DECEMBER 18 2009

Alan S. Blinder, WSJ: The Case for Optimism on the Economy. The credit markets are healing and net job creation may be only a month or two away. The U.S. economy is digging itself out of a deep hole. You have probably heard a lot of doom and gloom lately, including talk of a jobless recovery, an L-shaped recovery (which means no recovery at all), or even a W—the feared double-dip recession. The Scrooges have a point: There are serious dangers to the nascent recovery. But you've heard all that many times. Let me offer instead, in deliberately one-sided fashion, the case for optimism. It is, after all, the holiday season.

Tito Boeri, Project Syndicate: Saving Europe’s Lost Generation of Workers. Far too many post-mortems of the economic crisis are now being written. They are misleading and dangerous, not only because the crisis in the labor market is not yet over, but also because they contribute to complacency, thereby reducing pressure for reform. The current recession will be truly over only when new cohorts of workers are able to enter the labor market quickly and through the main door.

Morten L. Bech, Elizabeth Klee, NY Fed: The Mechanics of a Graceful Exit: Interest on Reserves and Segmentation in the Federal Funds Market. The results in this paper suggest that a graceful exit is indeed possible. First, our estimates suggest that, even amid high balances, the Federal Reserve can raise the effective federal funds rate when conditions warrant. As shown above, if the Federal Reserve raises the rate paid on excess reserves, the effective rate would move up in tandem according to our model estimates, although the relationship will likely be less than one-to-one due to the segmented nature of the market. Second, if the deviation between the policy rate and the effective rate is deemed to be too large, then our model suggests that the Federal Reserve can raise the effective federal funds rate even further by draining reserve using tools such as reverse repurchase agreements or a term deposit facility.

James Morley, Macroeconomic Advisers’: The great moderation: What caused it and is it over? Contrary to conventional wisdom, the Great Moderation was not a myth. There has been a very real, broad-based decline in U.S. macroeconomic volatility since the mid-1980s. The reduction in volatility does not appear to be primarily the result of better policy or changes in the structural response of the economy to shocks. Instead, the Great Moderation appears to be mostly due to smaller economic shocks (e.g., oil price shocks, productivity shocks, and inventory mistakes). The technological basis for the smaller shocks means that the prognosis for the continuation of the Great Moderation is much better than you might think (Pointer Economist´s view).

Frederic S. Mishkin et al, NBER: How Has the Monetary Transmission Mechanism Evolved Over Time. It is not clear that the magnitude of effect of monetary policy shock on aggregate real activity has changed much, although the effect might be more persistent since the early 1980s. However, there is some of evidence of an evolution in the response of prices and expenditure categories to monetary policy, both in terms of magnitude and timing. Finally, the evolution of the transmission of monetary policy has not been unidirectional: the evidence we uncovered is consistent with a reduced effect of monetary policy on prices and some expenditure categories in the 1980s followed by an increase in the 1990s.

Alain Chaboud et al, US Fed: Rise of the Machines: Algorithmic Trading in the Foreign Exchange Market. We find evidence that algorithmic trades tend to be correlated, suggesting that the algorithmic strategies used in the market are not as diverse as those used by non-algorithmic traders. Despite the apparent correlation of algorithmic trades, there is no evident causal relationship between algorithmic trading and increased exchange rate volatility. If anything, the presence of more algorithmic trading is associated with lower volatility. Third, we show that even though some algorithmic traders appear to restrict their activity in the minute following macroeconomic data releases, algorithmic traders increase their provision of liquidity over the hour following each release. Non-algorithmic order flow accounts for a larger share of the variance in exchange rate returns than does algorithmic order flow.

N. Gregory Mankiw, NYT: Tax Cuts Might Accomplish What Spending Hasn’t. When devising its fiscal package, the Obama administration relied on conventional economic models based in part on ideas of John Maynard Keynes. But various recent studies suggest that conventional wisdom is backward. One piece of evidence comes from Christina D. Romer, the chairwoman of the president’s Council of Economic Advisers. In work with her husband, David H. Romer, written at the University of California, Berkeley, just months before she took her current job, Ms. Romer found that tax policy has a powerful influence on economic activity. In a December 2008 working paper, Andrew Mountford of the University of London and Harald Uhlig of the University of Chicago report that “deficit-financed tax cuts work best among these three scenarios to improve G.D.P.” My Harvard colleagues Alberto Alesina and Silvia Ardagna have recently conducted a comprehensive analysis of the issue. The results are striking. Successful stimulus relies almost entirely on cuts in business and income taxes. Failed stimulus relies mostly on increases in government spending. These studies point toward tax policy as the best fiscal tool to combat recession, particularly tax changes that influence incentives to invest, like an investment tax credit.

Francesco D'Amuri, Juri Marcucci, VoxEU: The predictive power of Google data: New evidence on US unemployment. The demand for up-to-date economic indicators has led researchers to use Google to improve the predictive power of their models. This column presents evidence from the US and Italy that using search trends on Google significantly increases the accuracy of forecasting unemployment.

Beatrice Brunner, Andreas Kuhn, IZA: To Shape the Future: How Labor Market Entry Conditions Affect Individuals' Long-Run Wage Profiles. We study the long-run effects of initial labor market conditions on wages for a large sample of male individuals entering the Austrian labor market between 1978 and 2000. We find a robust negative effect of unfavorable entry conditions on starting wages. This initial effect turns out to be quite persistent and even though wages do catch up later on, large effects on lifetime earnings result. We also show that initial labor market conditions have smaller and less persistent effects for blue-collar workers than for white-collar workers.

Alison Felix, James R. Hines Jr, VoxEU: Corporate taxes and union wages. Painful tax increases will be necessary to restore fiscal balance after exiting the crisis. This column shows that wages are higher in US states with lower corporate income taxes – a reminder that efforts to tax firms more heavily create burdens that will be distributed among stakeholders, including many groups that governments otherwise attempt to help, such as workers.

Dani Rodrik, Project Syndicate: Making Room for China. China’s undervalued currency and huge trade surplus pose great risks to the world economy. They threaten a major protectionist backlash in the United States and Europe; and they undermine the recovery in developing and emerging markets. Left unchecked, they will generate growing acrimony between China and other countries. But the solution is not nearly as simple as some pundits make it out to be. There is a third path, but it would require re-writing the WTO’s rules. If China were allowed a free hand with industrial policies, it could promote manufactures directly while allowing the renminbi to appreciate.

John C. Bluedorn, Akos Valentinyi, Michael Vlassopoulos, VoxEU: Three centuries of climatic variation and the world income distribution. Hot countries tend to be poorer. This column uses the cross-century, cross-country variation in climatic temperatures to estimate the effects of historic temperature upon current incomes. The negative relationship between current temperature and income appears due to temperature variations in the 18th and 19th centuries. That suggests that the consequences of climate change may be felt for a very long time.

Eli Berman, Joseph Felter, Jacob N. Shapiro, NBER: Do working men rebel? Insurgency and unemployment in Iraq and the Philippines. Most aid spending by governments seeking to rebuild social and political order is based on an opportunity-cost theory of distracting potential recruits. The logic is that gainfully employed young men are less likely to participate in political violence, implying a positive correlation between unemployment and violence in places with active insurgencies. We test that prediction on insurgencies in Iraq and the Philippines, using survey data on unemployment and two newly- available measures of insurgency: (1) attacks against government and allied forces; and (2) violence that kills civilians. Contrary to the opportunity-cost theory, we find a robust negative correlation between unemployment and attacks against government and allied forces and no significant relationship between unemployment and the rate of insurgent attacks
that kill civilians.

Rajeev Syal, the Observer: Drug money saved banks in global crisis, claims UN advisor. Drugs money worth billions of dollars kept the financial system afloat at the height of the global crisis, the United Nations' drugs and crime tsar has told the Observer. Antonio Maria Costa, head of the UN Office on Drugs and Crime, said he has seen evidence that the proceeds of organised crime were "the only liquid investment capital" available to some banks on the brink of collapse last year. He said that a majority of the $352bn (£216bn) of drugs profits was absorbed into the economic system as a result.

Natasha Gilbert, SciAm: Modellers claim wars are predictable. Seemingly random attacks and a shadowy, mysterious enemy are the hallmarks of insurgent wars, such as those being fought in Afghanistan and Iraq. Many social scientists, as well as the military, hold that, like conventional civil wars, these conflicts can´t be understood without considering local factors such as geography and politics. But a mathematical model published today in Nature suggests that insurgencies have a common underlying pattern that may allow the timing of attacks and the number of casualties to be predicted. Insurgent attacks follow a universal pattern of timing and casualties.