MAY 20 2011

Viral Acharya et al, VoxEU: A race to the bottom: Understanding the US housing boom. At the centre of the global financial crisis was a housing boom and bust. A New York University team has produced an excellent book on the flaws in the design of US housing finance that opened the door for the mayhem that followed. This column, the first of a series of two, describes the race to the bottom that occurred among Fannie Mae, Freddie Mac, and the too-big-to-fail private financial institutions.

David Hauner, Jaewoo Lee, Hajime Takizawa, IMF: In Which Exchange Rate Models Do Forecasters Trust? The prominence of inflation points to the broad subscription to a version of purchasing power parity. The prominence of growth rates suggests the broad acceptance of the productivity-driven appreciation, either in terms of the classic Balassa-Samuelson effect or in terms of procyclical capital inflows. Other often-mentioned factors, including the current account balance, do not appear to play a common role in the exchange rate formation. These findings speak indirectly to the fundamental determinants of exchange rates. To the extent that market forecasters adhere to models or variables which have proven to help forecast exchange rates, inflation and GDP growth rates are time-tested drivers of exchange rate movements. They must have proven to have a robust explanatory power for explaining exchange rates, even though their marginal explanatory power must be highly limited in relation to shocks of all varieties that buffet exchange rates.

Jeremy J. Nalewaik, FED: Forecasting Recessions Using Stall Speeds. This paper presents evidence that the economic stall speed concept has some empirical content, and can be moderately useful in forecasting recessions. Specifically, output tends to transition to a slow-growth phase at the end of expansions before falling into a recession, and the paper designs Markov-switching models that behave in that way. While the switching models using output growth alone produce a considerable number of false positive recession signals, adding the slope of the yield curve, the percent change in housing starts, and the change in the unemployment rate to the model reduces false positives and improves recession forecasting. The switching model is particularly good at forecasting at long horizons, outperforming Blue Chip consensus forecasts.

Ruediger Fahlenbrach, Robert Prilmeier, Rene M. Stulz, NBER: This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance During the Recent Financial Crisis. We show that banks that performed worse during the 1998 crisis did so as well during the recent financial crisis.  This effect is economically important.  In particular, it is economically as important as the leverage of banks before the start of the crisis.  The result cannot be attributed to banks having the same chief executive in both crises.  Banks that relied more on short-term funding, had more leverage, and grew more are more likely to be banks that performed poorly in both crises.

Titan Alon el al, San Francisco Fed: What Is the Value of Bank Output? Measures of the nominal value of loan services, especially mortgages, can be improved by using more accurate and consistent standards, such as risk-adjusted reference interest rates. Other challenges in measuring financial services output include calculating real lending services, and measuring real and nominal services to depositors (see Wang et al.). Ultimately, the goal is to develop measures of financial output that make it easier to study the impact of the financial sector on real economic outcomes.

Johan Almenberg, Artashes Karapetyan, NB: Mental accounting in the housing market.  We report evidence that salience may have economically significant effects on homeowners' borrowing behavior, through a bias in favour of less salient but more costly loans. We outline a simple model in which some consumers are biased. Under plausible assumptions, the bias may affect prices in equilibrium. Market data support the predictions of the model.

Jordan Rappaport, Kansas Fed: The Effectiveness of Homeownership in Building Household Wealth. These results suggest that either homeownership or renting and investing can be reasonable strategies for building household wealth. In other words, the conventional wisdom that homeownership is usually the better strategy is probably too strong. For many households in many years, renting and investing the saved cash flow has built more wealth than homeownership."

David N.F. Bell, David G. Blanchflower, IZA: Youth Unemployment in Europe and the United States. This paper focuses particularly on youth unemployment, why we should be concerned about it, why it is increasing again, how the present difficulties of young people entering the labour market differ from those of the past and what useful lessons have been learned that may guide future policy. We focus on Europe and USA, but introduce evidence from other countries where appropriate. Our analysis of the UK NCDS birth cohort data provides evidence supporting the notion that early adulthood unemployment creates long lasting scars which affect labour market outcomes much later in life. Our chosen variables are weekly wages and happiness. Our results show significant effects at age 50 from early adulthood unemployment. These affects are stronger than more recent unemployment experiences.

Lisa Joensson, Marten Palme, Ingemar Svensson, NBER: Disability Insurance, Population Health and Employment in Sweden. In this paper, we posed three main research questions. The first question was whether the development of disability insurance recipiency over the past decades can be explained by changes in the health status of the population. We found some support for this hypothesis. The analysis showed that the demographic groups with the least advantageous health development were the same groups with the least advantageous development in disability insurance recipiency. The second question was whether the changes in disability insurance recipiency can be explained by changes in the eligibility rules in the disability insurance program. For some of the changes in eligibility for older workers, we found evidence of an effect on disability insurance recipiency. The final question was to what extent the changes in eligibility rules for older workers affected employment and labor force participation. The answer is ambiguous.

Kash, The Street Light Blog: Thoughts on Europe, the US, and Fearing the Future. In general, I always felt like countries on both sides of the Atlantic were basically similarly advanced, with if anything a slight edge going to the US. Over the last year or two, however, my perception has changed. I've begun to get the distinct (albeit also purely subjective) feeling that Europeans are simply better off than Americans. That Western Europe is now more advanced than the US. What has caused this change in my perception? That's the question I'm asking myself today. I'm not entirely sure what the answer is, but let me throw out a few of the contrasts that are simmering in my mind: trains that run on time; clean and well-maintained private and public spaces; reliable wireless data services; state-of-the-art transportation facilities and infrastructure; lack of anxiety about health care costs; relative affordability of vacations abroad for average people; ambitious and far-sighted public works projects; efficient and modern cities (even when they contain many centuries-old buildings) that incorporate modern technologies and simply work.

James Cloyne, CESifo: What are the Effects of Tax Changes in the United Kingdom? New Evidence from a Narrative Evaluation. This paper estimates the effects of tax changes on the U.K. economy. Identification is achieved by isolating the ‘exogenous’ tax policy shocks in the post-war U.K. economy using a narrative strategy as in Romer and Romer (2010). The resulting tax changes are shown to be unforecastable on the basis of past macroeconomic data. I find that a 1 per cent cut in taxes stimulates GDP by 0.6 per cent on impact and by 2.5 per cent over three years. These findings are remarkably similar to the corresponding estimates for the United States. The results reinforce the view that tax changes do indeed have powerful, persistent and significant effects on the economy. Finally, ‘exogenous’ tax changes are shown to have contributed to major episodes in the U.K. business cycle.

Grover J. "Russ" Whitehurst, Matthew M. Chingos, Brookings: Class Size: What Research Says and What it Means for State Policy Education, K-12 Education. Despite there being a large literature on class-size effects on academic achievement, only a few studies are of high enough quality and sufficiently relevant to be given credence as a basis for legislative action. It appears that very large class-size reductions, on the order of magnitude of 7-10 fewer students per class, can have meaningful long-term effects on student achievement and perhaps on non-cognitive outcomes. The academic effects seem to be largest when introduced in the earliest grades, and for students from less advantaged family backgrounds.  They may also be largest in classrooms of teachers who are less well prepared and effective in the classroom.

William L. Davis, Bob Figgins, David Hedengren, Daniel B. Klein, EJV: Economics Professors’ Favorite Economic Thinkers, Journals, and Blogs (along with Party and Policy Views). First-place positions as favorite economist in their respective categories are Adam Smith (by far), John Maynard Keynes followed closely by Milton Friedman, Gary Becker, and Paul Krugman. For journals, the leaders are American Economic Review and Journal of Economic Perspectives. For blogs, the leaders are Greg Mankiw followed closely by Marginal Revolution (Tyler Cowen and Alex Tabarrok).

Tim Harford, New York Times Magazine: The Art of Economic Complexity. These diagrams are the early fruits of a new approach to the most important unsolved problem of the last century: how to make a rich country out of a poor one. Thanks to César A. Hidalgo of the M.I.T. Media Lab, we can now visualize the differences between national economies in new ways. Hidalgo is a statistical physicist fascinated by the structure of networks, and along with the Harvard economist Ricardo Hausmann, he has been developing tools designed to study not just economic wealth but also economic structure and sophistication. Hidalgo and Hausmann think of economies as collections of "capabilities" that can be combined in different ways like an Erector set to produce different products. Because these capabilities cannot be easily identified and observed, Hausmann and Hidalgo track the silhouettes that the capabilities cast upon trade statistics. If a product is a significant part of a country's exports, it offers evidence that the country has certain kinds of related capabilities.

Steven D. Levitt, Thomas J. Miles, NBER: The Role of Skill Versus Luck in Poker: Evidence from the World Series of Poker. In determining the legality of online poker - a multibillion dollar industry - courts have relied heavily on the issue of whether or not poker is a game of skill.  Using newly available data, we analyze that question by examining the performance in the 2010 World Series of Poker of a group of poker players identified as being highly skilled prior to the start of the events. Those players identified a priori as being highly skilled achieved an average return on investment of over 30 percent, compared to a -15 percent for all other players. This large gap in returns is strong evidence in support of the idea that poker is a game of skill.