New evidence from new data. How much stimulus does spending provide? This column says that fiscal multipliers are much weaker in countries that have high debt, lower income, flexible exchange rates, and greater international openness. Policymakers should consider these characteristics when evaluating the benefits of any fiscal stimulus package.

Eric D, Gould, Guy Stecklov, IZA: Terror and the Costs of Crime. This paper argues that terrorism, beyond its immediate impact on innocent victims, also raises the costs of crime, and therefore, imposes a negative externality on potential criminals. Terrorism raises the costs of crime through two channels: (i) by increasing the presence and activity of the police force, and (ii) causing more people to stay at home rather than going out for leisure activities. Our analysis exploits a panel of 120 fatal terror attacks and all reported crimes for 17 districts throughout Israel between 2000 and 2005. After controlling for the fixed-effect of each district and for district-specific time trends, we show that terror attacks reduce property crimes such as burglary, auto-theft, and thefts-from-cars. Terror also reduces assaults and aggravated assaults which occur in private homes, but increases incidents of trespassing and "disrupting the police."

Adam S. Posen, PIEE: The Path of True Recovery Is Never Smooth. It takes a lot of repeated policy errors to keep a market economy down. Compared to where we were a year-ago, the world economy is in much better shape. The trick will be to sustain that positive overall environment while major adjustments take place within and between economies: from public spending to private demand; from extraordinary policy measures to normal automatic stabilizers and interest rate setting; from booms to lower sustainable growth rates; from previously favorable but now bloated sectors to new sources of employment and growth; from guaranteed banks to boring banking; and from net exporters to net importers (and vice versa). Fasten your seatbelts, it is going to be a bumpy ride for the next few years.

Michael Ehrmann, Panagiota Tzamourani, ECB: Memories of high inflation. Inflation has been well contained over the last decades in most industrialized
countries. This implies, however, that memories of high inflation are likely to fade, because over time larger parts of the population have never experienced high inflation, whereas those who have might forget. This paper tests whether memories of high inflation affect agents’ preferences about the importance attached to price stability. It finds that memories of hyperinflation are there to last, whereas those of less drastic inflation experiences tend to erode after around 10 to 15 years. The recent decline in the importance attached to price stability does therefore most likely reflect mitigated inflation concerns in an environment of low and stable inflation, but also the consequences of fading memories of high inflation. The longer central banks have successfully delivered price stability, the more important it is for them to engage in a proactive communication, especially with the younger generations, about the merits of low and stable inflation.