Archive for June 15th, 2007

Mishkin’s latest paper on Inflation

June 15, 2007

This is another exceptional stuff from this super economist and one of the best guys to explain thinngs so easily. Infact, the team in Federal Reserve is simply superb in explaining things. Be it Bernanke, Krozner, Kohn all excel in explaning complex areas.

This time it is Mishkin on his favourite topic Inflation. The paper is here .Why don’t we  have such explanations in India? I mean leave the empirical part, atleast we should have some understanding of the inflation process in India. If it is there I am not aware of it. I really don’t have words for NBER which keeps bringing so many thoughts (in form of academic papers) from the leading thinkers to people like me and all for free.

Anyways now to the paper.  The abstract says:

This paper first outlines the key stylized facts about changes in inflation dynamics in recent years: 1) inflation persistence has declined, 2) the Phillips curve has flattened, and 3) inflation has become less responsive to other shocks. These changes in inflation dynamics are interpreted as resulting from an anchoring of inflation expectations as a result of better monetary policy. The paper then goes on to draw implications for monetary policy from this interpretation, as well as implications for inflation forecasts.

I loved this on inflation persistence:

Specifically, we need to know whether inflation tends to revert quickly to its initial level, or whether the effects of the shock persist–that is, lead to a changed level of inflation for an extended period.

The most obvious way of measuring inflation persistence is to regress inflation on several of its own lags and then calculate the sum of the coefficients on lagged inflation. If the sum of the coefficients is close to 1.0, then shocks to inflation have longlived effects on inflation. In other words, inflation behaves like a random walk, so that when inflation goes up, it stays up. If the sum of the coefficients drops well below 1.0, then a shock to inflation has only a temporary effect on inflation, and inflation soon reverts back to its trend level.

The evidence for US is:

In particular, when autoregressions are run using rolling samples with a fixed width of, say, twelve years, the sum of the lagged coefficients often falls noticeably below unity as the sample advances to include the most recent data.

He further illustrates a model used in another paper:

Recent work by Jim Stock and Mark Watson (2007) provides an alternative and, to me, a quite intuitive way of thinking about inflation persistence. They estimate a model that decomposes inflation into two components. The first component, which can be thought of as the underlying trend, follows a random walk, so that shocks to this component persist indefinitely and thus affect the trend inflation rate going forward. The second component is a serially uncorrelated shock, meaning that such shocks are temporary and lead to only transitory fluctuations around the trend.

He then goes on to defend the fact that inflation expectations are very important and it is anchoring of the same which is crucial for any policymaker. Basically in a paper by a super team, it was pointed out that the role of inflation expectations is not as much as we think it to be. This wasn’t agreed by Lacker, Kohn, Poole  and now Mishkin.

Read the paper for the simplicity and the way he explains the empirical models. A good weekend read!

Lant Pritchett’s idea of development

June 15, 2007

Pritchett has one of the most unorthodox view on growth and development. (I had mentioned briefly about him here)

He says migration i.e. let the people migrate to developed countries as temporary wokers, earn a decent living and come back to their homes. Sample this (from this NYT profile):

To those standard solutions, trade and aid, Pritchett would add a third: a big upset-the-applecart idea, equally offensive to the left and the right. He wants a giant guest-worker program that would put millions of the world’s poorest people to work in its richest economies. Never mind the goats; if you really want to help Gure Sarki, he says, let him cut your lawn.

He has published a book called “Let Their People Come”, which is available for free online which puts forward most of his views. He says there are three generations of reforms:

The first generation tried everything at once — roads, drinking water, new crops — and failed through complexity. The second generation simplified: road builders just built roads; well diggers dug wells. But some villages got roads when they needed wells. And some villages got wells that did not work. Some villages got nothing because people stole the cash. The third generation program is flexible; the money can be put to many uses. It is “demand driven”; villagers decide. It is “transparent”; the accounting is posted on a bulletin board.

Further the article says:

Pritchett sees five irresistible forces for migration, stymied by eight immovable ideas. The most potent migration force is the one epitomized by Nepal: vast inequality. In the late 19th century, rich countries had incomes about 10 times greater than the poorest ones. Today’s ratio is about 50 to 1, Pritchett writes in “Let Their People Come.” The poor simply have too much to gain from crossing borders not to try. What arrests them are the convictions of rich societies: that migration erodes domestic wages, courts cultural conflicts and is unnecessary for — perhaps antithetical to — foreign development. When irresistible force meets immovable object, something gives — in this case legality. Migration goes underground, endangering migrants and lessening their rewards.

The key to breaking the political deadlock, Pritchett says, is to ensure that the migrants go home, which is why he emphasizes temporary workers (though personally he would let them stay). About 7 percent of the rich world’s jobs are held by people from developing countries. For starters, he would like to see the poor get another 3 percent, or 16 million guest-worker jobs — 3 million in the U.S. They would stay three to five years, with no path to citizenship, and work in fields with certified labor shortages. He assumes that most receiving countries would not allow them to bring families. Taxpayers would be spared from educating the migrants’ kids. Domestic workers would gain some protection through the certification process. And a revolving labor pool would reach more of the world’s poor.

However, he has opposers to his idea:

One of those people is Jeffrey D. Sachs, director of the Earth Institute at Columbia University. “Separation has spread adultery, divorce and AIDS across the developing world. “It’s tragic!” he said. “Let them come as a family! Having tens of millions of men separated from their families in temporary living conditions is hardly going to be conducive to the kind of world we’re aiming to build.

The best words come from Summers:

Lawrence Summers, Pritchett’s old mentor, said Pritchett’s book may be like Milton Friedman’s “Capitalism and Freedom,” which seemed “lunatic in the moment” but won converts with time. Still, he wonders if the West can create migrant subcastes without compromising its values and fears that voluntary compacts do not solve the moral problem.

It is phenomenal that the debate on how to reduce inequality and help development is finding may takers and such diverse and well-thought out points. A must read ….both the article and Pritchett’s book….

Assorted Links

June 15, 2007

1. Dani Rodrik defends Chinese Industrial model. The paper he provides reference to looks like a good read.

2. Finance Professor attributes the recent buying-spree behaviour akin to dinosaurs.

3. Mahindra-Renault planning a less than Rs. 1.5 lakh car. What about the roads? July 2007 issue of Bloomberg raises the same question (subscription reqd). Have any of the auto-majors gone to samm towns to see how messy it has already become. They can say that roads is not their problem. But then that is what Corporate Social Responsibility is all about.

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