Archive for August, 2008

Citibank India and Akerlof

August 20, 2008

I came across this interview of Indian Bank heads on the interest rate scenario, bank lending etc.

Citi India head Sanjay Nayar responds to this question:

Q: In this high interest rate environment, how will you plan to manage your profitability and balance sheet growth?

SN: As money gets dearer, we are becoming very selective to whom we give out loans.The basic driving principle to lend is that the individual has to be a Citi client either today or a client worthwhile for us tomorrow, where we get long-term sustainable revenues.
Read the words in emphasis (emphasis is mine). It is classic Akerlof’s theory of information asymmetry.   As interest rates rise, so does the problem of adverse selection (whom to give) and Banks are never sure whether the borrower will pay back the loan. In times of higher int rates, people with good projects will wait for rates to ease, but one with bad projects might be more willing as he/she has nothing to lose. If latter is selected,  the chances of moral hazard (knowing he has nothing to loose, he might take more risks) also increase.
Great to see your concepts being revised reading newspaper articles.

IFMR conference on food prices and poverty

August 20, 2008

IFMR, Chennai is organising a conference titled Rising food price and its implication on Poverty’ in their campus on 23 August 2008. The agenda and details of the conference are here.

The conference is divided into 3 sessions. First , at macro level -impact of WTO on food prices etc. Second at a micro level – impact of food prices on poor. Third one is on alleviating poverty in India. I am participating as a discussant in the conference and will be discussing the papers presented in the 3rd session.

I will keep you posted on the thoughts shared in the conference.

Assorted Links

August 20, 2008

1. WSJ Blog points Fedspeak- Richard Fisher (always a must read), It also points to Chinese Monetary Policy report

2. Frankel has a fantastic post on moral hazard.

3. ASB points optimism in Indian growth prospects

4. Someone’s forecasts are going right- Prof TTR

5. IDB on for-profit microfinance

6. ACB points to a superb finding- what happened to Citi furniture? :-). Also read the post on cash transfers

7. FCB on beer and research

8. DBB on Doha Round. It also says corruption indices don’t measure corruption.

Dr Doom- A profile of Nouriel Roubini

August 18, 2008

I came across this excellent profile of Nouriel Roubini (free subscription required). I had pointed his talk at IMF in September 2007 here. In Sep 2006 amidst the IMF audience he had predicted the subprime crisis and all laughed him off. In Sep 2007 in similar IMF setting , people listened to him with a lot of fanfare.

The entire article is very interesting and is a must read for all. It tracks his career, his early work, his influences and his work. His view of Keynes:

Roubinialso cites, as a more ideologically congenial example, the sweeping, cosmopolitan approach of the legendary economist John Maynard Keynes, whom Roubini, with only slight exaggeration, calls “the most brilliant economist who never wrote down an equation.”

Quite true. Keynes had so many ideas that he did not need to write an equation. His view on financial system:

For months Roubini has been arguing that the true cost of the housing crisis will not be a mere $300 billion — the amount allowed for by the housing legislation sponsored by Representative Barney Frank and Senator Christopher Dodd — but something between a trillion and a trillion and a half dollars.

But most important, in Roubini’s opinion, is to realize that the problem is deeper than the housing crisis. “Reckless people have deluded themselves that this was a subprime crisis,” he told me. “But we have problems with credit-card debt, student-loan debt, auto loans, commercial real estate loans, home-equity loans, corporate debt and loans that financed leveraged buyouts.” All of these forms of debt, he argues, suffer from some or all of the same traits that first surfaced in the housing market: shoddy underwriting, securitization, negligence on the part of the credit-rating agencies and lax government oversight. “We have a subprime financial system,” he said, “not a subprime mortgage market.”

(Emphasis is mine).

Monetary policies should also look at quantity based inflation

August 18, 2008

In a graduation course in economics, we cover basics of indices. There are two kinds of indices- price based and quantity based.

In Price based we keep quantities constant and measure the changes in price levels. In Quantity based, we keep prices constant and instead measure the changes in quantities. Price based have become popular and are used to measure price levels (inflation), change in stock prices etc. The quantity based indices have lost their relevance and at most you might be asked to calculate quantity based changes in the final exam. However, it is important to use quantity based indices as well especially in these inflationary times.

We often get to hear about firts, second and third round of inflationare pressures. This means say prices of fuel goes up then first it will show in direct fuel prices (first round), then in other products and services (as companies revise their prices; second round) and then in wages (as employees put pressures to increase wages as expenses increase;third round).

While discussing second round effects, we often say companies might not raise their prices. Higher prices imply lower consumption which imply lower revenues/profits. Hence, companies try and bear (postpone) the initial rise in inflation. So, we say the second and third round effect are highly uncertain and come with a huge lag.

Despite the competition, I keep wondering how do companies manage to keep prices low especially in such inflationary times. They are surely not here to do any charity. However, truth is second round inflation has already happened (and is happening for others in an indirect way.

On frequenting the various retail stores and observing the prices and quantity, I have noted that most companies that have not lowered the prices have instead lowered the quantities. Consumers are paying the same price for a lower quantity and indirectly are paying more than they were paying earlier for the same weight. This is nothing but higher inflation.

People usually notice and track prices but not quantities. The package sizes hardly change and a consumer feels he gets the same quantity. Infact, these days art of packaging has become so good that one might feel he is getting more when the actual quantity is reduced!!

This news from Hindustan Times (April 9, 2008) confirms the developments:

Next time you visit your neighbourhood kirana store, be sure to read the fine print on the packets. Maggi noodles, which always came in the familiar 100 gram pack, have gotten lighter by 5 grams. A 250 g pack of Red Label tea has slimmed down to 245 g. In both cases, prices have remained the same: Rs 10 for the noodles, Rs 52 for the tea.

This trend has caught up with most companies and most items you get are lower value for your money compared to say in 2007.

I was also wondering companies do advertise on their packs – lower prices, more value for same price etc. Why don’t they say (if not advertise) that consumers would get lower quabtity for the same price? Isn’t this misleading?  Surely consumers should know of the developments. The advertising should be symmetric and should tell consumers that they are getting lower value for money than previously.

That is why, I think it will be useful to also have quantity indices and track them in these times. Price inflation and quantity inflation should together tell us how much actual inflation is affecting the consumers.

Assorted Links

August 18, 2008

1. WSJ Blog points to  a paper which says people are optimists. It also points NBER calls recessions in US, who does it in Euroarea?  

2. Krugman says inflation should ease  

3. ASB on inequality

4. IDB points how people use microloans

5. ACB on impact of commodity prices. Also read this post– tigers or tatas?

6. MR points– Roubini is Dr Doom. Krugman also ponders over Roubini. It also asks why India has won so few medals in Olympics

7. FIn Prof points that shortselling restrictions did not work in US

8. FCB points inside mind of an investor. It also points why oil prices have fallen?

9. PSD Blog points credit-card defaults in US are proving to be a boon for India

10. DB Blog on Colombia reforms

11. Econbrowser says there is nothing to worry about recent US inflation

EAC releases economic outlook 2008-09

August 14, 2008

The Prime Minister’s Economic Advisory Council released the economic outlook for 2008-09. Here are a few highlights:

The Council projects that the Indian economy will grow by 7.7 per cent during 2008/09. Considering the magnitude of the adverse economic developments in 2008, the projected drop from 9.0 per cent last year to 7.7 per cent this year is in fact modest.

Savings and Investment:
In 2008/09, the overall savings rate will for the first time in recent years be significantly lower than the investment rate – reflecting an expansion in the rate of net absorption of foreign savings (that is, the current account deficit).

Current Account Deficit
The projected value of merchandise exports and imports is $ 208 and $342
billion respectively, leaving a BoP merchandise trade deficit of $134 billion, equivalent to 10.4 per cent of GDP, a sizeable increase from 7.7 and 7.1 percent in the last two years.
Total net invisibles are expected to increase by 27.5 per cent (compared to 31.4 per cent last year) to $92.7 billion. As a result the Current Account Deficit (CAD) is likely to expand to $41.5 billion, equivalent to 3.2 per cent of GDP – a major increase from 1.5 per cent of GDP in 2007/08. We estimate that the CAD/GDP ratio may be above 4.5 per cent

Capital Flows
Aggregate FDI inflows are estimated at $ 19.7 billion. Portfolio inflows
are estimated to be $4.1 billion in 2008/09, which is very large reduction from 2007/08. Net inflows on account of loans are expected to be $34 billion, about 19 per cent lower than in the previous year primarily due lower ECB/FCCB inflows. Net banking capital inflow and inflows under “other capital” are expected to be 50 percent lower than the previous year. Our estimate of total capital inflows in 2008/09 is $70.9 billion, which is 34 per cent less than in the previous year. This will however be more than adequate to finance the enlarged CAD, leaving about $29 billion to accrue in the foreign exchange reserves of the RBI.

The Council is of the view that co-ordinated policy action, coupled with some reinforcement of the recent cooling evident in world commodity prices and monetary actions by other central bankers can help bring the rate of inflation down by the end of March 2009 to 8 to 9 per cent. However in view of the large backlog of fuel price adjustments achieving a reduction to 7 per cent will take considerable effort and a confluence of favourable factors.

Fiscal Deficit
There are however serious fiscal risks arising from growing off-budget liabilities on account of fertiliser, food and oil, along with unbudgeted liabilities arising out of the farm loan waiver and NREGA schemes and the implementation of the Sixth central P ay Commission. These liabilities could amount to 5 per cent of the GDP in 2008/09, over and above the budgeted central fiscal deficit of 2.5 per cent.

So, after 5 year average of 8.8% EAC expects to see a 7.7% growth in 2008-09. The moderation seems to be hitting Indian economy. The savings are expected to decline and with similar investment levels, we should see more absorption of foreign savings and less of a problem for central bank.

What is more surprising is the way FII inflows have deserted Indian economy. The expected inflows are USD 4.1 bn lower than 29 bn received in 2007-08. I am wondering where did the India a sustainable growth story disappear? In these times we should see more inflows in equity markets as equity prices are much lower but what we see is the opposite. Does that mean Indian story has disappeared? No, it hasn’t as even with 7.7%, India will be one of the fastest growing economy in present times.

What is worrisome is also the fiscal deficit number. EAC says with all the off-balance sheet items, it is expected to be 7.5% of GDP (2.5% projected and 5% off-balance sheet items). This is indeed a very high figure and markets will be keenly looking for these numbers.

EAC also points to the inconsistency in the IIP numbers:

The fundamental problem with anecdotal evidence is its partial nature. It can therefore run counter to what a more broad-based indicator such as IIP would throw up. There are some problems associated with the antiquated base ye


It expects output growth in basic and intermediate goods at a pace possibly higher than being reported by the IIP. For example, cement production data shows growth of over 14 per cent in the April–June quarter of 2008/09, while the IIP data for the corresponding 2-digit category (non-metallic minerals) reports growth of 1.4 per cent during April & May 2008.  

ar. Clearly, the IIP base year and classification categories are in need of urgent revamp.

I have posted earlier about the need to revamp IIP indices but my arguement was mainly consumer durable goods.  Most consumer durable goods consumed now  like DVD players, mobile phones etc are not part of the index. Likewise, capital goods required to produce these items are also missing. So, we see a much lower growth in consumer items. Now, with these classification problems, it seems the growth is higher than the released figure.

Assorted Links

August 14, 2008

1. WSJ Blog points to Greenspan interview. It also points inflation hawks in US appear subdued.

2. TTR points to failings of HBS.

3. ACB points – “even our best institutes produce indifferent research”

4. NB points to a speech favoring applying beh eco to social security

5. PSD Blog points Financing the next Silicon Valley.

Fab Four- Fab no more

August 13, 2008

Mostly Economics has been discussing sports quite frequently recently. This does not imply that economics is taking a backstage but will continue to be at the centre.

Another test match, another failure of India’s middle order – Rahul Dravid, Sachin Tendulkar, Saurav Ganguly and VVS Laxman. . It is called Fabulous Four (Fab 4) by the cricket experts as having such a batting line-up is enough to give any side headaches. They have been a part of some good Indian and a part of away victories (see this analysis of India’s test records at home and away; the record away has improved dramatically after 2000). However, their performances recently have been very disappointing and questions need to be asked.

With such a batting line up, the recent performances have been so bad that one only feels ashamed. I can understand India not winning test matches as we don’t have quality bowlers (that is a myth as bowlers have usually done a good job if batters have put up a decent score to defend) but the dramatic collapses have ensured we have only lost them. And this is not a one time issue but has been happening quite frequently.

After a spectacular failure at Melbourne in 2007, Sydney in 2008 (though the test was highly controversial, what was still unexplainable was they couldn’t last one session), Ahmedabadin 2008 (against South Africa where they made just 76 runs in Ist innings) and now the 2008 seriesagainst Sri Lanka. What has been common is the horrible performance of Fab 4. Time and time again it has been seen that there is nothing fab about them but should instead be called Brittle- 4, shaky – 4 , etc (even Krazzy – 4  as they don’t realise their true potential and keep committing harakiri on the cricket pitch)

Some might call my reaction as overreaction as they have won many a golden test matches for India. Agreed. But have they won enough? Having so much experience and given such a long run, we should have won many more matches especially in recent times and not lost is such humiliating fashion. The recent loss in Sri Lanks was the third worst defeat in India Test Cricket History and we could barely score half of runs scored by Sri Lanka in first inning.

Some have said BCCI does not learn its lessons and always makes the Indian team have a very tight schedule and less practice matches. Point taken but these guys should not take so much time to adjust. Nor are the three part of the one-day series and clearly have much more rest than the others.

All in all high team to infuse some fresh talent in Indian test cricket. At the most we will loose many and win some, which we are doing anyways.

Assorted Links

August 13, 2008

1. ASB points to a new paper which predicts Indian inflation better

2. TTR doesa reality check on subprime crisis

3. AC points economics at Elton John concert 🙂

4. MR points to a new paper on CEO compensation. Also see economists want to be rockstars and vice-versa

5. NB points to a review of Nudges book

6. Mankiw pointsto a fantastic article from Marty Feldstein

Assorted Links

August 13, 2008

1. WSJ Blog points leave out exports and US recession would have been a no brainer

2. Fin Prof points to a fantastic paper on behavioral biases and macroeconomy

3. ASB pointsto an article on capital account liberalisation

4. TTR reviews allowing foreign banks in India. He also asks a question to Philip Purcell, former chairman of Morgan Stanley 🙂

5. PSD Blog on University ranking

6. A fantastic blog returns –Macroblog

7. Econbrowser askswill as oil prices fall, will Americans reverse their energy consumption

An update on world economy

August 12, 2008

I had pointed to a presentation showing trends in Indian economy.

I came across this superb update from Dallas Fed on trends in world economy. It majorly covers US, UK and Spain. Dallas Fed has very interesting economic updates full of charts and graphs. This one is another one.

A good presentation on Indian Economy outlook and trends

August 12, 2008

I came across this very useful presentation by Dr. Arvind Virmani, Chief Economic Advisor, Finance Ministry of India.

He explains the trends in several economic indicators – growth, inflation, investment, savings, capital flows etc . Though, I prefer speeches/papers to PowerPoint presentations as one never really understands the entire idea in latter. Still, this ppt is very good as it has some fantastic graphs and lucid flow.


I keep getting mails from people asking me to send them presentations on outlook on Indian Economy for next 6 months, 1 year etc. I am sorry I don’t have links to any. If I come across, I will add them.

SEBI fines i-bankers for shoddy work

August 12, 2008

This newspiece from ET caught my eye. It says:

Capital market regulator SEBI is set to impose penalties on some of India’s top investment bankers for what it considers “shoddy work” done by them while handling public offerings over the past few years. The regulator’s Market Intermediaries Regulation and Supervision Department (MIRSD) has uncovered serious shortcomings in the due diligence process for initial public and rights offerings, besides open offers, carried out by seven investment bankers — Kotak, Enam, DSP Merrill Lynch, SBI Caps, HSBC, Keynote and Aryaman Financial.

The word shoddy and all big names associated with i-banking being fined is serious stuff. There was a mad rush for IPOs in 2006 and 2007 and some lax in standards can’t be ruled out. There were many companies whose IPOs were questioned by several analysts but still received huge subscriptions.

This development is not yet on SEBI website and it will be interesting to see any such official release on the topic.

Economics PhDs In India becoming a scarce commodity

August 11, 2008

I have raised numerous concerns over declining research standards in India ( See  Indian academia salaries- Too low or too high?, A request to India’s Ivy Leagues- show us some research, Deciphering the B-school ranking in India etc) .

This recent Business Standard article further confirms my views and extends the scope of discussion from B-Schools to Economics departments/ Schools.

D K Srivastava, director of Madras School of Economics (MSE), is disappointed when he sees 50 Master’s students graduate every year with lucrative job offers. MSE admits two or three students every year for its doctoral programme, a third of what it can accommodate. Aggregate data on the number of students completing their PhD in Economics are not available.

Even the Indira Gandhi Institute of Development Research (IGIDR), a premier institute set up by the Reserve Bank of India (RBI) for research in development issues, found it difficult to attract students for its PhD programme a couple of years ago.

What are the reasons?

Three issues — faculty profile, poor scholarship funding and job opportunities — are being cited as reasons Indian universities have failed to attract good quality students, said four economists, including three heads of the institutions, who were contacted for this article.

Apart from scholarships, the faculty profile and the syllabus play an important role in attracting students. “What I learnt ten years ago is not even offered here in India,” said Parth J Shah, economist and former professor of Economics at the University of Michigan.

The opportunity cost of doing a PhD is huge:

Students graduating from Master’s programme in MSE and IGIDR get job offers in the salary range of Rs 6 lakh and Rs 8 lakh a year — mostly from banks, financial institutions and consultancies. Candidates even after completing the PhD would get only Rs 50,000 more than what a Master’s level students would get, said IGIDR’s Nachane.

“The opportunity cost for a student with Masters Degree to pursue a PhD in economics is very high,” he added referring to Rs 6 lakh salary the PhD student would have earned for four years, if employed.

So, is it that people are not interested in doing PhDs? Not really. Most head west.

For the few students who want to pursue a PhD, foreign universities have emerged as a viable option. These overseas institutions are targeting Indian students and are offering liberal scholarships that are hard for Indian counterparts to match, said D M Nachane, director of IGIDR.

Overall pretty worrisome times. With so many IITs and IIMs coming up, one keeps wondering where the faculty will come from. But obviously they are interested only in big P- placements. As long as they are good, rest can be ignored.

I was talking to a friend who tracks these colleges and was asking him about the fellowship programmes at the IIMs. He said the same there is no point as industry does not value it. He said exactly the same after five yeasr you get the same salary as you get in a Master’s program. But the same industry values the MBA/Masters in economics programs highly. I keep wondering how can doctoral programs be inferior than master’s program. What is going on?  

A big problem in education that has surfaced in India is brands. What matters is not what you know but from which school/college you are. The post graduate programs are considered a brand from some school but not doctoral programs. For doctoral programs the fancy thing is to get it from a US based University. Even the Indian Universities value the foreign degrees more and it is easy to see most faculty has done its PhD abroad. So, a PhD from India suffers on both counts. Neither the corporate guy takes him/her, nor is he/she preferred in the academia. So, people either join industry after masters or go abroad for PhD. I really don’t know how can we get out of this rut.


I was just thinking how can Indian econ departments/B-Schools get out of this “no research/hardly any research” problem. Let me take a cue from one of the most taught management strategy models – BCG Matrix

I think they need to acknowledge that  they have ignored PhD/research for a while and instead concentrated on Master’s programs. These programs were Stars (Shooting Stars is more appropriate)  and had high growth rates and high market shares. These stars have become the cashcows and have got these schools some revenue and recognition.

Now, is the time to focus on research which is a dog/question mark and move it to a star category. It is research that makes the quality of teaching superior and will ensure that cash cow (master’s programs) continues to remain one. If you do not have good teachers the cow will soon die an abrupt death.

Another point is the application forms. I have looked at quite a few forms and find the entire process pretty cumbersome. I don’t understand the case for the same. With such dismal enrollment these standards can be simplified. Prospective students should be asked to fill a simple form and interviewed. Once this is clear, the other formalities can be submitted (attested mark-sheets, referral letters etc.)

Most of these forms also have a Statement of Purpose (SoP) which is simply a concept borrowed from the US universities. The US universities have SoP  as they get applications from all over the globe, so they need to sort out applicants. This is not the case here and reason etc for doing PhD discussed can be discussed in the interview itself. Anyways SoP writing does not achive the purpose as I am sure most is cliched stuff and with plenty of advice on the web, most SoPs would be very similar. To seperate serious from non-serious applicants, an interview would be needed anyway.

Rodrik on development

August 11, 2008

I came across this superb interview of Dani Rodrik. It very neatly covers his research and summarises his views on development.

Check his take on Washington Consensus:

When the original Washington Consensus was first enumerated by John Williamson, almost all of the items on the list were relatively simple policy measures; they didn’t have a very strong institutional background. Things like price liberalization, opening up to trade, having a realistic real exchange rate, eliminating financial repression, none of these really required institutional investments. They really did not recognize that what was really important was the institutional underpinnings.

However, number ten on the agenda, was “Secure Property Rights”. And the history of this is interesting because, actually, that was an after-thought for John Williamson. When he had first listed all the things he had then on the agenda, he came up with nine. Of course, that was not a round number, so he said: “I better come up with a tenth item!” and the tenth item, number ten in the list, was Secure Property Rights! Secure Property Rights is a clear institutional recommendation; that’s the foundation, many people would say, of long-term prosperity.


First individual Gold medal for India

August 11, 2008

I have been waiting for the moment all my life.

Abhinav Bindra wins the first ever individual Gold medal for India in Beijing Olympics 2008. He achieved the feat in 10 m Air rifle beating China and Finland shooters.

As a kid I always flipped newspapers to see the medal tally of India and was always disppointed. Somehow we managed one medal in every Olympic to keep us away from the Nil scoreboard. The prayers were to see one medal and that was it. Last time a Gold came was in 1980 and that was in hockey.

Things changed a bit when Leander  one Bronze in 1996, Rajyaarhan Rathore won Silver in Athens 2004 and now Bindra wins Gold in 2008.

It was a superb feeling to hear the National Anthem play when Bindra received the medal. Goose pimples all around. Thank you Abhinav Bindra for giving us this moment.

Assorted Links

August 11, 2008

1. WSJ Blog points to Olympic predictions.

2. Mankiw points to comments on impact of fiscal stimulus

3. DB Blog points to the World’s most expensive city – Luanda

4. Has dollar depreciation impacted oil prices. Find out from Hamiton

Human Behavior leads to poor forecasts

August 8, 2008

I came across an excellent paper from Prakash Loungani and Jair Rodriguez of IMF. The paper reviews the forecasting experience of various private forecasters in forecasting recessions.

The findings:

 Only two recessions were predicted a year in advance and one of those predictions came toward the turn of the year, as shown in column 3 of Table 2. Requiring recessions to be predicted a year ahead may seem like an unreasonably high bar to set. Lowering the bar to the start of the year in which the recession occurred does indeed improve the performance somewhat: 8 of the 26 recessions were predicted in February of the year in which they occurred and 16 were predicted by August. But even as the year drew to a close, 6 of 26 recessions remained undetected by forecasters.

Moreover, while forecasters increasingly start to recognize recessions in the year in which they occur, the results in column 4 show that the magnitude of the recession is underpredicted in the vast majority of cases. For instance, even as late as December of the year of the recession, the forecast is more optimistic than the outcome in 15 cases.

The remaining columns of Table 2 show the average forecast error at the different forecast horizons over all 26 episodes and also for the G7 and EM7 countries separately. Note that average forecast errors continue to be quite substantial even for forecasts made fairly late in the year of the recession. For instance, in August the average forecast error is 0.6 percentage points for industrialized countries and 2.4 percentage points for developing countries.

In all forecasting has been as Bernanke in his speech (November 14, 2007) said:

 The only economic forecast in which I have complete confidence is that the economy will not evolve along the precise path implied by our projections.  Nevertheless, as I have already noted, because policy affects spending and inflation with a lag, Committee members have no choice other than to make medium-term forecasts–provisional and subject to uncertainty though they may be.


Now, what were the reasons for the misses?


The tendency not to revise forecasts promptly, while particularly costly in a recession, is a feature of forecasts in all years. Our inspection and analysis of forecasts for the 14 countries in non-recession years shows that forecasts are revised in a very smooth fashion: the forecast revisions—the changes in the forecast between successive horizons—are smooth.


Meaning people keep sitting and don’t revise forecasts. In a shorter article Loungani explains:


Efficient forecasts, Nordhaus showed, “appear jagged because they incorporate all news quickly. Inefficient forecasts appear smoother … for they let the news seep in slowly.”

This tendency to smooth forecasts excessively is particularly costly at present, when some economies around the globe appear poised at turning points and could experience outright recessions or marked slowdowns. Making predictions at turning points requires unusual alertness on the part of forecasters to incoming economic information and a willingness to raise alarms about possible recessions, even at the risk that some of these calls will turn out to be wrong. However, the evidence shows that forecasters are unwilling or unable to signal that the economy is heading for a recession until one is absolutely imminent; and even then they initially underestimate the extent of the decline.

The authors also show people are slow to respond to not just national news but also foreign news and as a result we have the decoupling theory going for a lot longer than the reality.

The questions authors don’t answer is why do forecasters not revise their forecasts often? I mean news is all over the place these days and still teh revisions do not happen. Why? Let me throw two answers to it – Both from field of behavioral economics.

First reason is overconfidence , which I have explained here. The main tenet is economists suffer from overconfidence bias and think their outlook is supreme. The nature of the job is also such that unless they display confidence no one will hear them.

Second, which is more relevant to the above experiment is that people ignore negative news a lot longer than positive news. This is called extreme aversion. This bias leads people to hold loosing stocks and sell winners (expecting them to rebound) and in this case hold on to the negative news a lot longer than is needed.

Third, people suffer from anchoring bias and rely much more on the past trend than new development. their Infact, I have shown earlier that forecasters in India do not revise their forecasts even amidst high growth and as a result their forecasts were much lower than actual. It is only when the high figure becomes quite apparent do they revise their forecasts upwards.

The paper raises concerns but I don’t see this behavior correcting. It is human nature and will take a lot of time to change. I have made a case earlier as well that in order to improve forecasting we need some accountability.  The economists/analysts need to also project how likely is it that this forecast doesn’t happen. This will also help people make their own estimates and not rely blindly on the experts. Second, we need to keep official scores of either same economist or similar such predictions.

Anyways, a fantastic paper and tells you much more about forecasts going wrong in a simple manner. It is unlike those papers where only lesson you get is the model was wrong.

But still I don’t know why did the authors give behavioral economics a miss. I mean they could have just thrown these ideas for future researchers. I think one of the main reasons is most economists still don’ give importance to behavioral economics. It is high time this attitude is changed.

Assorted Links

August 8, 2008

1. A new blog – Awkward Corner

2. WSJ Blog points to a debate on should Fed announce inflation targets. It points to a paper which says Fed moves beat stimulus.This is surprising.

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