JUNE 24 2010

Claudio Borio, Bent Vale and Goetz von Peter, BIS: Resolving the financial crisis: are we heeding the lessons from the Nordics? How does the management and resolution of the current crisis compare with the response of the Nordic countries in the early 1990s, widely regarded as exemplary? We argue that, while intervention has been prompter, the measures taken so far remain less comprehensive and in-depth. In particular, the cleansing of balance sheets has proceeded more slowly, and less attention has been paid to reducing excess capacity and avoiding competitive distortions. In general, policymakers have given higher priority to sustaining aggregate demand in the short term than to encouraging adjustment in the financial sector and containing moral hazard. We argue that three factors largely explain this outcome: the more international nature of the crisis; the complexity of the instruments involved; and, hardly appreciated so far, the effect of accounting practices on the dynamics of the events, reflecting in particular the prominent role of fair value accounting (and mark to market losses) in relation to amortised cost accounting for loan books. There is a risk that the policies followed so far may delay the establishment of the basis for a sustainably profitable and less risk-prone financial sector.

Niko Dötz, Christoph Fischer, Buba: What can EMU countries’ sovereign bond spreads tell us about market perceptions of default probabilities during the recent financial crisis? This paper presents a new approach for analysing the recent development of EMU sovereign bond spreads. Based on a GARCH-in-mean model originally used in the exchange rate target zone literature, spreads are decomposed into a risk premium, an expected loss component and a liquidity premium. Time-varying default probabilities are derived. The results suggest that the rise in sovereign spreads during the recent financial crisis mainly reflects an increased expected loss component. In addition, the rescue of Bear Stearns in March 2008 seems to mark a change in market perceptions of sovereign bond risk. The government bonds of some countries lost their former role as a safe haven. While price competitiveness always helps to explain sovereign spreads, it increasingly moved into investors’ focus as financial sector soundness weakened."

Jacopo Carmassi, Stefano Micossi, VoxEU, How politicians excited financial markets’ attack on the Eurozone. As the recent austerity measures can testify, Europe’s leaders are acutely concerned about government debt. This column tracks policy announcements from the start of the Eurozone crisis in December 2009, arguing that governments may have contributed to turmoil with their public display of confusion – ultimately undermining credibility. But if Eurozone governments show unity of purpose, this credibility can be restored.

John Taylor, Stanford University: Macroeconomic Lessons from the Great Deviation. You may not have heard much about the Great Deviation. I define it as the recent period during which macroeconomic policy became more interventionist, less rules-based, and less predictable. It is a period during which policy deviated from the practice of at least the previous two decades, and from the recommendations of most macroeconomic theory and models. My general theme is that the Great Deviation killed the Great Moderation, gave birth to the Great Recession, and left a troublesome legacy for the future.

Francis Warnock, CFR: How dangerous is US government debt? The dollar’s status as the world’s reserve currency has become a facet of U.S. power, allowing the United States to borrow effortlessly and sustain an assertive foreign policy. But the capital inflows associated with the dollar’s reserve-currency status have created a vulnerability, too, opening the door to a foreign sell-off of U.S. securities that could drive up U.S. interest rates. A sell-off came close to happening in 2009. How the United States uses this reprieve will affect the nation’s ability to borrow for years to come, with broad implications for the sustainability of an active U.S. foreign policy.

Michael D. Bordo, Thomas F. Helbling, NBER: International Business Cycle Synchronization in Historical Perspective. In this paper, we review and attempt to explain the changes in business cycle synchronization among 16 industrial countries and the over the past century and a quarter, demarcated into four exchange rate regimes. We find that there is a secular trend towards increased synchronization for much of the twentieth century and that it occurs across diverse exchange rate regimes. This finding is in marked contrast to much of the recent literature, which has focused primarily on the evidence for the past 20 or 30 years and which has produced mixed results. We then examine the role of global shocks and shock transmission in the trend toward synchronization. Our key finding here is that global (common) shocks generally are the dominant influence

Raven Molloy, Hui Shan, Fed: The Effect of Gasoline Prices on Household Location. Gasoline prices influence where households decide to locate by changing the cost of commuting. Consequently, the substantial increase in gas prices since 2003 may have reduced the demand for housing in areas far from employment centers, leading to a decrease in the price and/or quantity of housing in those locations relative to locations closer to jobs. Using annual panel data on ZIP codes and municipalities in a large number of metropolitan areas of the United States from 1981 to 2008, we find that a 10 percent increase in gas prices leads to a 10 percent decrease in construction after 4 years in locations with a long average commute relative to locations closer to jobs, but to no significant change in house prices. Thus, the supply response may prevent the change in housing demand from capitalizing in house prices. Because housing is durable, the resulting change in construction has a long-lived impact on the spatial distribution of housing units

Alicia H. Munnell et al, Center for Retirement Research: Valuing Liabilities in State and Local Plans. State and local plans generally follow an actuarial model and discount their liabilities by the long-term yield on the assets held in the pension fund, roughly 8 percent. Most economists contend that the discount rate should reflect the risk associated with the liabilities, and given that benefits are guaranteed under most state laws, the appropriate discount factor is a riskless rate, roughly 5 percent, as discussed below. Thus, the economists’ model would produce much higher liabilities than those currentlyreported on the books of states and localities. This brief attempts to separate the question of valuing liabilities from the questions of funding and investment. As background, it explains the current approach to valuing liabilities in the private and public sectors. Second, it discusses why, given their guaranteed status, state and local pension liabilities should be discounted at a riskless rate and shows how much measured liabilities would increase by applying such a rate. Third, it argues that valuing liabilities is only one factor entering the funding calculation, and that using a riskless discount rate does not necessarily mean that contributions should increase immediately.

Ryan D. Edwards, NBER: Trends in World Inequality in Life Span Since 1970. Previous research has revealed much global convergence over the past several decades in life expectancy at birth and in infant mortality. I examine life-span inequality in a broad, balanced panel of 180 rich and poor countries observed in 1970 and 2000. Convergence in infant mortality has unambiguously reduced world inequality in total length of life starting from birth, but world inequality in length of adult life has remained stagnant. Underlying both of these trends is a growing share of total inequality that is attributable to between-country variation. Especially among developed countries, the absolute level of between-country inequality has risen over time. The sources of widening inequality in length of life between countries remain unclear, but signs point away from trends in income, leaving patterns of knowledge diffusion as a potential candidate.

Andrew Leigh, Christine Neill, IZA: Do Gun Buybacks Save Lives? Evidence from Panel Data. In 1997, Australia implemented a gun buyback program that reduced the stock of firearms by around one-fifth. Using differences across states in the number of firearms withdrawn, we test whether the reduction in firearms availability affected firearm homicide and suicide rates. We find that the buyback led to a drop in the firearm suicide rates of almost 80 per cent, with no statistically significant effect on non-firearm death rates. The estimated effect on firearm homicides is of similar magnitude, but is less precise. The results are robust to a variety of specification checks, and to instrumenting the state-level buyback rate.

Edward L. Glaeser, NYT Blog: The Health of the Cities. For centuries, cities have been killing fields – places where proximity led to death and disease. In the 17th century, life expectancy at birth was 20 years lower in London than in the English countryside. Yet now, the average life expectancy in New York City is one and a half years higher than in the nation as a whole. How did city living get so healthy?