Archive for January 30th, 2010

Economics stands for….

January 30, 2010

Greg Mankiw points to an email he has received from an economics professor Gordon Boronow. Boronowhas created an acrostic device to remember what economics stands for. He adds exclaimation marks at the end. Here it goes:

Ten Key Principles in Economics

Everything has a cost. There is no free lunch. There is always a trade-off.

Cost is what you give up to get something. In particular, opportunity cost is cost of the tradeoff.

One More. Rational people make decisions on the basis of the cost of one more unit (of consumption, of investment, of labor hour, etc.).

iNcentives work. People respond to incentives.

Open for trade. Trade can make all parties better off.

Markets Rock! Usually, markets are the best way to allocate scarce resources between producers and consumers.

Intervention in free markets is sometimes needed. (But watch out for the law of unintended effects!)

Concentrate on productivity. A country’s standard of living depends on how productive its economy is.

Sloshing in money leads to higher prices. Inflation is caused by excessive money supply.

!! Caution: In the short run, falling prices may lead to unemployment, and rising employment may lead to inflation.

Amazing this….Thanks Prof. Boronow.

Why europe based economists prefer to study/work in US?

January 30, 2010

Guy Sorman has written a nice article on Europe based economists (HT: MR and Economix).  It discusses why large number of Europe based economists moves to US to study and prefer to stay in US after their studies as well.

Some facts:

One-third of the faculty of Harvard University’s economics department hails from Europe. At the University of Chicago’s Booth School of Business, half of the finance department’s faculty is European. And these schools aren’t alone: European economists are overrepresented at all first-tier American universities and have had a huge influence on economic thinking, doing cutting-edge research in areas ranging from modeling financial markets to assessing risk.

Why?

(more…)

Importance of institutional design for monetary policy

January 30, 2010

Mervyn King gave a speech in 2004 on importance of institutions of monetary policy.

I argue that it is useful to think about the optimal design of monetary institutions using the insights  from the theory of incomplete contracts. The core of the monetary policy  problem is the uncertainty about future social decisions resulting from the successors to any given monetary policy strategy. The impossibility stems from the observation that collective decisions cannot be enforced so that it is impossible to commit to future collective decisions. The undesirability reflects the fact that we cannot articulate all possible future states of the world.

Monetary institutions expand the possibility frontier of the technology of collective decisions by raising the costs of making inefficient deviations from pre-announced paths. I illustrate the importance of institutional design for the operation of monetary policy by reference to three case studies: the collapse of exchange rate regimes in Brazil and the United Kingdom; currency arrangements in Iraq and their reform after the 2003 war; and the relationship between central banks and governments when the zero constraint on nominal interest rates is binding.

Very interesting case studies. Especially of currency arrangements in Iraq. There were 2 currencies in Iraq in 1991 – one known as Swiss Dinar in North Iraq and Saddam Dinar in South Iraq. Saddam Dinar was backed by government but not Swiss and still remained a currency! How the two move because of changes in political regime is fascinating stuff.

However, for current times the 3rd case study is more appropriate. King says:

The interplay between monetary policy and debt management may not matter too much when short-term interest rates are positive because the central bank can control the level of interest rates, even if debt management affects the optimal level of rates. But when rates are at their zero bound then the central bank no longer has instrument independence. Indeed, because its actions can be offset by appropriate sales or purchases in the government debt market, it loses goal independence too. It becomes crucial that fiscal and monetary authorities cooperate.

Interesting again. I never thought it this way. In ZIRP, central bank loses both instrument independence (as rates are zero) and goal independence (what goals as finance ministry/treasury  rules!).  Read the case study of Japan in this context.


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