FEBRUARY 19 2010

Olivier Blanchard, Giovanni Dell’Ariccia, Paolo Mauro, IMF: Rethinking Macroeconomic Policy. The crisis was not triggered primarily by macroeconomic policy. But it has exposed flaws in the precrisis policy framework. In many ways, the general policy framework should remain the same. The ultimate goals should be to achieve a stable output gap and stable inflation. But the crisis has made clear that policymakers have to watch many targets, including the composition of output, the behavior of asset prices, and the leverage of different agents. It has also made clear that they have potentially many more instruments at their disposal than they used before the crisis. The crisis has also reinforced lessons that we were always aware of, but with greater experience now internalize more strongly. Low public debt in good times creates room to act forcefully when needed. Good plumbing, in terms of prudential regulation, and transparent data in the monetary, financial, and fiscal areas are critical to our economic system functioning well.

Louise Story, Landon Thomas Jr. And Nelson D. Schwartz, NYT: Wall St. Helped to Mask Debt Fueling Europe’s Crisis. Wall Street tactics akin to the ones that fostered subprime mortgages in America have worsened the financial crisis shaking Greece and undermining the euro by enabling European governments to hide their mounting debts. In dozens of deals across the Continent, banks provided cash upfront in return for government payments in the future, with those liabilities then left off the books. Such derivatives, which are not openly documented or disclosed, add to the uncertainty over how deep the troubles go in Greece and which other governments might have used similar off-balance sheet accounting. Despite persistently high deficits, a 1996 derivative helped bring Italy’s budget into line by swapping currency with JPMorgan at a favorable exchange rate, effectively putting more money in the government’s hands. In return, Italy committed to future payments that were not booked as liabilities. As recently as 2008, Eurostat, the European Union’s statistics agency, reported that “in a number of instances, the observed securitization operations seem to have been purportedly designed to achieve a given accounting result, irrespective of the economic merit of the operation.” Edward Hugh, in A Fistful of Euros Blog writes: Just What Is The Real Level Of Government Debt In Europe?

Paul van den Noord, ECFIN Briefs: Exit strategy: is 1937/38 relevant? The 1937/38 recession in the United States is often quoted as a warning against premature exits from monetary and fiscal stimulus. The presumption is that the 1937/38 recession was indeed due to such a premature exit. This Economic Brief presents evidence that goes against this view. The 1937/38 recession is equivalent to a downturn in 2016/17, which is obviously of little relevance now. Moreover, the cutback in policy stimulus at the time was not an early but rather a late exit, in the wake of an unduly late and timid entry. Even more importantly, while the 1937/38 recession can be attributed to cut backs in policy stimulus to some extent, other factors appear to have been predominant. Notably, geopolitical tensions played a major role, along with adverse business confidence effects of Roosevelt's New Deal policies. Concerning the latter, the strengthening of wage bargaining power amid mass unemployment and heightened uncertainty over property rights were prominent.

Kevin B. Moore, Michael G. Palumbo, Fed: The Finances of American Households in the Past Three Recessions: Evidence from the Survey of Consumer Finances. This paper uses household-level data from the Federal Reserve Board's series of Surveys of Consumer Finances to document three factors that appear to have contributed to greater financial stress in the household sector in the current downturn compared with the prior two: 1) substantial and widespread reductions in home values that resulted in sizable erosions of home equity and net worth for many homeowners; 2) markedly expanded holdings of corporate equity among middle-income households which lost significant market value, on net, as stock prices sunk; and, 3) greater debt on household balance sheets and overall financial vulnerability around the onset of the 2008-09 recession, particularly for those in the middle of the income distribution.

Zheng Liu et al, FedSan Francisco: Do credit constraints amplify macroeconomic fluctuations? Previous studies on financial frictions have been unable to establish the empirical significance of credit constraints in macroeconomic fluctuations. This paper argues that the muted impact of credit constraints stems from the absence of a mechanism to explain the observed persistent comovements between housing prices and business investment. We develop such a mechanism by incorporating two key features into a DSGE model: we identify shocks that shift the demand for collateral assets and we allow productive agents to be credit-constrained. A combination of these two features enables our model to successfully generate an empirically important mechanism that amplifies and propagates macroeconomic fluctuations through credit constraints."

Uri Dadush, Vera Eidelman, Carnegie: Exchange Rates and the Crisis: The Dog That Didn’t Bark. At the outbreak of the crisis, the world’s exchange rate “system”—a messy construct of flexible, managed, and pegged regimes, including a few currency boards and a large currency union—was not reassuring. The dollar, the world’s reserve currency, belonged to the country at the epicenter of the crisis. The specter of the protectionism, competitive devaluations, and sovereign debt crises that wrecked the world economy during the Great Depression loomed, and the IMF, the system’s ostensible surveillor and lender of last resort, had become dysfunctional. Yet, exchange rates have adjusted in a remarkably orderly way and, while month-to-month volatility increased in 2009, changes in real exchange rates since the crisis’ outbreak have been modest, with a few notable exceptions. This orderly adjustment appears to have contributed to and resulted from global policy’s successful response to the crisis.

N. Gregory Mankiw, NYT: What’s Sustainable About This Budget? Moreover, even in the long run, a balanced budget is too strict a standard. Because of technological progress, population growth and inflation, the nation’s income and tax base grows over time. If the government’s debts grow at or below that pace, servicing the debt will not become a major problem. That means the government can run budget deficits in perpetuity, as long as they are not too large. Recent history illustrates this principle. From 2005 to 2007, before the recession and financial crisis, the federal government ran budget deficits, but they averaged less than 2 percent of gross domestic product. Because this borrowing was moderate in magnitude and the economy was growing at about its normal rate, the federal debt held by the public fell from 36.8 percent of gross domestic product at the end of the 2004 fiscal year to 36.2 percent three years later.

James W. Fuchs, Timothy A. Bosch, St Louise Fed: Why Are Banks Failing? Although today's challenges are great, the four underlying reasons for bank failures have not changed from those of years' past, which are: an imbalance of risk versus return, failure to diversify, offering products and services that management doesn't fully understand and poor management of risks.

Gregory Clark, UCDAVIS: Was there ever a Ruling Class? Surnames and Social Mobility in England, 1200-2009. This paper reports on a preliminary investigation of surname distributions as a measure long run social mobility. In England this
suggests two surprising claims. First, England, all the way from the heart of the Middle Ages in 1200 to 2009, is a society without persistent social classes, at least among the descendants of the medieval population. It was a world of complete social mobility, with no permanent over-class and under-class, a world of complete equal opportunity. However, for some recent immigrant groups it may no longer be true. Instead of moving from a world of immobility and class rigidity in medieval England to a world of equal opportunity, we may have moved in the opposite direction. Other modern societies such as the US and Brazil also show sign of persistent social classes. There was, however, a gain from being in the upper class in any generation in the form of leaving more copies of your DNA permanently in later populations.

Marianne Simonsen, Lars Skipper, Niels Skipper, Aarhus University: Price Sensitivity of Demand for Prescription Drugs: Exploiting a Regression Kink Design. This paper investigates price sensitivity of demand for prescription drugs using drug purchase records for at 20% random sample of the Danish population. We identify price responsiveness by exploiting exogenous variation in prices caused by kinked reimbursement schemes and implement a regression kink design. Thus, within a unifying framework we uncover price sensitivity for different subpopulations and types of drugs. The results suggest low average price responsiveness with corresponding price elasticities ranging from -0.08 to -0.25, implying that demand is inelastic. Individuals with lower education and income are, however, more responsive to the price. Also, essential drugs that prevent deterioration in health and prolong life have lower associated average price sensitivity.

Stephen Gandel, The Curious Capitalist Blog: The Real Economic Cost of Snow. How much does a snow storm cost? Every year, on days like the one we are having today on the East Coast and in the Midwest, economic forecasters try to estimate the impact of all the white stuff falling from the sky. The numbers are always huge. And they are always wrong. The biggest reason is that snow storms are often looked at as a snap shot. What is the money spent or lost on that day. That ignores how the economy really works. And it ignores the way snow works. Money spent today doesn't disappear. Snow on the other hand does. Snow expenditures go into the economy and pop out somewhere else. Money not spent today doesn't disappear either.