Archive for September 4th, 2009

Blogging going to be weak next week onwards

September 4, 2009

As I go on a leave for a week, the blogging is likely to be very weak. The blogging will resume from 14 Sep 2009 onwards.

Bye till then. Meanwhile keep posting your comments on the previous posts. And also let me know of any suggestions to make Mostly Economics a better place.


Us National Security issues during great depression and current crisis

September 4, 2009

Martin Feldstein can clearly extend his career to a top security strategeist. I had long ago posted about his papers/articles on terrorism which had given me an economics perspective on terrorism and institutions needed to counter it.

His new paper (cant locate the free version) reviews how this crisis poses issues for US national  security.He compares the security threats post great depression and now. The abstract says:


Krugman thrashing economics and economists

September 4, 2009

Paul Krugman this time in this very long article. Though much of what Krugman says is well known by now and discussed by many . But is still a must read. And when Krugman writes purely on economics you can just push everything for laters. He is such a gifted writer and economist. In this he takes you on a journey of economic history and how the various  thoughts shaped up.

The focus of the article is on Monetarists vs Keynesian (moves later in the article to freshwater econs vs saltwater econs) and how the first group just doesn’t understand second one.  He says how the economic profession has been blinded by the idea of free/perfect markets with rational beings ignoring recessions/crisis from the models. He points to important research papers which led to the beliefs which had captured all. He also points to those key ideas which argued otherwise but were ignored.

He says the way out is to re-embrace Keynesian ideas:

So here’s what I think economists have to do. First, they have to face up to the inconvenient reality that financial markets fall far short of perfection, that they are subject to extraordinary delusions and the madness of crowds. Second, they have to admit — and this will be very hard for the people who giggled and whispered over Keynes — that Keynesian economics remains the best framework we have for making sense of recessions and depressions. Third, they’ll have to do their best to incorporate the realities of finance into macroeconomics.

He has some kind words for behavioral economics as well:

Economics, as a field, got in trouble because economists were seduced by the vision of a perfect, frictionless market system. If the profession is to redeem itself, it will have to reconcile itself to a less alluring vision — that of a market economy that has many virtues but that is also shot through with flaws and frictions. The good news is that we don’t have to start from scratch. Even during the heyday of perfect-market economics, there was a lot of work done on the ways in which the real economy deviated from the theoretical ideal. What’s probably going to happen now — in fact, it’s already happening — is that flaws-and-frictions economics will move from the periphery of economic analysis to its center.

There’s already a fairly well developed example of the kind of economics I have in mind: the school of thought known as behavioral finance. Practitioners of this approach emphasize two things. First, many real-world investors bear little resemblance to the cool calculators of efficient-market theory: they’re all too subject to herd behavior, to bouts of irrational exuberance and unwarranted panic. Second, even those who try to base their decisions on cool calculation often find that they can’t, that problems of trust, credibility and limited collateral force them to run with the herd.

It is a Krugman Special on the crisis. Especially his summarising (to be precise making fun of) of key papers which have led to much of eco thinking is quite a read. Sample this on Ed Prescott works on business cycles:

By the 1980s, however, even this severely limited acceptance of the idea that recessions are bad things had been rejected by many freshwater economists. Instead, the new leaders of the movement, especially Edward Prescott, who was then at the University of Minnesota (you can see where the freshwater moniker comes from), argued that price fluctuations and changes in demand actually had nothing to do with the business cycle. Rather, the business cycle reflects fluctuations in the rate of technological progress, which are amplified by the rational response of workers, who voluntarily work more when the environment is favorable and less when it’s unfavorable. Unemployment is a deliberate decision by workers to take time off.

Put baldly like that, this theory sounds foolish — was the Great Depression really the Great Vacation? And to be honest, I think it really is silly. But the basic premise of Prescott’s “real business cycle” theory was embedded in ingeniously constructed mathematical models, which were mapped onto real data using sophisticated statistical techniques, and the theory came to dominate the teaching of macroeconomics in many university departments. In 2004, reflecting the theory’s influence, Prescott shared a Nobel with Finn Kydland of Carnegie Mellon University.


Must must read. And yes don’t miss the cartoons on top of the page.

Can term spreads lead to recessions and output

September 4, 2009

St Louis Fed has another great publication called Review (apart from economic synopses). Review comes once in every 2 months and is usually based on a theme. However, there are times when just assortment of articles is covered.

In the latest review (Sep-Oct 09), there is an excellent literature survey on the topic – do term spreads help predict economic activity. Term spread is the difference between yields of long term government bonds and short-term bonds. The authors explain the basics and cover a lot of empirical literature. The broad findings are:

  • Does the yield spread forecast output growth? Does it forecast recessions? The answer to both questions is a on estimation of linear forecasting models using qualified “yes.” Early studies based  on estimation of linear forecasting models using  postwar U.S. data, as well as several recent studies, find that the term spread forecasts output growth well.
  • Much research finds that the term spread is useful for forecasting output growth, especially at horizons of 6 to 12 months, and that the term spread remains useful even if other variables, including measures of monetary policy, are added to the forecasting model.
  • However, several recent studies also find considerable variation in the ability of the spread to forecast output growth across countries and time periods.
  • In particular, several studies find that the spread’s ability to predict output growth has diminished since the mid-1980s.
  • In general, studies show that the term spread is a more reliable predictor of recessions than of output growth and that the spread provides good recession forecasts, especially up to one year ahead.
  • Several studies note that the relationship between the nominal yield curve and future economic activity is likely to depend on the nature of the monetary regime, including the relative responsiveness of the monetary authority to output and inflation. For example, the term spread is likely to forecast output growth better when the monetary authority is more responsive to output than inflation and when inflation is relatively persistent.

Great stuff. The authors also show graphs where they plot term spreads with recessions in US, UK and Germany. In most recession episodes, one sees the term spreads declining substantially.

The best part about this paper is usually papers on term spreads are highly technical and very difficult to understand. This paper explains broad findings of most of the papers in English, which is a good start for anyone. You can then pick up the other covered papers. Atleast you know, what the paper is trying to say.

Superb stuff.

Bank of Argentina Conference

September 4, 2009

Great economics brains had assembled at a Bank of Argentina Conference – Merton, Eichegreen, Goodhart, Obsfeld and Rakesh Mohan as well.

All the papers and presentations have been uploaded. Happy reading.

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