Paul Krugman, NYT Blog: How Much Of The World Is In a Liquidity Trap? Being in a liquidity trap reverses many of the usual rules of economic policy. Virtue becomes vice: attempts to save more actually make us poorer, in both the short and the long run. Prudence becomes folly: a stern determination to balance budgets and avoid any risk of inflation is the road to disaster. Mercantilism works: countries that subsidize exports and restrict imports actually do gain at their trading partners’ expense. How much of the world is currently in a liquidity trap? Almost all advanced countries. The US, obviously; Japan, even more obviously; the eurozone, because the ECB probably couldn’t engage in Fed-style quantitative easing even if it wanted to, given the lack of a single backing government; Britain. Essentially the whole advanced world, accounting for 70 percent of world GDP at market prices, is in a liquidity trap.
Laurel Graefe, Jacob Smith, Atlanta Fed: A look at the income-side estimates of growth. Last week, a post in the New York Times' blog on Okun's law made note of the statistical discrepancy between the two methods for calculating national output: "…there are two measures of output growth—the usual measure, which adds up total spending in the economy, and the alternative, which adds up total income. In theory, the two should be exactly the same. In practice, they have been very different during this recession… These GDI numbers suggest that output growth actually declined much more sharply than had been widely understood." Indeed, the recession looks deeper and the recovery seems much less pronounced, looking at the income-side data. History suggests that when these two measures of national output disagree, GDP tends to get revised in the direction of GDI and not the other way around. It would be prudent not to dismiss the latest divergence in the two measures because it suggests that the decline in national output has been more protracted, and the recovery more modest, than what is being reflected in GDP.
Joachim Fels et al, Morgan Stanley: What Fiscal Tightening? We continue to forecast solid, above-consensus global GDP growth of 4.4% this year - despite growth downgrades in Europe, a weaker 1Q in the US (largely weather-related) and the recent softening in the China Manufacturing PMI. At the same time, we think that downside risks for the global economy in 2011 are mounting. First, many central banks in EM are about to start tightening monetary policy, and we expect the Fed to nudge official rates higher from 3Q10 and thus earlier than markets currently expect. Second, our macro team is looking for significantly higher bond yields this year and for a sell-off in developed equity markets. If so, it would dampen growth prospects for next year further. Third, we expect sovereign debt concerns to spread throughout the advanced economies as fiscal policy in most developed countries is on an unsustainable path.
Nouriel Roubini, Project Syndicate: States of Risk. The dilemma is that, whereas fiscal consolidation is necessary to prevent an unsustainable increase in the spread on sovereign bonds, the short-run effects of raising taxes and cutting government spending tend to be contractionary. In countries like the euro-zone members, a loss of external competitiveness, caused by tight monetary policy and a strong currency, erosion of long-term comparative advantage relative to emerging markets, and wage growth in excess of productivity growth, impose further constraints on the resumption of growth. A vicious circle of public-finance deficits, current-account gaps, worsening external-debt dynamics, and stagnating growth can then set in. Eventually, this can lead to default on euro-zone members’ public and foreign debt, as well as exit from the monetary union by fragile economies unable to adjust and reform fast enough.
Prakash Loungani, IMF: Housing Prices: More Room to Fall? Though there are some signs of stabilization, the global correction in housing markets continued through 2009. House prices in the OECD economies fell on average about 5 percent in real terms between the fourth quarter of 2007 and the third quarter of 2009.House prices in most countries still remain well above the levels observed at the beginning of the upturn in the early 2000s. Prices remain above rents and incomes. Econometric models show that house prices increased during 2000–06 to a greater degree than can be explained by either short-run driving forces or long-run relationships: the corrections thus far have not erased all of the excesses generated by the house price increases. That leads to an uncomfortable conclusion: house prices in many countries still have room to fall.
Robert J. Shiller, Project Syndicate: A Crisis of Understanding. Few economists predicted the current economic crisis, and there is little agreement among them about its ultimate causes. The problem for macroeconomics is that the types of causes mentioned for the current crisis are difficult to systematize. The mathematical models that macroeconomists have may resemble weather models in some respects, but their structural integrity is not guaranteed by anything like a solid, immutable theory. The most important new book about the origins of the economic crisis, Carmen Reinhart’s and Kenneth Rogoff’s This Time Is Different, is essentially a summary of lessons learned from virtually every financial crisis in every country in recorded history. But the book is almost entirely non-theoretical. This leaves us trying to use patterns from past, dissimilar crises to try to infer the likely prognosis for the current crisis. As a result, we simply do not know if the recovery will be solid or disappointing.
Huixin Bi, Eric M. Leeper, NBER: Sovereign Debt Risk Premia and Fiscal Policy in Sweden. What are the tradeoffs between short-run stabilization and long-run sustainability when the perceived riskiness of government debt depends, in part, on the current and expected fiscal environment in place? We calibrate a simple model to Swedish fiscal data in two periods: before and after the financial crisis of the early 1990s. We compute the dynamic fiscal limit, which depends on the peak of the Laffer curve, for the pre-crisis and three alternative post-crisis fiscal policies. The model simulates the macroeconomic consequences of alternative policies in the face of the sequence of bad output shocks that Sweden experienced from 1991-1997.
Carmen M. Reinhart, NBER: This Time is Different Chartbook: Country Histories on Debt, Default, and Financial Crises. This Chartbook provides a pictorial history, on a country-by-country basis, of public debt and economic crises of various forms. It is a timeline of a countrys creditworthiness and financial turmoil. The analysis, narrative, and illustrations in the book “This Time is Different” were primarily organized around themes (serial default, inflation, etc.), although detailed tables in the book chronicled country-specific information on the dating, frequency, incidence, etc. of specific crises episodes by country. The Chartbook compliments the thematic analysis with individual country histories, and provides the grounds for a systematic analysis of the temporal patterns of debt cycles, banking and sovereign debt crises, hyperinflation, and, for the post World War II period, the reliance on IMF programs.
Mark Whitehouse, WSJ Blog: Atlanta Fed’s Altig on Small Business’s Potential to Derail Recovery. In recent weeks, policy makers from President Barack Obama to Federal Reserve Chairman Ben Bernanke have been taking extraordinary measures to remove what they see as a serious impediment to the recovery: A dearth of credit for the small businesses that many economists say must play a leading role in creating new jobs. David Altig, head of research at the Atlanta Fed, notes that an outsized fraction of the job losses during this recession came from small businesses, particularly very small businesses with less than 50 employees. We’re looking for explanations. One obvious candidate is that this was the group that would have more difficulty with a credit event, which clearly this recession was.
Jaison R. Abel, Ishita Dey, and Todd M. Gabe, NY Fed: Productivity and the Density of Human Capital. We estimate a model of urban productivity in which the agglomeration effect of density is enhanced by a metropolitan area’s stock of human capital. Estimation accounts for potential biases due to the endogeneity of density and industrial composition effects. Using new information on output per worker for U.S. metropolitan areas along with a measure of density that accounts for the spatial distribution of population, we find that a doubling of density increases productivity by 2 to 4 percent. Consistent with theories of learning and knowledge spillovers in cities, we demonstrate that the elasticity of average labor productivity with respect to density increases with human capital. Metropolitan areas with a human capital stock one standard deviation below the mean realize no productivity gain, while doubling density in metropolitan areas with a human capital stock one standard deviation above the mean yields productivity benefits that are about twice the average.
Gary Becker, Becker Posner Blog: The Long-Term Unemployed: Consequences and Possible Cures. A current proposal in Washington is to give companies a subsidy if they hire workers who have been unemployed for longer than a few months. But the great majority of the new hires that would receive a subsidy under such a proposal to stimulate employment would have occurred anyway. The program would end up being another costly subsidy to businesses. The only real remedy for the long-term (and other) unemployed is to have the economy grow fast. It would help a lot if the leaders in Washington did not try to radically transform various aspects of the economy while we are recovering from a serious recession, and thereby magnify the high degree of uncertainty that is typically caused by a recession.
Deliana Kostova, VoxEU: Do higher cigarette prices deter smoking? Evidence from developing nations. Do higher cigarette prices deter smoking? This column finds that policymakers in developing countries could reduce cigarette consumption by youths by raising taxes. A 10% increase in the price will reduce youth cigarette demand by 18.3%.
Petter Lundborg, Paul Nystedt, Dan-Olof Rooth, IZA: No Country for Fat Men? Obesity, Earnings, Skills, and Health among 450,000 Swedish Men. We find that the crude obesity penalty in earnings, which amounts to about 18 percent, is linked to supply-side characteristics that are associated with both earnings and obesity. In particular, we show that the penalty reflects negative associations between obesity, on the one hand, and cognitive skills, non-cognitive skills, and physical fitness, on the other. Our results suggest that employers use obesity as a marker for skill limitations in order to statistically discriminate.
C. Eisenegger et al, University of Zurich: Prejudice and truth about the effect of testosterone on human bargaining behaviour. Evidence from animal studies in rodents shows that testosterone causes aggressive behaviour towards conspecifics. Folk wisdom generalizes and adapts these findings to humans, suggesting that testosterone induces antisocial, egoistic, or even aggressive human behaviours. Here we show that the sublingual administration of a single dose of testosterone in women causes a substantial increase in fair bargaining behaviour, thereby reducing bargaining conflicts and increasing the efficiency of social interactions. However, subjects who believed that they received testosterone—regardless of whether they actually received it or not—behaved much more unfairly than those who believed that they were treated with placebo. Thus, the folk hypothesis seems to generate a strong negative association between subjects’ beliefs and the fairness of their offers, even though testosterone administration actually causes a substantial increase in the frequency of fair bargaining offers in our experiment.
Isabelle Brocas, Juan D. Carrillo, VoxEU: Neuroeconomic theory: Using neuroscience to understand the bounds of rationality. Neuroeconomic theory will soon play a crucial role in the building of new reliable theories capable of explaining and predicting individual behaviour and strategic choices. The main message is that the individual is not one coherent body. The brain is a multi-system entity (with conflicting objectives, restricted information, etc.) and therefore the decision-maker must be modelled as an organisation. We conclude with an analogy. Before the so-called modern theory of the firm, organisations were modelled as individual players characterised by an input-output production function. The systematic study of interactions between agents and decision processes within organisations (acknowledging informational asymmetries, incentive problems, restricted communications channels, hierarchical structures, etc.) led to novel economic insights. Applying a similar methodology to study individual decision-making is, in our view, the most fruitful way to understand the bounds of rationality.
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