NOVEMBER 26 2010

Carlo Cottarelli, Lorenzo Forni, Jan Gottschalk, Paolo Mauro, IMF: Default in Today's Advanced Economies: Unnecessary, Undesirable, and Unlikely. This note summarizes the main arguments put forward by some market commentators who argue that default is inevitable, and presents a rebuttal for each argument in turn. Their main arguments focus on the size of the adjustment and continued market concerns reflected in government bond spreads. The essence of our reasoning is that the challenge stems mainly from the advanced economies’ large primary deficits, not from a high average interest rate on debt. Thus, default would not significantly reduce the need for major fiscal adjustment. In contrast, the economies that defaulted in recent decades did so primarily as a result of high debt servicing costs, often in the context of major external shocks. We conclude that default would not be in the interest of the citizens of the countries in question. Fiscal adjustment supported by reforms that enhance economic growth is a more effective response.

The Pragmatic Capitalism Blog: Here’s a longer perspective of the chart I’ve often referenced in the past showing how similar our current inflation trend is to Japan’s in the 90′s. As the housing double dip takes hold in the coming months it’s likely that inflation will remain very low and concerns about deflation will reemerge. The latest figures, released this week, showed that overall inflation in consumer prices was 1.2 percent in the 12 months through October, while the core inflation rate — excluding food and energy — rose just 0.6 percent. The previous low for that index, of 0.7 percent, came in the 12 months through February 1961, when the economy was in recession.

Gauti B. Eggertsson (NY Fed) Paul Krugman (Princeton): Debt, Deleveraging, and the Liquidity Trap. A Fisher-Minsky-Koo approach. In this paper we present a simple New Keynesian-style model of debt-driven slumps – that is, situations in which an overhang of debt on the part of some agents, who are forced into rapid deleveraging, is depressing aggregate demand. Making some agents debt-constrained is a surprisingly powerful assumption: Fisherian debt deflation, the possibility of a liquidity trap, the paradox of thrift, a Keynesian-type multiplier, and a rationale for expansionary fiscal policy all emerge naturally from the model. We argue that this approach sheds considerable light both on current economic difficulties and on historical episodes, including Japan’s lost decade (now in its 18th year) and the Great Depression itself.

Sylvain Leduc, San Francisco Fed: Confidence and the Business Cycle. The idea that business cycle fluctuations may stem partly from changes in consumer and business confidence is controversial. One way to test the idea is to use professional economic forecasts to measure confidence at specific points in time and correlate the results with future economic activity. Such an analysis suggests that changes in expectations regarding future economic performance are important drivers of economic fluctuations. Moreover, periods of heightened optimism are followed by a tightening of monetary policy.

Alessandro Vercelli, University of Siena: Economy and economics: the twin crises. This paper explores the interaction between the Great recession triggered by the US subprime mortgages crisis and the twin crisis of macroeconomics. We argue that a major determinant of the subprime crisis and its dire consequences has been an approach to economics that is unable to deal with irregular phenomena. On the other hand, the unexpectedly deep financial crisis that has heavily affected the real economy makes clear that we need a major redirection of macroeconomic theory to make it able to explain, forecast and control irregular phenomena. The recent interaction between the crisis of the economy and the crisis of macroeconomics is analyzed in the light of similar preceding episodes in the 20th century: the Great contraction of the 1930s and the Great stagflation of the 1970s.

George Selgin, William D. Lastrapes, Lawrence H. White, CATO: Has the Fed Been a Failure? As the one-hundredth anniversary of the 1913 Federal Reserve Act approaches, we assess whether the nation‘s experiment with the Federal Reserve has been a success or a failure. Drawing on a wide range of recent empirical research, we find the following: (1) The Fed‘s full history (1914 to present) has been characterized by more rather than fewer symptoms of monetary and macroeconomic instability than the decades leading to the Fed‘s establishment. (2) While the Fed‘s performance has undoubtedly improved since World War II, even its postwar performance has not clearly surpassed that of its undoubtedly flawed predecessor, the National Banking system, before World War I. (3) Some proposed alternative arrangements might plausibly do better than the Fed as presently constituted. We conclude that the need for a systematic exploration of alternatives to the established monetary system is as pressing today as it was a century ago.

Shigeru Fujita, Philadelphia Fed: Effects of the UI Benefit Extensions: Evidence from the Monthly CPS. Using the monthly CPS, I estimate unemployment-to-employment (UE) transition rates and unemployment-to-inactivity (UN) transition rates by unemployment duration for male workers. When estimated for the period of 2004-2007, during which no extended benefits are available, both of the transition-rate profiles show clear patterns consistent with the expiration of regular benefits at 26 weeks. These patterns largely disappear in the profiles for the period of 2009-2010, during which large-scale extensions have become available. I conduct counterfactual experiments in which the estimated profiles for 2009-2010 are replaced by the hypothetical profiles inferred from the ones for 2004-2007. The results indicate that the benefit extensions in recent years have raised male workers’ unemployment rate by 0.9-1.7 percentage points. Roughly 50-60% of the total increase is attributed to the effects on UE transition rates and the remaining part is accounted for by the effects on UN transition rates.

Camille Landais, Pascal Michaillat, Emmanuel Saez, NBER: Optimal Unemployment Insurance over the Business Cycle. Job rationing during recessions introduces two novel effects ignored in previous studies of optimal unemployment insurance. First, job-search efforts have little effect on aggregate unemployment because the number of jobs available is limited, independently of matching frictions. Second, while job-search efforts increase the individual probability of finding a job, they create a negative externality by reducing other jobseekers’ probability of finding one of the few available jobs. Both effects are captured by the positive and countercyclical wedge between micro-elasticity and macro-elasticity of unemployment with respect to net rewards from work. We derive a simple optimal unemployment insurance formula expressed in terms of those two elasticities and risk aversion. The formula coincides with the classical Baily-Chetty formula only when unemployment is low, and macro- and micro-elasticity are (almost) equal. The formula implies that the generosity of unemployment insurance should be countercyclical. We illustrate this result by simulating the optimal unemployment insurance over the business cycle in a dynamic stochastic general equilibrium model calibrated with US data.

Andreas Knabe, Ronnie Schöb, Joachim Weimann, VoxEU: Unemployment and happiness: A new take on an old problem. “We were happy in those days… Because we were poor”, goes the old Monty Python sketch. This column suggests there might be some shred of truth in this joke. It finds that while unemployed people report being less satisfied with their life in general, their emotional wellbeing experienced during day-to-day activities does not seem to suffer at all.

Eric A. Hanushek, Ludger Woessmann, NBER How Much Do Educational Outcomes Matter in OECD Countries? We show that cognitive skills can account for growth differences within the OECD, whereas a range of economic institutions and quantitative measures of tertiary education cannot. Under the growth model estimates and plausible projection parameters, school improvements falling within currently observed performance levels yield very large gains. The present value of OECD aggregate gains through 2090 could be as much as $275 trillion, or 13.8 percent of the discounted value of future GDP. Extensive sensitivity analyses indicate that, while differences between model frameworks and alternative parameter choices make a difference, the economic impact of improved educational outcomes remains enormous. Interestingly, the quantitative difference between an endogenous and neoclassical model framework – with improved skills affecting the long-run growth rate versus just the steady-state income level – matters less than academic discussions suggest. We close by discussing evidence on which education policy reforms may be able to bring about the simulated improvements in educational outcomes.

Ernesto Reuben, Pedro Rey-Biel, Paola Sapienza, Luigi Zingales, IZA: The Emergence of Male Leadership in Competitive Environments. We present evidence from an experiment in which groups select a leader to compete against the leaders of other groups in a real-effort task that they have all performed in the past. We find that women are selected much less often as leaders than is suggested by their individual past performance. We study three potential explanations for the underrepresentation of women, namely, gender differences in overconfidence concerning past performance, in the willingness to exaggerate past performance to the group, and in the reaction to monetary incentives. We find that men’s overconfidence is the driving force behind the observed prevalence of male representation.

Lane Kenworthy, Consider the Evidence Blog: When is economic growth good for the poor? The following charts show what happened in the United States and Sweden from the late 1970s to the mid 2000s. On the vertical axes is the income of households at the tenth percentile of the distribution — near, though not quite at, the bottom. On the horizontal axes is GDP per capita. The data points are years for which there are cross-nationally comparable household income data. Both countries enjoyed significant economic growth. But in the U.S. the incomes of low-end households didn’t improve much, apart from a brief period in the late 1990s. In Sweden growth was much more helpful to the poor.

Dani Rodrik's weblog: Are high food prices good or bad for poverty? It depends on whether the poor are selling or buying, of course. High food prices benefit poor farmers who are net food sellers, and hurt poor food consumers in urban areas. Low food prices have the opposite effects. In each case, the net effect on poverty depends on the balance between these two effects. But you would hardly know it from reading what NGOs and international organizations have produced on the topic. Why do NGO institutions always accentuate the negative? Swinnen argues the reason has to do with international organizations’ incentives to capture media attention, capitalize on “sudden shocks,” and emphasize the negative in the “news” (to which people seem to pay more attention). Whatever the reason, it makes for bad public policy.

Shankar Vedantam, Slate: Parents Are Junkies. If parenthood sucks, why do we love it? Because we're addicted. The unexpected, kind, and loving things that children do produce chemical surges in their parents’ brains like the rush of the pipe or the needle. Like addicts, parents will sacrifice anything for the glimpses of heaven that their offspring periodically provide. Furthermore, the roller coaster of parenting seems designed to ensure addiction. The unpredictability of those moments of bliss is an important factor in their addictiveness. If you give animals a predictable reward — say, a shot of sugar every time they press a lever — you can get them to press that lever quite regularly. But if you want irrational and addictive behavior, you make the reward unpredictable.