FEBRUARY 18

Justin Weidner, John C. Williams, San Francisco Fed: What Is the New Normal Unemployment Rate? Mounting evidence suggests that structural factors may have increased the “normal” rate of unemployment to about 6.7%. Much of this increase is likely to be temporary. In particular, the extension of unemployment benefits probably accounts for about half of the increase. But, even with a 6.7% natural rate, current and forecasted levels of unemployment imply that significant labor market slack will persist for several years. It is important to stress that each of the methods used to estimate the natural rate is subject to considerable error, especially given the limited experience of very high unemployment in the post-World War II U.S. economy.

Alberto Martin, Jaume Ventura, VoxEU: Origins and macroeconomic implications of asset bubbles.  Modern economies often experience large movements in asset prices that have significant macroeconomic effects. Yet many of these movements in asset prices seem unrelated to economic fundamentals and are often termed “bubbles”. This column explains how recent advances in the theory of rational bubbles can help us to understand these movements in asset prices and their macroeconomic implications.

Gabriele Galati, Richhild Moessner, BIS: Macroprudential policy – a literature review. The recent financial crisis has highlighted the lack of analytical frameworks to help predict and cope with the global build-up of financial imbalances whose sudden unwinding turned out to have severe macroeconomic consequences. With the benefit of hindsight, there has been a fundamental lack of understanding of system-wide risk. In particular, there has been a failure to appreciate how aggressive risk-taking by different types of financial institutions – against the background of robust macroeconomic performance and low interest rates – supported a massive growth in balance sheets in the financial system. In terms of policy, the recent financial crisis has highlighted the need to go beyond a purely micro-based approach to financial regulation and supervision. In recent months, the number of policy speeches, research papers and conferences that discuss a macro perspective on financial regulation has grown considerably. There is a growing consensus among policymakers that a macroprudential approach to regulation and supervision should be adopted:

Kenneth J. Arrow, B. Douglas Bernheim, Martin S. Feldstein, Daniel L. McFadden, James M. Poterba, and Robert M. Solow: 100 Years of the American Economic Review: The Top 20 Articles. We was appointed by Robert Moffitt with the task of selecting the “Top 20” articles published in the American Economic Review during its first hundred years. We decided against trying to define formally the criteria for inclusion: they surely comprise sheer intellectual quality, influence on the ideas and practices of economists, and general significance or breadth; but it would be fruitless to try to specify the marginal rates of substitution among these. In the event, our early ballots showed an encouraging unanimity or near-unanimity, especially about the leading candidates. We very quickly converged on the Top 15 articles. There were occasional differences of opinion, only to be expected from a group with diverse interests, as we filled in the remaining three to five places. Here is our final list, arranged alphabetically, along with a brief reminder about each. There are few, if any, surprises.

Joshua Aizenman, Gurnain Kaur Pasricha, NBER:  Net Fiscal Stimulus During the Great Recession. This paper studies the patterns of fiscal stimuli in the OECD countries propagated by the global crisis.  Overall, we find that the USA net fiscal stimulus was modest relative to peers, despite it being the epicenter of the crisis, and having access to relatively cheap funding of its twin deficits.  The USA is ranked at the bottom third in terms of the rate of expansion of the consolidated government consumption and investment of the 28 countries in sample. Contrary to historical experience, emerging markets had strongly countercyclical policy during the period immediately preceding the Great Recession and the Great Recession.  Many developed OECD countries had procyclical fiscal policy stance in the same periods. Federal unions, emerging markets and countries with very high GDP growth during the pre-recession period saw larger net fiscal stimulus on average than their counterparts.  We also find that greater net fiscal stimulus was associated with lower flow costs of general government debt in the same or subsequent period.

N. Gregory Mankiw, NYT: Emerging Markets as Partners, Not Rivals. In his State of the Union address last month, President Obama set the stage for a coming policy debate and his re-election bid with a catch phrase. Six times, he called on Americans to “win the future.” And he used the variant “winning the future” three other times. But is this really a good way to frame the economic challenges we face? Listening to the president, you might think that competition from China and other rapidly growing nations was one of the larger threats facing the United States. But the essence of economic exchange belies that description. Other nations are best viewed not as our competitors but as our trading partners. Partners are to be welcomed, not feared. As a general matter, their prosperity does not come at our expense.

David Miles et al, BoE: Optimal bank capital. We use empirical evidence on UK banks to assess costs; we use data from shocks to incomes from a wide range of countries over a long period to assess risks to banks and how equity funding (or capital) protects against those risks. We find that the amount of equity capital that is likely to be desirable for banks to hold is very much larger than banks have held in recent years and also higher than targets agreed under the Basel III framework.

Sebastian Barnes et al, OECD: The GDP Impact of Reform. A Simple Simulation Framework. The plausible scenarios suggest that the largest long-run GDP per capita gains may be obtained from reforms that would raise the quantity and quality of education, strengthen competition in product markets, reduce the level and/or duration of unemployment benefits, cut labour tax wedges and relax employment protection legislation. Past reforms in these areas might also have contributed to as much as half of GDP per capita growth in OECD countries in the decade prior to the recent financial and economic crisis. Simulations further indicate that addressing all policy weaknesses in each OECD country by aligning policy settings on the OECD average could raise GDP per capita by as much as 25% in the typical country.

Dan Ariely et al, Boston Fed: Large Stakes and Big Mistakes. Most upper‐management and sales force personnel, as well as workers in many other jobs, are paid based on performance, which is widely perceived as motivating effort and enhancing productivity relative to non‐contingent pay schemes. However, psychological research suggests that excessive rewards can in some cases produce supra‐optimal motivation, resulting in a decline in performance. To test whether very high monetary rewards can decrease performance, we conducted a set of experiments at MIT, the University of Chicago, and rural India. Subjects in our experiment worked on different tasks and received performance‐contingent payments that varied in amount from small to large relative to their typical levels of pay. With some important exceptions, we observed that high reward levels can have detrimental effects on performance.

Mirco Tonin, Ann-Sofie Kolm, IZA: In-Work Benefits and Unemployment. We analyze the impact of in-work benefits on some of the main labour market indicators in a search framework, taking into account the effects on labour market equilibrium. We find that in-work benefits increase labour force participation, employment, and search intensity by the unemployed, while wages and the unemployment rate decline. Moreover, we show that the positive effect on employment and labour force participation in equilibrium exceeds that in partial equilibrium, i.e., when wage are fixed, if the unemployment rate is inefficiently high. Results from numerical simulations suggest that the quantitative impact on unemployment and employment is significantly larger when the effect of benefits on wages is taken into

account.

Kevin Lang, Erez Siniver, NBER: Why Is an Elite Undergraduate Education Valuable? Evidence from Israel. In this paper we compare the labor market performance of Israeli students who graduated from one of the leading universities, Hebrew University (HU), with those who graduated from a professional undergraduate college, College of Management Academic Studies (COMAS). Our results support a model in which employers have good information about the quality of HU graduates and pay them according to their ability, but in which the market has relatively little information about COMAS graduates. Hence, high-skill COMAS graduates are initially treated as if they were the average COMAS graduate, who is weaker that a HU graduate, consequently earning less than UH graduates. However, over time the market differentiates among them so that after several years of experience, COMAS and HU graduates with similar entry scores have similar earnings. Our results are therefore consistent with the view that employers use education information to screen workers but that the market acquires information fairly rapidly.

Anders Björklund, Markus Jäntti, John E. Roemer, IZA: Equality of Opportunity and the Distribution of Long-Run Income in Sweden. Equality of opportunity is an ethical goal with almost universal appeal. The interpretation taken here is that a society has achieved equality of opportunity if it is the case that what individuals accomplish, with respect to some desirable objective, is determined wholly by their choices and personal effort, rather than by circumstances beyond their control. We use data for Swedish men born between 1955 and 1967 for whom we measure the distribution of long-run income, as well as several important background circumstances, such as parental education and income, family structure and own IQ before adulthood. We address the question: in Sweden, given its present constellation of social policies and institutions, to what extent is existing income inequality due to circumstances, as opposed to 'effort'? Our results suggest that several circumstances, importantly both parental income and own IQ, are important for long-run income inequality, but that variations in individual effort! account for the most part of that inequality.

Jeremiah Dittmar, VoxEU: Information technology and economic change: The impact of the printing press. Despite the revolutionary technological advance of the printing press in the 15th century, there is precious little economic evidence of its benefits. Using data on 200 European cities between 1450 and 1600, this column finds that economic growth was higher by as much as 60 percentage points in cities that adopted the technology.

John Ifcher, Homa Zarghamee, Santa Clara University: Happiness and Time Preference: The Effect of Positive Affect in a Random-Assignment Experiment. John Ifcher and Homa Zarghamee address the tricky and oft-ignored role of emotion in decision-making. Their study measured whether positive affect impacts time preference – that is, whether people are more patient when they’re happy. They found that people are indeed more willing to wait when they’re in a good mood. As an individual’s rate of time preference affects the actual decision they make, knowing the relationship of short term emotions to time preference points to how to nudge individuals to make long term decisions instead of short-term ones