MAY 21 2010

Robert J. Shiller, NYT: Fear of a Double Dip Could Cause One. World markets soared initially on the announcement of the nearly $1 trillion rescue plan, and then declined. But as the economist John Maynard Keynes cautioned long ago, such market reactions are basically a “beauty contest” — with investors trying to predict the short-term reaction that other investors think still other investors will have. In other words, don’t view these beauty contests as a heartfelt response to a fundamental change in the economy. In fact, there is still a real risk of a double-dip recession, though it can’t be quantified by the statistical models that economists use for forecasts. Instead, the danger stems from the weakness and vulnerability of confidence — whose decline could bring markets down, further stress balance sheets and cause cuts in consumption, investment and local government expenditures.

Justin Weidner, John C. Williams, San Francisco Fed: The Shape of Things to Come. Economic recoveries from the past two recessions have been much more gradual than the rapid V-shaped recoveries typical of earlier downturns. Analysis of the factors that determine economic growth rates indicates that recovery from the most recent recession is likely to be faster than from the two previous recessions, but slower than earlier V-shaped recoveries.

Paul Krugman, NYT Blog: Et Tu, Wolfgang? Perhaps the most startling and frustrating thing about the debate over the fate of the euro is the way almost everyone avoids confronting the core issue — the elephant in the euro. With a unified currency, adjustment to differential shocks requires adjustments in relative wages — and because the nations of the European periphery have gone from boom to bust, their adjustment must be downward. At this point, wages in Greece/Spain/Portugal/Latvia/Estonia etc. need to fall something like 20-30 percent relative to wages in Germany.

Edward Hugh, Fistful of Euros Blog: Much Ado About (Some Of) The Wrong Things. In this context I can either see one of two alternatives: a) either Germany (and possibly one or two other smaller economies) temporarily leaves the eurozone and revalues; or b) The peripheral economies undertake a sizeable internal devaluation (say 20%, but this is just a rule of thumb estimate). At the present time most EU policymakers remain unconvinced that we need a shift of this magnitude. Yet there is surprisingly little detailed study of how the economies concerned are going to get back to growth without this price correction. Indeed the EU Commission itself has strongly pointed out that the rates of private consumption growth being assumed for these economies by the national governments in the Stability Programme estimates are highly optimistic. What would be nice would be for someone to set up a small model to try to examine just how much ongoing growth in the combined goods and services trade surplus countries like Spain now need to achieve to get positive growth in headline GDP under a variety of different assumptions, including stagnant domestic consumption and reduced fiscal spending

Caroline Baum, Business Week: Greek Contagion Myth Masks Real Europe Crisis. I hate to pour cold water on that theory, but healthy countries aren’t susceptible to Greece’s disease. The sick ones, already plagued with high debt levels and bloated state budgets, don’t need a carrier. Capital flight from these countries “is not evidence of contagion,” said economist and author Anna Schwartz. Of course, Schwartz said that in 1998 following the Asian financial crisis. Schwartz punctured the notion that financial crises spread from the initial source to innocent victims. Nations are vulnerable because of their “home grown economic problems,” she said. Schwartz’s insights are equally valid today. Capital isn’t fleeing sovereign debt markets in Spain and Portugal because Greece can’t pay its bills. Bond yields are rising because of an increased risk those countries may find themselves in the same boat as Greece: unable meet their debt obligations.

IMF: Fiscal Monitor. Navigating the Fiscal Challenges Ahead. Even as the global economy improves, fiscal balances in the advanced economies are, on average, worsening. While World Economic Outlook projections for 2010 output growth in the advanced economies have increased by a full percentage point since the last issue of the Monitor, updated projections in Section I of the Monitor show that after discounting for reduced financial sector support operations, both headline and cyclically adjusted (CA) fiscal deficits in these countries will increase in 2010—relative both to the 2009 outturn and to projections made six months ago. Based on current likely policies, the advanced economies will continue to run sizable primary deficits over the medium term, leading the average general government gross debt ratio—which has already ballooned by close to 20 percent of GDP since the onset of the crisis—to rise by a further 20 percentage points by 2015, reaching about 110 percent of GDP. These developments are occurring amid heightened market sensitivity to variations in fiscal performance across countries. Section II shows that many countries will be facing historically high financing requirements this year, making them especially susceptible to market pressures.

Pragmatic Capitalism Blog: A Deflationary Red Flag in the $ U.S. Dollar. If the chart below doesn’t grab your attention then few things will. In my opinion, the performance of the dollar is the surest evidence of the kind of environment we’re currently in. The surging dollar is a clear sign that inflation is not the concern of global investors. This is almost a sure sign that deflation is once again gripping the global economy and should be setting off red flags for equity investors around the world. The recent action in the dollar is eerily reminiscent of the peak worries in the credit crisis when deflation appeared to be taking a death grip on the global economy and demand for dollars was extremely high. The recent 16% rally in the dollar is a sign that investors are once again worried about the continuing problem of debt around the world and they’re reaching for the safety of the world’s reserve currency – the dollar. As asset prices decline and bond yields collapse this is a clear sign that inflation is not the near-term concern, but rather that the debt based deflationary trends continue to dominate global economic trends.

Narayana R. Kocherlakota, Minneapolis Fed: Modern Macroeconomic Models as Tools for Economic Policy. It is hard to compute macro models with financial frictions. It does not become easier to compute models with both labor market frictions and financial frictions. The models do not capture an intermediate messy reality in which market participants can trade multiple assets in a wide array of somewhat segmented markets. As a consequence, the models do not reveal much about the benefits of the massive amount of daily or quarterly reallocations of wealth within financial markets. The difficulty in macroeconomics is that virtually every variable is endogenous, but the macroeconomy has to be hit by some kind of exogenously specified shocks if the endogenous variables are to move.

CBO: How Policies to Reduce Greenhouse Gas Emissions Could Affect Employment. The Congressional Budget Office (CBO) has analyzed the research on the effects that policies to reduce green house gases would have on employment and concluded that total employment during the next few decades would be slightly lower than would be the case in the absence of such policies. In particular, job losses in the industries that shrink would lower employment more than job gains in other industries would increase employment, thereby raising the overall unemployment rate. Eventually, however, most workers who lost jobs would find new ones. In the absence of policies to reduce emissions of greenhouse gases, changes to the climate also might affect employment; however, this brief does not address such changes because that effect would probably arise after the next few decades, and it has not been studied as carefully by researchers.

Sewell Chan, Washington Post: Is Ben Bernanke Having Fun Yet? Nine days ago, Ben S. Bernanke, the Federal Reserve chairman, caught a Friday-night flight from here so he could address 1,100 graduates at the University of South Carolina the next morning about “The Economics of Happiness.” After the speech, he took a call in his hotel room from Jean-Claude Trichet, head of the European Central Bank, and the next day pledged billions of dollars to help Europe stave off a financial crisis — a flashback to the huge lending programs the Fed put together in 2008 to forestall economic collapse at home. Mr. Bernanke, 56, hasn’t had much time to reflect on whether history’s verdict on his extraordinary actions of recent years will be harsh or forgiving. Nor has he had time to read the spate of new books about how he and two Treasury secretaries, Henry M. Paulson Jr. and Timothy F. Geithner, navigated a maelstrom that left millions of Americans jobless, homeless or broke.

Arne Feddersen, Wolfgang Maennig, University of Hamburg: Mega-Events and Sectoral Employment: The Case of the 1996 Olympic Games. This paper extends earlier studies in several ways. First, monthly rather than quarterly data will be employed. Second, the impact of the 1996 Olympics will be analyzed for 16 different sectors or subsectors. Third, in addition to standard DD models, we use a non-parametric approach to flexibly isolate employment effects. Regarding the Olympic effect, hardly any evidence for a persistent shift in the aftermath of or the preparation for the Olympic Games is supported. We find a significant positive employment effect in the monthly employment statistics exclusively during the staging of the Olympic Games (July 1996). These short-term effects are concentrated in the sectors of “retail trade”, “accommodation and food services”, and “arts, entertainment, and recreation”, while other sectors showed no such effects.

Markus Brückner, Hans Peter Grüner, VoxEU: The OECD’s growth prospects and political extremism. Will the global crisis lead to a rise in political extremism just as during the Great Depression? This column examines the vote share for extreme parties in a sample of 16 OECD countries over three decades. A one-percentage-point decline in growth leads to a one-percentage-point increase in the vote share for right-wing or nationalist parties.

Paul Frijters, Juan D. Barón, IZA: The Cult of Theoi: Economic Uncertainty and Religion. Sacrifices to deities occur in nearly all known religions. In this paper, we report on our attempts to elicit this type of religious behaviour towards “Theoi” in the laboratory. The theory we test is that, when faced with uncertainty, individuals attempt to engage in a reciprocal contract with the source of uncertainty by sacrificing towards it. In our experiments, we create the situation whereby individuals face an uncertain economic payback due to “Theoi” and we allow participants to sacrifice towards this entity. Aggregate sacrifices amongst participants are over 30% of all takings, increase with the level of humanistic labelling of Theoi and decrease when participants share information or when the level of uncertainty is lower. The findings imply that under circumstances of high uncertainty people are willing to sacrifice large portions of their income even when this has no discernable effect on outcomes.