DECEMBER 31 2010

Barry Eichengreen, National Interest: Mr. Bernanke Goes to War. Reassuring foreign central banks and governments with big investments in American Treasury securities would require Washington to put in place a credible plan for balancing the federal government budget. It would require putting the social security trust fund on a sustainable footing. It would require solving once and for all the problem of Medicare and Medicaid costs. Not only would emerging markets be reassured, but the United States itself would be better off. Averting a currency war, then, is simple. Doing so doesn’t require some grand bargain between the United States and China. It only requires each party to recognize what is in its self-interest. Restoring peace and harmony to the financial sphere doesn’t require an outbreak of international cooperation. It only requires an outbreak of common sense.

Véronique Genre et al, ECB: Combining the forecasts in the ECB survey of professional forecasters: can anything beat the simple average? For GDP growth and the unemployment rate, only few of the forecast combination schemes are able to outperform the simple equal-weighted average forecast. Conversely, for the inflation rate there is stronger evidence that more refined combinations can lead to improvement over this benchmark. In particular, for this variable, the relative improvement appears significant even controlling for data snooping bias.

Michelle L. Barnes, N. Aaron Pancost, Boston Fed: Internal Sources of Finance and the Great Recession. The rising stockpile of cash as a share of total assets at U.S. firms has intrigued economists since at least the paper of Bates, Kahle, and Stulz (2006), yet there has been relatively little work on where this cash has come from and how it is related to investment performance. We exploit Statement of Cash Flows data from Compustat to decompose firms’ cash stocks and show that the rise in cash holdings has coincided with an increased willingness to save internally generated cash. We show that although investment is normally sensitive to externally generated cash, the increased sensitivity of investment to cash during the Great Recession is driven by cash from internal sources. Smaller firms were also more affected by the recent downturn than larger firms. Our results agree with the findings of Almeida, Campello, and Weisbach (2004) on cash hoarding and financial constraints, as well as the estimates in Duchin, Ozbas, and Sensoy (2010) on the important role of saved cash during the financial crisis.

Uri Dadush, VoxEU: Who gains from a renminbi revaluation? If China appreciates its currency, who will gain and who will lose out? This column argues that the single greatest beneficiary from a gradual renminbi revaluation, accompanied by measures to stimulate demand, will be China itself. Ironically, the US, which has been leading the charge on renminbi appreciation, would likely be among the losers. Certainly, a very large one-off revaluation that disrupts China’s growth hurts everyone.

Knut Røed, Jens Fredrik Skogstrøm, IZA: Creative Unemployment. We examine the impact of job loss on entrepreneurship behavior in Norway. Our identification strategy relies on the use of mass layoffs caused by bankruptcies as indicators of exogenous displacement. We find that working in a company which is going to close down due to bankruptcy during the next four years raises the subsequent entrepreneur rate by 3.7 percentage points (155 %) for men and 1.8 percentage points (180 %) for women, compared to working in a stable firm. These estimates are much larger than what has previously been reported in the literature. Taking into account that many workers lose their jobs in the comparison group of stable firms also, we reckon that the full effects of displacement are even larger.

Torbjørn Haegeland et al, IZA: Why Children of College Graduates Outperform their Schoolmates: A Study of Cousins and Adoptees. Massive cross-sectional evidence exists indicating that children of more educated parents outperform their schoolmates. However, evidence for causal interpretation of this association is weak. We examine a causal relationship using two approaches for identification within the same data: cousins with twin parents and adopted children. We find no effect of mothers' education on children's school performance using the children-of-twins approach. However, for adopted children, mother's education has a small positive effect. Tracking the work experience of parents during offspring childhood, we find no support that this effect can be explained by a higher labor force participation among more educated mothers.

Merwan Engineer, Ian King, University of Victoria: Maximizing Human Development. The Human Development Index (HDI) is widely used as an aggregate measure of overall human well being. We examine the allocations implied by the maximization of this index, using a standard growth model — an extended version of Mankiw, Romer, andWeil’s (1992) model — and compare these with the allocations implied by the golden rule in that model. We find that maximization of the HDI leads to the overaccumulation of both physical and human capital, relative to the golden rule, and consumption is pushed to minimal levels. We then propose an alternative specification of the HDI, which replaces its income component with a consumption component. Maximization of this modified HDI yields a “human development golden rule” which balances consumption, education and health expenditures, and avoids the more extreme implications of the existing HDI.

Eric A. Hanushek, NBER: The Economic Value of Higher Teacher Quality.

Most analyses of teacher quality end without any assessment of the economic value of altered teacher quality. This paper combines information about teacher effectiveness with the economic impact of higher achievement. It begins with an overview of what is known about the relationship between teacher quality and student achievement. This provides the basis for consideration of the derived demand for teachers that comes from their impact on economic outcomes. Alternative valuation methods are based on the impact of increased achievement on individual earnings and on the impact of low teacher effectiveness on economic growth through aggregate achievement. A teacher one standard deviation above the mean effectiveness annually generates marginal gains of over $400,000 in present value of student future earnings with a class size of 20 and proportionately higher with larger class sizes. Alternatively, replacing the bottom 5-8 percent of teachers with average teachers could move the U.S. near the top of international math and science rankings with a present value of $100 trillion.

Christian Helmers, Mark Rogers, VoxEU: The impact of university research on corporate patenting. There is broad agreement that research at universities has knock-on benefits for innovation and the wider economy in general. The question remains “how?”. This column presents evidence from across the UK suggesting that local university research has a positive effect on the number local small firms that patent and that this effect strengthens the better the university.

Steve Martin, Paul Dolan, Harvard Business Review: Dear Taxpayer, Congratulations! You've Won Your Money Back. In 2007, the Internal Revenue Service (IRS) introduced a series of additional penalties for any US citizen who knowingly submitted a less than complete and honest tax return. While understandable the approach was anything but successful. In fact, it resulted in a 22% increase in tax fraud the following year. We wonder if a lottery might provide a more positive and innovative approach to dealing the problem. Every citizen who submits their tax return and payment honestly and on time has their social security number entered in a lottery with a number (to be determined) of citizens winning a prize. What might that prize be? How about a letter from the IRS with a check:

"Dear Taxpayer, Congratulations! You've won your money back."

Jonah Lehrer, NYT: A Physicist Solves the City. West saw the metropolis as a sprawling organism, similarly defined by its infrastructure. (The boulevard was like a blood vessel, the back alley a capillary.) This implied that the real purpose of cities, and the reason cities keep on growing, is their ability to create massive economies of scale, just as big animals do. After analyzing the first sets of city data — the physicists began with infrastructure and consumption statistics — they concluded that cities looked a lot like elephants. In city after city, the indicators of urban “metabolism,” like the number of gas stations or the total surface area of roads, showed that when a city doubles in size, it requires an increase in resources of only 85 percent.