Archive for October, 2009

Explaning the crisis in one simple sentence

October 16, 2009

Calvin Trillin has written a terrific article in NYT:

“IF you really want to know why the financial system nearly collapsed in the fall of 2008, I can tell you in one simple sentence.”

The statement came from a man sitting three or four stools away from me in a sparsely populated Midtown bar, where I was waiting for a friend……
“The financial system nearly collapsed,” he said, “because smart guys had started working on Wall Street.” He took a sip of his martini, and stared straight at the row of bottles behind the bar, as if the conversation was now over.

What does Smart Guys imply? All those lower 1/3rd of a class who were smart and were just interested in making money. Read the entire piece for more details and finer points.

Krugman also responds to the article and kind of agrees to it.  

Well, how times have changed. Now you find the best of the class dying to get into an i-bank, sell-side research, buy-side research, Private Equity, Hedge Funds etc. I have received a few emails from students specialising in finance (which was very embarrassing fort me as I am such a struggler still) wanting to become an i-banker without knowing anything about it.

Huge monies and hype made us believe something exciting was happening there. Well once you join you realise most of its is actually just castles in the air. Sad but true. Much of actual/useful work in finance is considered to be plain boring.


Interviews of John Taylor, Rogoff-Reinhart, Maskin and IMF economists

October 16, 2009

I came across three excellent interviews:

Excellent stuff.

Impact of recessions on Trade – A historical analysis

October 15, 2009

There has been tons of research lately analysing the impact of global recession/US recession on economies. The analysis has happened plus/minus financial crisis. The financial crisis has been further categorised into housing, equity market crisis.

What about the impact of global crisis on international trade? Caroline Freund of World Bank has written a paper on this issue.

The author examines the impact of historical global downturns on trade flows. The results provide insight into why trade has dropped so dramatically in the current crisis, what is likely to happen in the coming years, how global imbalances are affected, and which regions and industries suffer most heavily.

The author finds that the elasticity of global trade volumes to real world GDP has increased gradually from around 2 in the 1960s to above 3 now. The author also finds that trade is more responsive to GDP during global downturns than in tranquil times. The results suggest that the overall drop in real trade this year is likely to exceed 15 percent.

There is significant variation across industries, with food and beverages the least affected and crude materials and fuels the most affected. On the positive side, trade tends to rebound very rapidly when the outlook brightens.

The author also finds evidence that global downturns often lead to persistent improvements in the ratio of the trade balance to GDP in borrower countries.

It is a pretty simply done paper but has quite interesting insights. Read on…

Importance of prices

October 15, 2009

John  Taylor points to this excellent write-up on price system by Russell Roberts.

In the end Roberts says:

Prices create harmony. They settle what would otherwise be disputes between buyers and sellers. They adjudicate. They create information and encourage people to use that information in ways that could never be done by a human settler of disputes, a graphite czar.

It takes you to the first microeconomics class immediately. It also serves as a useful lesson in economic writing.

A review of Monetary Policy research

October 15, 2009

Fed organised a conference on Monetary Policy. Fed Vice Chairman Don Kohn has given an excellent speech summarising  tons of monetary policy research which has been used/useful for policymaking. All these papers would be refined to develop a handbook of monetary economics.

John Taylor was at the conference and takes a jive at Krugman:

The meeting demonstrated how completely wrong Paul Krugman is about recent developments in economics, at least as he portrayed the subject in the New York Times Magazine last month. This was not an all efficient markets meeting. The talk from start to finish was about the market imperfections, price rigidities, deadweight losses due to market power, and imperfect information, which all occur in monetary economics. If anything there was too much focus on market distortions. Overall I saw tremendous progress documented at the meeting. The presentation by my Stanford colleague Pete Klenow and his coauthor Ben Malin, for example, reviewed the impressive volume of empirical research on firm price setting decisions using new BLS data sets. Their discussant Marty Eichenbaum pointed to even more of this kind of research, which solidifies and bolsters the type of monetary theory that has been developed in recent years

As per Taylor, the problem was not with research/economists but economic policy:

But if there has been so much progress in monetary economics, then why did we have the financial crisis? I argued that it was the policy, not the economics, which got off track. When the policy implications of the research were followed by policy makers, we had good economic performance, as in the period called the Great Moderation. When policy got off track, the Great Moderation ended in the financial crisis and Great Recession. I am hoping that policy will get on track again and we will have Great Moderation II.

I think economists are acting really childish. The idea is not about  who is wrong/right but work together to plaster the much fractured economics and trust in it.

Euro in crisis – proving the sceptics wrong?

October 15, 2009

Ewald Nowotny, Governor of the Austrian National Bank has an interesting speech evaluating Euro’s and ECB’s role in the crisis.

He says Euro has withstood quite well in this crisis and has proved its sceptics wrong:

There were many sceptics: It can’t happen, It’s a bad idea, and It can’t last, as Rudiger Dornbusch has nicely summed up the arguments of the critics (Jonung and Drea 2009). The intellectual tool at the heart of the discussion on monetary union was the theory of optimum currency areas (OCA), which goes back to Mundell (1961). The argument is well known: Countries or regions facing asymmetric shocks need different monetary policies and an adjustment in the exchange rate. As the vocal euro-sceptic Martin Feldstein put it:

“A single monetary policy for a group of heterogeneous countries that experience different shocks cannot be optimal – the problem is that, when it comes to monetary policy, one size cannot fit all.” (Feldstein 2009).

If heterogeneous regions do share a common currency, they need alternative adjustment mechanisms like flexible wages, mobile factors, both labour and capital, and fiscal transfers. The better these alternative adjustment mechanisms work, the lower is the cost to go for a common currency. Introducing a common currency or joining a monetary union then comes down to comparing the costs with the benefits (De Grauwe 2007). In the euro area the bottom line is negative, according to the sceptics. The crucial alternative adjustment mechanisms are too weak, raising the costs of a common currency beyond the expected benefits (Feldstein 1997).

He reviews a lot of research on 10 years of Euro. He even looks at what if Euro was not there scenario in this crisis. He looks at the experience of Denmark in this crisis which is a non-EMU member. Denmark faced numerous problems in this crisis. So much so, the crisis has led Denmark Central bank Gov making a case to join EMU.

Financial Access in vogue

October 14, 2009

PSD Blog points to couple of developments in the field of access to finance. Hope something useful comes out of it. And it is not just hanky-panky stuff.

A note on Financial Market Utilities

October 14, 2009

Chicago Fed Economists have an excellent discussion on Financial Market Utilities (FMU). FMUs are companies that facilitate clearing and settlement in financial markets. Be it bond, currency or equity markets, FMUs play a very important understateed role in financial markets.

A must read. IT tells you a bit about everything on FMUs – history, functions, names of key FMUs in US etc.

Cinema and financial markets- an analogy

October 14, 2009

I came across this nice short crisp paper by Lasse Heje Pedersen of NUY. He says:

The dangers of shouting fire in a crowded theater are well understood, but the dangers of rushing to the exit in the financial markets are more complex. Yet, the two events share several features, and I analyze why people crowd into theaters and trades, why they run, what determines the risk, whether to return to the theater or trade when the dust settles, and how much to pay for assets (or tickets) in light of this risk. These theoretical considerations shed light on the recent global liquidity crisis and, in particular, the quant event of 2007.

I liked the comparison with the theatre. It is a useful analogy which one can use to explain this crisis to freshers.

Acknowledging Economic Bloggers

October 14, 2009

Roving Bandit has this inspiring post:

I’ve just been reading the latest draft of a paper by Miguel, Saiegh and Satyanath which measures the correlation between violence on the football (soccer) field in European leagues (yellow/red cards) and violence in a player’s home country (civil war). Blattman blogged about an earlier draft a while ago.

Great paper, but what caught my eye were the acknowledgements:

We are grateful to Dan Altman, Ray Fisman, Matias Iaryczower, Abdul Nouri, Dani Rodrik, seminar participants at Stanford, UCSD, UCLA, IPES, and at the 4th Annual HiCN Workshop at Yale, and a host of anonymous bloggers for useful comments, and Dan Hartley, Teferi Mergo, Melanie Wasserman and Tom Zeitzoff for excellent research assistance. All errors remain our own.”

Wow. I have noted quite a few blogposts of Paul Krugman in other papers mentioned as a reference/point of debate etc.  But then he is Paul Krugman.

THis is excellent for economic bloggers like me who try and write extensively on economic research done around the world. I know it will be difficult for me to ever write a paper which will be mentioned as a reference in any of the top papers. However, it will be great if any of the blogposts can make an impact towards betterment of a paper.


Papers like these interest me quite  abit. But haven’t got anytime.

Elinor Ostrom becomes the first Woman to get Nobel Prize for Economics

October 12, 2009

So the award is finally out. It goes to Oliver Williamson (of UC Berkeley) and Elinor Ostrom (of Indian Univ) for their work on governance. Most predictions I have seen got it wrong. I don’t want to take any credit but had mentioned instituional economics in my predictions post. When I said instiutional economics it was very much Williamson that was on my mind. 

What is more amazing is Elinor Ostrom ( of Indiana Univ) becomes the first woman to get Eco Nobel. What is more embarrassing is  I haven’t read any of her work. This is like 2007 for me when I woke up to mechanism design theory.

Press Release says:

Elinor Ostrom
Indiana University, Bloomington, IN, USA,

“for her analysis of economic governance, especially the commons”


Oliver E. Williamson
University of California, Berkeley, CA, USA,

“for his analysis of economic governance, especially the boundaries of the firm”

There is basic information for the public and advanced information for the budding economists/other interested. Both are usually excellent and something I wait more than the name of the recepient. It teaches you so much. It would be out with a speed read soon. Speed read is here

I would post more as I find out more about their work. I have read a bit of Williamson. Someone told me when North/Fogel got it in 1993 some people cringed that Williamson didn’t get it. And would have to wait longer. It took 16 years!!

Now get on to some reading.


As expected there is tons of material. And quite a few top econs are not familar with the work of Ostrom. Ostrom has created a storm really.

Public Trust on Central Banks does a dive in this crisis

October 12, 2009

This is what I feared but has come true. All these years, Central Banks have worked  very hard to achieve public’s trust on them.  The Central bank credibility has been very crucial. But in this crisis, the way central banks have  acted and reacted, credibility was bound to take a hit. Their initial interventions were highly opaque  and central bankers were completely caught off-guard.

Daniel Gros and Felix Roth in voxeu write that Central Bank credibility has declined within the public. Infact, it has plummeted.

Most observers agree that central banks can claim partial credit for the stabilisation that have been achieved and the prospect of a recovery. This column warns that the general public seems to hold a completely different opinion; trust in central banks has declined and the reaction of central banks to the crisis is generally judged as unsatisfactory. Central bankers all over the world should redouble their efforts to regain the trust of the people towards their institution.

The authors study bi-annual Eurobarometer (EB) Surveys which polls people in Euroarea over trust in ECB etc. The Jan-Feb 2009 survey shows trust index for ECB at -ve.

The fall in trust in the ECB occurred in almost all euro area countries. However, as one would expect, the level remains significantly higher in the eight smallest euro area countries (including Ireland) than the three largest (Germany, France and Italy), which account for about two-thirds of the population (Figure 2). In the three large euro area countries, more people mistrust the ECB than trust her, where as the opposite is true in all but one of the smaller euro area member countries. This relatively higher trust in the ECB is what one would expect given that the experience of Iceland (and that of the Baltic states) has shown the potential benefits of belonging to the euro area.

But there are also interesting differences among the three largest economies – Germany, France and Italy. It is apparent that trust in the ECB was always lowest in France, but it was still usually in positive territory. However, between October-November 2008 and January-February 2009, it fell from 6% to -21%. Trust in the ECB used to be highest in Italy (close to +40% at the start of EMU) but even there it is now negative, as it is in Germany.

The problem is not unique to ECB:

The last poll (from July 2009) is particularly instructive. In this survey, respondents were asked: “Do you feel the European Central Bank/Bank of England/Federal Reserve has responded appropriately to the challenges of the economic downturn and its consequences?”

In the case of the US, 18% more answered “no” than answered “yes”. In continental Europe the verdict on the ECB was even more negative, with a balance of 24% for those answering “no”. In this poll, the Bank of England scores best with a negative balance of only 6 percentage points.

In three of the four large euro area countries surveyed in continental Europe, citizens are more negative towards the ECB than US citizens are towards the Federal Reserve. See Panel A in Table 1 for details. In analysing each of the four European cases individually (Panel B), one sees that Spanish and Italian citizens hold an even lower opinion of the ECB (-39% and -30%) than French or Germans (-22% and -11%).

Not great news at all. I don’t know whether central bankers have seen these results. Most speeches I have read/been reading seem to be ignorant of these developments. Most think they have done a great job in mitigating the crisis and talk about reforms in financial stability & regulation. But the recent survey results point to different ideas. The public trust in central banks has waned and requires urgent attention.

Economics of idlis

October 12, 2009

Idli is a rice-lentil based snack that originated in South India and has become hugely popular all around India and world as well.

Niranjan Rajadhyaksha has an interesting post on the economics lessons a plate of idli offers.

I always feel remembering menu prices is a very good way to track food inflation.  So, Niranjan is bang on target with this one – You do not need to follow the government’s weekly inflation release to know that high food prices are pinching.

However, Niranjan points to some other economics lessons one could learn while buying idli (or any other food item) from  a food joint.  The point about restaurant owners slicing the market into two segments is pretty commonly seen in Mumbai – most Restaurants offer you 2 seating facilities- AC and non AC. AC ones are charged more for the same dish.

And I have also noted, this charging of extra for an extra bowl of sambhar/chutney differs across restaurants. It is not always related to inflation alone.  Some expensive restaurants charge you a bomb for a dosa/idly  and all extra servings of sambhar/chutney are free.  Like I have visited quite a few in Delhi who do this. The cheaper Udupi style ones (more frequently seen in Mumbai) who serve to all and have a very quick services as their business depends on more footfalls, are the ones who charge you for extra  sambhar/chutney.  I asked an owner of one such Udupi once this question, and he told me that people then keep ordering bowls of sambhar/chutney, making it costly for the restaurant. One extra serving is fine with all, but people always want more. Hence, the rule of asking people to pay up for anything extra.

I had earlier pointed how restaurants nudge you to buy salads ahead of meals (which was not really appreciated/understood  properly by the visitors). Simple eco lessons are seen at quite a few places. You just have to sit and notice it.

A contrarian paper on impact of Climate Change

October 9, 2009

When the entire world is gearing up to discuss and understand and limit impact of climate change, there are some  who think contradictory. All this is welcome as then only we will have a healthy debate

Robert Mendelsohn of Yale is one such contrarian.  In this paper he covers  a vast literature to show the impact of climate change on eco growth is at best limited. He covers the research on impact of climate change on various eco variables- agriculture, water, forest, recreation etc. He also says chances of catastrophic events is very rare. He says mitigation costs are overstated. According to him the biggest threat of climate change is:

The biggest threat climate change poses to economic growth, however, is not from climate damages or efficient mitigation policies, but rather from immediate, aggressive, and inefficient mitigation policies. Immediate aggressive mitigation policies could lead to mitigation costs equal to $28 trillion (Stern 2006). This is 14 times higher than the mitigation costs of an optimal policy. If these policies were no more efficient than current policies, the costs could easily rise to $56 trillion. These misguided mitigation programs pose a serious threat to economic growth. They would impose heavy additional costs on the global economy that cannot be justified by the limited reductions in climate risk that they offer.

:-). He points that in short run, mitigation costs functions are price inelastic and will be very expensive.

An inelastic short‐run marginal cost function implies that large reductions of emissions in the short run will be very expensive. There simply is no inexpensive way to reduce emissions sharply in the short run. Renewable energy sources such as hydroelectricity have largely been exhausted. Solar and wind power are expensive except in ideal locations and circumstances. Other strategies such as shifting from coal to natural gas can work only in the short run as they cause more rapid depletion of natural gas supplies.

In the short run, a rushed public policy is likely to be inefficient. It will likely exempt major polluters as Europe now does with coal. Very few national mitigation programs regulate every source of emission. Most countries have sought to reduce emissions in only a narrow sector of the national economy. Rushed programs will likely invest in specific technologies that are ineffective, such as the United States has done with ethanol. Ethanol produces as much greenhouse gas as gasoline. The inelasticity of the marginal cost function implies that mitigation programs that are not applied universally will be very wasteful. Regulated polluters will spend a lot to eliminate a single ton while unregulated polluters will spend nothing.

He also says for mitigation to work, international participation is needed (a point Nordhaus makes). Without it, again it will be inefficient and costly. So, overall we are just heading towards making more wasteful policies.


Come to think of it, he is trying to make the right points. There is a sudden rush to do everything about climate change. It is the hot thing and big time in fashion. Yes, we need to be aware and even if changes are expected say 40-50 years from now, we need to start working on them gradually. We all should be aware and educated about this issue. But just to glamorize it and do some short term policies and ignore it later, will not work.  We need to debate this issue with more seriousness minus all the jazz.

 See Mendelsohn’s number of paperson Climate change. It is just amazing. The research culture in US Univs just leaves you short of breath. They devote so much time to it. And there are so many econs who are completely unknown but have done amazing work.

Obama gets Nobel peace prize 2009

October 9, 2009

This is an amazing piece of news. Nobel Committee has decided to award 2009 Peace Prize to the US President- Barack Obama. The award is for:

“for his extraordinary efforts to strengthen international diplomacy and cooperation between peoples”
The press release is here.

The Norwegian Nobel Committee has decided that the Nobel Peace Prize for 2009 is to be awarded to President Barack Obama for his extraordinary efforts to strengthen international diplomacy and cooperation between peoples. The Committee has attached special importance to Obama’s vision of and work for a world without nuclear weapons.

Obama has as President created a new climate in international politics. Multilateral diplomacy has regained a central position, with emphasis on the role that the United Nations and other international institutions can play. Dialogue and negotiations are preferred as instruments for resolving even the most difficult international conflicts. The vision of a world free from nuclear arms has powerfully stimulated disarmament and arms control negotiations. Thanks to Obama’s initiative, the USA is now playing a more constructive role in meeting the great climatic challenges the world is confronting. Democracy and human rights are to be strengthened.

Only very rarely has a person to the same extent as Obama captured the world’s attention and given its people hope for a better future. His diplomacy is founded in the concept that those who are to lead the world must do so on the basis of values and attitudes that are shared by the majority of the world’s population.

For 108 years, the Norwegian Nobel Committee has sought to stimulate precisely that international policy and those attitudes for which Obama is now the world’s leading spokesman. The Committee endorses Obama’s appeal that “Now is the time for all of us to take our share of responsibility for a global response to global challenges.”

I read somewhere he has been in reckoning for a while. To get it at this point of time when he has just become US president in 2009 is great stuff. What a year for Obama. The US also seems to be easing out of the Great Recession.
This also puts Obama under severe pressure. As the President of the US, he needs to keep doing his good work. This is a great honor and all eyes would be on him. May be the Nobel Committee awarded him the prize just now, so that the pressure is always on. 
Whoever I am breaking this news to say- What for?? Some have even called it strange choice. Someone even said may be they had no choice this time.
I am sure this prize is going to be debated left, right and centre. 

Interviews of Fisher, De Soto and Solow

October 9, 2009

Via the blogosphere, I came three interviews of 3 economists on 3 very different issues.

Loads of insights in very few words. Especially the interview of De Soto.

Nice Updates on US and Global economy

October 9, 2009

Dallas Fed has interesting and very readable updates on US economy and International economy. It has good charts and is very brief. Makes an impact right away.  Very helpful in getting a snapshot. The recent update on US economy is pretty good as well.

History of US Capital Markets

October 8, 2009

History never ceases to surprise. Economic and Financial History all the more as what you see as newer trends have all been there in the past in some other form/name.

I was reading this excellent paper from NYU financial historian – Richard Sylla ( I pointed to his another superb paper on CRAs here and Fed here). Here he tracks the growth of US capital market since 1790-1840. It was pretty active then as well.

He begins by saying unlike the mammoth history of banking systems very little is known of capital markets. He looks at the possible reasons and then looks at the US capital market in that period. All today’s fancy ideas like arbitrage etc were present even then. He even attributes the high growth rates in that period to the growth in finance at that point of time. As the paper was written in 1998, this last point has been thrashed big time in this crisis.

Richard Sylla is easily one of the best financial historians around. It is amazing stuff.

Growing up in recessions

October 8, 2009

I was reading this interesting paper from Paola Giuliano and Antonio Spilimbergo. It says:

Do generations growing up during recessions have different socio-economic beliefs than generations growing up in good times? We study the relationship between recessions and beliefs by matching macroeconomic shocks during early adulthood with self-reported answers from the General Social Survey. Using time and regional variations in macroeconomic conditions to identify the effect of recessions on beliefs, we show that individuals growing up during recessions tend to believe that success in life depends more on luck than on effort, support more government redistribution, but are less confident in public institutions. Moreover, we find that recessions have a long-lasting effect on individuals’ beliefs.

The paper is much like the inflation memories paper I had pointed a while ago. So, jsut like inflation, people tend to have memories for recession as well.

All these papers again point to the need to remember history not just from the angle of macroeconomic events but also the impact it had on people. However, much of our research only sees consumer/producer as a forward looking rational agent. In reality, people make their decisions based on the past experiences as well. It is a very important ingredient in their decision making.

Thinking about Paul Romer idea of Charter Cities

October 8, 2009

I am terribly late on this issue, but nevertheless… I just read about it a while ago as it was on my pending list for a while. Anyways, Paul Romer ( I am told he is always a prospective Nobel Prize candidate for his work on growth theory) of Stanford University has brought this idea of building Charter Cities as a new model for development.

The project details are here, FAQs are here and there is a blog as well where he is debating and discussing the idea. So what is it?

Charter cities offer a truly global win-win solution. These cities address global poverty by giving people the chance to escape from precarious and harmful subsistence agriculture or dangerous urban slums. Charter cities let people move to a place with rules that provide security, economic opportunity, and improved quality of life. Charter cities also give leaders more options for improving governance and investors more opportunities to finance socially beneficial infrastructure projects.

All it takes to grow a charter city is an unoccupied piece of land and a charter. The human, material, and financial resources needed to build a new city will follow, attracted by the chance to work together under the good rules that the charter specifies.

Action by one or more existing governments can provide the essentials. One government provides land and one or more governments grant the charter and stand ready to enforce it.

He offers a few examples as well –

Case 1: Canada develops a Hong Kong in Cuba
Case 2: Indonesians flock to a manufacturing hub in Australia
Case 3: States in India compete for the chance to build a charter city

Although the concept is interesting, it is hardly anything novel. For instance in India, we have tried to create similar charter cities in form of Special Economic Zones (preceded by Export Processing Zones.  Though Romer’s concept is far more bigger talking about a complete city and just focused on one form of economic activity.

However, there are numerous problems getting them started – land litigation issues,  etc etc. It was a big bubble around 2007 and we just don’t know what happened to the SEZs which had been started at so many places in India.

The developing economies have too many of such issues and is always difficult to get them going.

The broad idea is also similar to what Paul Romer’s idea of growth theory- organising existing resources more efficiently to produce better outcomes (see this for some idea). So, instead of looking at fancy ideas to drive growth and development, just re-organise the various resources (land, labour etc).

Urbanomics has a nice critique saying it might not work.

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