MAY 14 2010

Carmen M. Reinhart, Vincent R. Reinhart, Washington Post: 5 Myths about the European debt crisis. 1. This is a new type of crisis. 2. Small economies such as Greece can't launch major financial turmoil. 3. Fiscal austerity will solve Europe's debt difficulties. 4. The euro is to blame for Greece's financial woes. 5. It can't happen here.

Martin Wolf, Wolfexchange: Must large capital inflows always end in crisis? Why is running current account deficits so dangerous? There are four reasons: first, it often means unsustainable asset price bubbles in the capital-importing country; second, it means unsustainable build-ups of debt in the private and public sectors of the capital-importing economy; third, it often means an unsustainable expansion of the financial system, characterized by excessive leverage and excessive build-ups of risky assets financed by supposedly risk-free liabilities; finally, it also often means a build-up of currency mismatches within the economy, particularly in the financial system, which makes the economy extremely vulnerable to currency collapses.

Carlos Caceres, Vincenzo Guzzo, Miguel Segoviano: IMF: Sovereign Spreads: Global Risk Aversion, Contagion or Fundamentals? Over the past year, euro area sovereign spreads have exhibited an unprecedented degree of volatility. This paper explores how much of these large movements reflected shifts in (i) global risk aversion (ii) country-specific risks, directly from worsening fundamentals, or indirectly from spillovers originating in other sovereigns. The analysis shows that earlier in the crisis, the surge in global risk aversion was a significant factor influencing sovereign spreads, while recently country-specific factors have started playing a more important role. The perceived source of contagion itself has changed: previously, it could be found among those sovereigns hit hard by the financial crisis, such as Austria, the Netherlands, and Ireland, whereas lately the countries putting pressure on euro area government bonds have been primarily Greece, Portugal, and Spain, as the emphasis has shifted towards short-term refinancing risk and long-term fiscal sustainability. The paper concludes that debt sustainability and appropriate management of sovereign balance sheets are necessary conditions for preventing sovereign risk from feeding back into broader financial stability concerns.

Robert Samuelson, Real Clear Politics: The Welfare State's Death Spiral. The welfare state's death spiral is this: Almost anything governments might do with their budgets threatens to make matters worse by slowing the economy or triggering a recession. By allowing deficits to balloon, they risk a financial crisis as investors one day -- no one knows when -- doubt governments' ability to service their debts and, as with Greece, refuse to lend except at exorbitant rates. Cutting welfare benefits or raising taxes all would, at least temporarily, weaken the economy. Perversely, that would make paying the remaining benefits harder. If only a few countries faced these problems, the solution would be easy. Unlucky countries would trim budgets and resume growth by exporting to healthier nations. But developed countries represent about half the world economy; most have overcommitted welfare states. What happens if all these countries are thrust into Greece's situation? One answer -- another worldwide economic collapse -- explains why dawdling is so risky.

Alina Carare, Ashoka Mody, IMF: Spillovers of Domestic Shocks: Will They Counteract the “Great Moderation”? The paper has three main findings. First, the reduction in output volatility apparently ceased in some advanced industrialized countries by the mid-1990s, and a mild tendency towards increased volatility was evident in some countries. Besides Japan (documented by Bernanke, 2004), one large country experiencing an increase in output growth volatility is Germany. Second, and of greater significance for interpreting recent events, the bottoming out of the decline in volatility and its possible reversal was associated with an increased role for spillovers, starting sometime in the mid-1990s. Third, it was not the size of the spillover "shocks" but rather the sensitivity of countries to these shocks that increased over time.

Greg Mankiew: Does a common currency area need a centralized fiscal authority? Paul Krugman has a thoughtful and thought-provoking column on Greece today. A large part of his argument is that Europe is not an optimal currency area because it lacks a large central government enacting transfer payments among the various regions. I am not so sure. The United States in the 19th century had a common currency, but it did not have a large, centralized fiscal authority. The federal government was much smaller than it is today. In some ways, the U.S. then looks like Europe today. Yet the common currency among the states worked out fine.

Pierre Monnin and Terhi Jokipii, SnB: The Impact of Banking Sector Stability on the Real Economy. This article studies the relationship between the degree of banking sector stability and the subsequent evolution of real output growth and inflation. Adopting a panel VAR methodology for a sample of 18 OECD countries, we find a positive link between banking sector stability and real output growth. This finding is predominantly driven by periods of instability rather than by very stable periods. In addition, we show that an unstable banking sector increases uncertainty about future output growth. No clear link between banking sector stability and inflation seems to exist. We then argue that the link between banking stability and real output growth can be used to improve output growth forecasts. Using Fed forecast errors, we show that banking sector stability (instability) results in a significant underestimation (overestimation) of GDP growth in the subsequent quarters.

Edward L. Glaeser, Joshua Gottlieb, Joseph Gyourko, Harvard: Did Credit Market Policies Cause the Housing Bubble? Theoretical and empirical analyses suggest that neither interest rates, nor downpayment requirements, nor approval rates moved enough over the past decade to generate the magnitude of price changes that parts of the United States experienced. Moreover, other standard explanations for rising housing prices, like rising incomes, also fail to explain much of the price volatility. Using the standard toolkit of the empirical economist, we are unable to offer much of an explanation for what happened. We do believe that faulty expectations played some role in what happened. If economists are going to better understand housing bubbles, we will surely need to accept that home buyers often have very exuberant beliefs about housing prices.

Eric A. Hanushek, Ludger Woessmann, NBER: The Economics of International Differences in Educational Achievement. This chapter reviews the economic literature on international differences in educational achievement, restricting itself to comparative analyses that are not possible within single countries and placing particular emphasis on studies trying to address key issues of empirical identification. While quantitative input measures show little impact, several measures of institutional structures and of the quality of the teaching force can account for significant portions of the immense international differences in the level and equity of student achievement. Variations in skills measured by the international achievement tests are in turn strongly related to individual labor-market outcomes and, perhaps more importantly, to cross-country variations in economic growth.

Nicola D. Coniglio, Giuseppe Celi, Cosimo Scagliusi, University of Bari: Organized Crime, Migration and Human Capital Formation: Evidence from the South of Italy. The presence of organized crime is a pervasive feature of many developed and developing countries. Even if ‘mafia’ organizations have greatly enlarged the geographical scope of their activities, as in the past they are still deeply rooted in specific territories where their presence generates a host of influences on socio-economic performances (perverse social capital). We identify municipalities where the presence of organized crime is particularly pervasive in an Italian region, Calabria, where is based one of the most powerful international criminal organization, 'Ndrangheta. Our results suggest that the presence of organized crime inhibits the accumulation of human capital both directly (reducing the incentive to invest in formal education) and indirectly by increasing migration outflows.

Ian Ayres, Barry Nalebuff: Lifecycle Investing: A New, Safe, and Audacious Way to Improve the Performance of Your Retirement Portfolio. Of course, to more evenly expose yourself to the market, you have to buy more stock when you’re young. The problem is that most people haven’t saved much for retirement in their 20s and 30s. It would be nice to buy more stock when you’re starting off. But a reasonable initial reaction is that you can’t invest what you don’t have. That’s just wrong. If you’ve saved $4,000 for retirement, you can borrow another $4,000 and invest $8,000 in stock index funds. The idea of mortgaging your retirement savings seems to go against everything we’ve been taught about prudence. I hope to convince you that modest amounts of leverage when you’re young can pay big diversification benefits.

Ben S. Bernanke, Fed: The Economics of Happiness. Notwithstanding that income contributes to well-being, the economics of happiness is also a useful antidote to the tendency of economists to focus exclusively on material determinants of social welfare, such as the GDP. GDP is not itself the final objective of policy, just as an increase in income may not be a good enough reason for you to change jobs. Obtaining broader measures of human welfare is challenging, but not impossible. Indeed, the United Nations has produced its human development reports for 20 years, and the Organisation for Economic Co-operation and Development has been engaged in a comprehensive project to examine the progress of societies in order to ensure that economic policymaking focuses on improving human welfare, broadly construed