SEPTEMBER 16 2011

Ryan Avent, Economist Blog: Europe, through the looking glass. The Germans, on the other hand, seem to be in complete denial. German leaders are pushing for more, rather than less, austerity, despite the damage severe cuts are inflicting on the economy. They're not too fond of greater fiscal integration, which would relieve pressure on the struggling periphery, nor are they interested in broader ECB bond purchases or an appropriately loose monetary policy. The Germans are keen on nagging southern Europe to boost its competitiveness, but they don't seem anxious to give up their persistent trade surplus. Having placed Greece in an impossible economic situation, the Germans are now ready to give up on the Greek economy entirely:

Paul Krugman, NYT: An Impeccable Disaster. Financial turmoil in Europe is no longer a problem of small, peripheral economies like Greece. What’s under way right now is a full-scale market run on the much larger economies of Spain and Italy. At this point countries in crisis account for about a third of the euro area’s G.D.P., so the common European currency itself is under existential threat. And all indications are that European leaders are unwilling even to acknowledge the nature of that threat, let alone deal with it effectively.

Barry Eichengreen, Project Syndicate: Europe on the Verge of a Political Breakdown. Europe doesn’t have months, much less years, to resolve its crisis. At this point, it has only days to avert the worst. It is critical that leaders distinguish what must be done now from what can be left for later. The first urgent task is for Europe to bulletproof its banks. Doubts about their stability are at the center of the storm. The second urgent task is to create breathing space for Greece. The Greek people are making an almost superhuman effort to stabilize their finances and restructure their economy. But the government continues to miss its fiscal targets, more because of the global slowdown than through any fault of its own. The third urgent task is to restart economic growth. Financial stability, throughout Europe, depends on it. Without growth, tax revenues will remain stagnant, and the capacity to service debts will continue to erode. Social stability, similarly, depends on it. Without growth, austerity will become intolerable. Here, too, the problem has several solutions. Germany can cut taxes. Better still would be coordinated fiscal stimulus across northern Europe.

Alberto Alesina, Francesco Giavazzi, VoxEU: The Italian situation: Clarification and a prediction. As Italy’s Prime Minister Silvio Berlusconi announces a new austerity bill based on tax rises, this column argues that the country’s leaders are in denial – it is as if they are trying to take aspirin to hide the symptoms of pneumonia. The authors predict that, with the current political class in power, Italy will soon enter another recession and, eventually, another crisis.

John C Bluedorn, Jörg Decressin, Marco E Terrones, VoxEU: Do equity price drops foreshadow recessions? There are concerns that the recent sharp drop in equity prices in the advanced economies may signal a rise in the risk of a double-dip recession. This column examines the performance of equity prices as predictors of new recessions in the G7 economies. The findings suggest that equity prices are useful predictors of recessions in most of these countries. Recent drops in equity prices suggest that the probability of a double-dip recession in France, the UK, and the US has increased substantially.

Paul Krugman, Eastern Economic Journal: The Profession and the Crisis. I’m sorry if I have painted a bleak picture of the role of economists in the crisis. Unfortunately, that's the way it looks to me. So what can be done to improve that picture? Some economists are pushing forward with new macroeconomic models that incorporate the lessons of the crisis. Me too! And by all means, let's do that. But as I’ve said, our big problem was not lack of models. There are also many calls for new economic thinking; there's even an institute dedicated to that project. Again, fine — but the biggest problem we had as a profession wasn’t failure to keep up with a changing world, it was failure to remember what our fathers learned. What we really need is a change in the destructive social dynamics that brought us to this point. And I wish I knew how to do that. But my problem is obvious: I’m an economist, and it seems that we need some kind of sociologist to solve our profession's problems.

Adam Posen, BoE: How to do more. For all the talk about monetary austerity promoting creative destruction, it does not work that way. In Japan in the 1990s for example, a period of insufficiently aggressive monetary stimulus fed the lending to zombie companies, i.e., unproductive borrowers on whose loans the banks could not afford to take losses...It was only when macroeconomic policy led a recovery in Japan in the 2000s that capital flowed out of the places it had been trapped and into new and growing businesses...Similarly, in the aftermath of the U.S. savings-and-loan crisis, real reallocation of credit from bad banks and borrowers to worthwhile investment only began in earnest when monetary policy eased in the late 1980s. In short, sometimes destruction is just destructive.

Robert Fairlie, Florian Hoffmann, Philip Oreopoulos, NBER: A Community College Instructor Like Me: Race and Ethnicity Interactions in the Classroom. This paper uses detailed administrative data from one of the largest community colleges in the United States to quantify the extent to which academic performance depends on students being of similar race or ethnicity to their instructors. To address the concern of endogenous sorting, we use both student and classroom fixed effects and focus on those with limited course enrolment options. We also compare sensitivity in the results from using within versus across section instructor type variation. Given the computational complexity of the 2-way fixed effects model with a large set of fixed effects we rely on numerical algorithms that exploit the particular structure of the model’s normal equations. We find that the performance gap in terms of class dropout and pass rates between white and minority students falls by roughly half when taught by a minority instructor. In models that allow for a full set of ethnic and racial interactions between students and instructors, we find African-American students perform particularly better when taught by African-American instructors.

James J. Heckman, NBER: Integrating Personality Psychology into Economics. What can economists take from and contribute to personality psychology? What do we learn from personality psychology? Personality traits predict many behaviors sometimes with the same strength as conventional cognitive traits. Personality psychology considers a wider array of actions than are usually considered by economists. It enlarges the economist's way to describe and model the world. Cognition is one aspect of personality broadly defined. Personality traits are not set in stone. They change over the life cycle. They are a possible avenue for intervention and policy. Personality psychologists lack precise models. Economics provides a framework for recasting the field. More precise models reveal basic identification problems that plague measurement in psychology. Such analyses show that, at an empirical level, “cognitive" and “noncognitive" traits are not easily separated. Personality psychologists typically present correlations - not causal relationships. Many contemporaneously measured relationships suffer from the problem of reverse causality. Econometric tools can be used to define and estimate causal mechanisms and to understand the causes of effects.