Wishing all a very Happy New Year

Mostly Economics wishes all its visitors a very happy new year. May 2010 bring all prosperity and success. 

Keep visiting the site, sending your suggestions and posting comments.

A snapshot on causes of the Financial Crisis

I had posted about this rich reading list on financial crisis compiled by Menzie Chinn.

In Chinn’s reading list, I would suggest one shoulld see this short note by Mark Jickling. It is a nice summary of most of the the causes of the financial crisis. It lists the causes, their explanations, rebuttals for the explained causes and references.

Very useful. Can be used by students for presentations on the crisis.

Is United States Bankrupt?

Laurence Kotlikoff of Boston Univ wrote this paper in 2006.

Is the U.S. bankrupt? Or to paraphrase the Oxford English Dictionary States at the end of its resources, exhausted, stripped bear, destitute, bereft, wanting in property, or wrecked in consequence of failure to pay its creditors?

Many would scoff at this notion. They’d point out that the country has never defaulted on its debt; that its debt-to-GDP (gross domestic product) ratio is substantially lower than that of Japan and other developed countries; that its long-term nominal interest rates are historically low; that the dollar is the world’s reserve currency; and that China, Japan, and other countries have an insatiable demand for U.S. Treasuries.

Others would argue that the official debt reflects nomenclature, not fiscal fundamentals; that the sum total of official and unofficial liabilities is massive; that federal discretionary spending and medical expenditures are exploding; that the United States has a history of defaulting on its official debt via inflation; that the government has cut taxes well below the bone; that countries holding U.S. bonds can sell them in a nanosecond; that the financial markets have a long and impressive record of mispricing securities; and that financial implosion is just around the corner.

This paper explores these views from both partial and general equilibrium perspectives.

The findings:

The third section turns to economic measures of national insolvency, namely, measures of the fiscal gap and generational imbalance. This partial-equilibrium analysis strongly suggests that the U.S. government is, indeed, bankrupt, insofar as it will be unable to pay its creditors, who, in this context, are current and future generations to whom it has explicitly or implicitly promised future net payments of various kinds.

The world, of course, is full of uncertainty. The fourth section considers how uncertainty changes one’s perspective on national insolvency and methods of measuring a country’s long-term fiscal condition. The fifth section asks whether immigration or productivity improvements arising deepening can ameliorate the U.S. fiscal condition. While immigration shows little promise, productivity improvements can help, provided the government uses higher productivity growth as an opportunity to outgrow its fiscal problems rather than perpetuate them by effectively indexing expenditure levels to the level of productivity.

He suggests reforms in 3 areas:

The final section offers three radical policies to eliminate the nation’s enormous fiscal gap and avert bankruptcy. These policies would replace the current tax system with a retail sales tax, personalize Social Security, and move to a globally budgeted universal healthcare system implemented via individual-specific health-insurance vouchers. The radical stance of these proposals reflects the critical nature of our time. Unless the United States moves quickly to fundamentally change and restrain its fiscal behavior, its bankruptcy will become a foregone conclusion.

A good radical read on state of US public finances. He estimates the total fiscal gap to be USD 65.9 trillion including social security, medicaid etc payments. This was in 2006. I am sure the fiscal gap has increased much more because of the current crisis. There have been many studies lately on US public debt but I don’t really know whether they estimate all possible costs of US government.

Waiting for an update from Kotlikoff on the same.

Future of American Capitalism

WSJ Blog has interviews of 2 econs on future of American capitalism:

• Raghuram Rajan
• Jeremy Stein

There is one common question on state of US brand of capitalism and both agree that it is going to be discredited.

Has the decade of the 2000s — with the downfall of Enron, the bursting of the Internet bubble and the Great Panic — discredited the U.S. model of capitalism?

Raghuram Rajan: The rhetoric has changed considerably. People don’t say that the U.S. is the place to emulate any more. The U.S. used to be pretty good at giving lectures in the past, so now of course other countries are taking the chance to thumb their nose at them.

Some people are concluding that capitalism doesn’t work. The problem is that they don’t have anything reasonable to replace it with. To say that we needed more regulation is not to say that markets don’t work.

Jeremy Stein: The risk is that the U.S. model will be discredited more broadly than it ought to be. The lesson that we learn is that we need to do certain things to reform financial markets, but we don’t want to throw out the whole model. Our labor markets are less constrained than European labor markets, we have more IPOs per capita than most other countries. A lot of that stuff remains a strength of the United States.

What is the next best alternative? There are no answers. This crisis is making us rethink on nearly everything in economics…

Teaser Rates offered in India…are any lessons being learnt?

Deepak Parikh yet again. He is perhaps the only one who talks about the unfair practices in housing market in India. Mint has an interview of the HDFC Chairman.

Wars and impact on financial markets

I didn’t know how to summarise this paper in the title of the post.

I just finished reading this paper from Niall Fergusson. It is such an amazing paper and a must read. He begins the paper saying:

We are living through a paradox—or so it seems. Since September 11, 2001, according to a number of neo-conservative commentators, America has been fighting World War III (or IV, if you like to give the Cold War a number). For more than six years, these commentators have repeatedly drawn parallels between the “War on Terror” that is said to have begun in September 2001 and World War II. Immediately after 9/11, Al Qaeda and other radical Islamist groups were branded “Islamofascists”. Their attack on the World Trade Center was said to be our generation’s Pearl Harbor. In addition to coveting weapons of mass destruction and covertly sponsoring terrorism, Saddam Hussein was denounced as an Arab Hitler. The fall of Baghdad was supposed to be like the liberation of Paris. Anyone who opposed the policy of pre-emption was an appeaser. And so on.

Yet throughout this period of heightened terrorist threats and overseas military interventions, financial markets have displayed a remarkable insouciance. The U.S. stock market was affected only momentarily by the attacks of 9/11. True, between September 10 and September 21, 2001, the Dow Jones Industrial Average declined by as much as 14 per cent. Within just over two months, however, the Dow had regained its pre-9/11 level.

He says it is amazing how financial markets discount geopolitical events and don’t anticipate it. It is only when war events turn true and sour, do markets start chickening out.

History suggests that financial markets do not always anticipate major geopolitical crises. Part II of this paper shows how the majority of investors in London, then the world’s biggest capital market, were caught unawares by the escalation of the conflict in the Balkans in July 1914—so much so that there was a disastrous liquidity crisis in most financial centers even before war had broken out.

However, the markets learn the lessons with certain conditions:

Part III shows how the origins of the First World War have been revealed only with the benefit of hindsight; at the time, they were largely invisible. The same, however, cannot be said of the Second World War. Investors learned from the searing experiences of 1914-23, which saw a wide range of European currencies and securities drastically reduced in value as a result of inflation and outright default. They therefore sought to adjust their portfolios defensively as soon as they saw a renewed risk of world war. Indeed, to judge by securities price data, the City of London (like other markets, notably those in Scandinavia) began positioning itself for another major conflict some years before it actually began. If 1914 was a bolt from the blue, 1939 seemed long overdue.

What are the lessons?

The first point is that it is as hard for investors as for generals to learn lessons from a previous war. Knowing what had happened to various asset classes after 1914 did not make it easier to know when to sell those that had lost out or buy those that had fared well. Nor was there any guarantee that the next war would have the same financial impact as the previous war, because of changes in military technology and government regulation.

As part V argues, these same problems arose again for investors after 1945. Simply because the Cold War never became truly “hot” does not mean that the probability of a nuclear war between the superpowers was always zero. Investors once again tried to learn from history when the Korean War broke out, acting on the assumption that it might have similar effects to World War II (for example on commodity prices).

Twelve years later, by contrast, financial markets evinced only short-lived and mild anxiety at the time of the Cuban missile crisis, reflecting a realization on the part of investors that a world war in the age of the hydrogen bomb would have incalculable consequences against which it would be futile to hedge. In the remaining three decades of the Cold War, the superpowers’ consistent success in settling their disputes by diplomatic means (or proxy conventional wars) reassured investors that their rivalry would not erupt into a hot war, so that markets became progressively less sensitive to international crises.

If financial market data and commentary are reliable guides, then, this is roughly how expectations of war are formed: retrospectively more than prospectively, though with some allowance for changes in the nature of warfare. Excellent stuff. The linkages of war with financial markets is something I hve never read before. What amazing lessons

Super stuff from Ferguson. What insights on thinking about geopolitical risks and impact on financial markets.

What are the risks in current times?

A period such as our own, of sporadic terrorism and small conventional wars, might therefore be expected to encourage the belief that future wars will also be small, with inconsequential financial effects.

The seeming indifference of today’s financial markets to political risk should therefore be regarded not as evidence that the world will likely avoid a major conflict in the foreseeable future, but merely as evidence that the world has avoided a major conflict in the recent past. Given the relative youth of most employees in the financial sector, and the relative shortness of most senior executives’ careers, “recent” may be taken to mean approximately the past twenty-five years.

A major conflict would strike this generation of bankers and fund managers much as the war of 1914 struck their predecessors: like “a bolt from the blue”.

Well, well, well…..

Read the whole thing. Very rich…Is a nice revision of World War History as well.

On reading the paper, I just recalled this previous post where I wondered whether financial markets see the emerging risks in the Indian political system as well? We can see the similarity in Indian situation as well. If you read any India based newspaper politics section would suggest huge risks but financial section would suggest “All is well”. Things in political only look worse going from hereon and still nothing seems to matter financial markets. Can this continue? Will something hit Indian financial markets – a bolt from the blue? I hope not but the possibility cannot be ignored. Atleast Fergusson’s paper tells you why it cannot be ignored.

Prospect magazine’s top 25 brains of the financial crisis

Prospect Magazine has named the 25 brains who have contributed to the public conversation in this financial crisis. Let me give away  the winner right away- Simon Johnson.

Who has contributed best to the “public conversation” during these turbulent times?

The financial crisis has destroyed both wealth and received wisdom. The idea that prices are always right and markets self-correct is fatally challenged. Even Alan Greenspan admits that the “whole intellectual edifice” of the efficient market hypothesis collapsed in the summer of 2008. The financial establishment is in a state of deep confusion. As the FT’s Gillian Tett put it in September’s Prospect: it is like “a priest who has lost faith in the Bible, but still has to go to church.” But this is not a bad thing, for it has opened up new ways of thinking about markets, institutions and the all-important cause of financial reform.

Unfamiliar voices have come to prominence, aided by a new wave of financial bloggers eager to push fresh ideas. But who has made the most impact? Prospect assembled a panel of experts to draw up a list of leading “public intellectuals” of the financial crisis in 2009 and then decide on the most important. Our criteria were simple. Anyone who had made an impact on policy with their ideas, or who had changed the “public conversation” was a candidate.

The panel sifted hundreds of names, with an unavoidable bias towards Britain and the US, but felt the most important contributions had been in financial reform—those trying to work out what to do next. The crisis has laid a staggering financial burden on the world, with some $14 trillion propping up US and EU banks. We cannot afford another one. Moreover, we urgently need a new regulatory philosophy. Are liquid markets always good? Is complexity in financial services harmful? Can finance firms stop “herding,” creating wild booms and busts?

After considering so many names, came the final list.

We considered all of this, and gradually whittled the names down to a shortlist of just 25 (see facing page), and then a top three. In reverse order, the bronze medal went to Adair Turner, chairman of Britain’s Financial Services Authority, who bravely questioned the social usefulness of some financial activity, and called for regulators to force banks to hold more capital against risky trades, cutting their profitability. Next, silver went to Avinash Persaud, a respected analyst who spotted nine years ago the dangerous interaction between firms “herding” and new risk management techniques. During 2009 he has been arguing for new “macro-prudential” regulation to stop what he discovered a decade ago.

But there was a clear winner. He is Simon Johnson, an economist at the prestigious Peterson Institute in Washington, DC, who has been leading the argument against overmighty banking. His ideas are well grounded in theory, but he has also done more than any academic to popularise his case: writing articles, a must-read blog, and appearing tirelessly on television.

This is thoroughly deserved. I think Simon Johnson will come tops in most of such lists. I just took a relook at FP’s top 100 thinkers list and am surprised not to find Johnson’s name there at all.

His write up on financial oligarchy has changed the way we think about financial sector completely. He has followed the article with numerous write-ups and follow-ups on how things are only getting worse and unless we reform it, more crisis are going to follow. This coming from a ex-Chief economist of IMF is itself quite revolutionary and has goven it the necessary weight.

Measuring Financial Stability – a literature survey

BIS Economists  Blaise Gadanecz and Kaushik Jayaram have written a superb literature survey on measures of financial stability.

This paper is a modest contribution to review the work done towards developing quantitative measures of financial stability and their use in published FSRs. The paper is structured as follows. In Section I, we look at definitions of financial stability and what they mean for identifying key variables, which we discuss in Section II. In Section III, we review how these individual variables might be combined into composite indicators for the purposes of monitoring key sectors of the economy and assigning critical values. In Section IV, we provide a comparative view of the main variables and indicators used in selected FSRs. In Section V we discuss recent attempts to construct a single aggregate measure of financial stability. The final section concludes.

Very useful primer on financial stability measures. Not surprisingly, lots of issues still remain despite loads of work. The concept of financial stability itself is in unstable stages.

How NBER Corporate Finance Program’s research work helps understand the current crisis?

I had mentioned previously what a rich resource was NBER Reporter, a NBER publication.

The Dec-09 Reporter carries a very useful summary of the research done in NBER’s Corporate Finance Program. It is written by Raghuram Rajan who directs the program. Usually, the reporter carries a survey of the program but Rajan prefers to focus on the papers that help us understand the current crisis.

The NBER’s Program on Corporate Finance was founded in 1991, and has initiated some very promising avenues of research since then. Narrowly interpreted, corporate finance is the study of the investment and financing policies of corporations. Because firms are at the center of economic activity, and almost any topic of concern to economists –from microeconomic issues like incentives and risk sharing to macroeconomic issues such as currency crises — affects corporate financing and investment, it is however increasingly difficult to draw precise boundaries around the field.

The range of subjects that Corporate Finance Program members have addressed in their research reflects this broad scope. Rather than offering a broad brush survey of all the work currently being done, however, I thought it would be most useful to focus on what our researchers have contributed to the analysis of the ongoing financial crisis. Even here, I have had to be selective, given the large number of papers on this subject in the last two years. I should also note that even prior to the crisis, Corporate Finance Program members had done important work on such topics as credit booms, illiquidity, bank runs, and credit crunches. This work laid much of the foundation for the more recent analyses. In the interests of space, though, I will not survey that earlier work.

He says there is some consensus on causes of the crisis:

A number of papers offer an overview of the crisis (Brunnermeier, 14612; Diamond and Rajan, 14739; Gorton, 14398). There is some consensus on its proximate causes: 1) the U.S. financial sector financed low-income borrowers who wanted to buy houses, and it raised money for such lending through the issuance of exotic new financial instruments; 2) banks seemed very willing to take risks during this time, and a significant portion of these instruments found their way, directly or indirectly, into commercial and investment bank balance sheets; 3) these investments were largely financed with short-term debt. But what were the more fundamental reasons for these proximate causes?

He then explores papers which look at these causes. He covers papers in 7 broad heads:

1. Why Low Income Borrowers?
2. Were banks more willing to take risks?
3. Financing with Short-Term Debt
4. The Panic and Fire Sales
5. The Rescue Efforts
6. What did not cause the panic?
7. Other Issues

Very good literature survey from Rajan. I mean you have all the major papers that are cited to explain the crisis in one place. And then you know what each paper attempts to say.

Highly recommended reading.

Economics in 10 easy steps

Ross Gittins, Herald’s Economics Editor, has written a very nice article on principles of economics (HT: Greg Mankiw).  He says there are 10 broad principles of economics:

Here’s a never-to-be-repeated holiday special: all you need to know about economics in 10 easy steps. They come courtesy of the best-selling introductory economics textbook by Gregory Mankiw of Harvard University (with Joshua Gans and Stephen King co-authors of the Australian edition).

Economics is the study of how society manages its scarce resources, where ”scarce” means there are fewer resources than we’d like to be able to use.

The 10 principles are divided into 3 sections. Here is a further summary of the 10 principles:

• Section 1: How people make decisions?
  • Principle 1: Economics is about trade-offs – efficiency vs equity
  • Principle 2: Opportunity cost – Joining a Univ vs Working fulltime
  • Principle 3: Marginal Thinking – The pricing should be in line with marginal costs
  • Principle 4: Incentives matter
• Section 2 : How people interact?
  • Principle 5: Trade makes everyone better off
  • Principle 6: Markets are a good way to organise economic activity. Central Planning doesn’t work
  • Principle 7: Govt can improve market outcomes in case of market failures, market power, spillovers etc
• Section 3: How Economy works?
  • Principle 8:  Country’s standard of living depends on its ability to produce goods and services.
  • Principle 9: Prices rise when the government prints too much money
  • Principle 10: Society faces a short-run trade-off between inflation and unemployment

Notice how principles move from ‘within individual’ to ‘between individuals’ to ‘country level economics’.

Very useful summary of principles of economics.

Chiang Mai Initiative signed finally

I first learnt of Chiang Mai Initiative (CMI)  via a Barry Eichengreen paper.

Wikipedia offers some light:

The Chiang Mai Initiative (CMI) is an initiative under the ASEAN+3 framework which aims for creation of a network of Bilateral Swap Arrangements (BSAs) among ASEAN+3 countries. After 1997 Asian Financial Crisis member countries started this initiative to manage regional short-term liquidity problems and to facilitate the work of other international financial arrangements and organizations like IMF.

What lessons are offered for Teaching Economics from the current crisis?

John Taylor has a super post on the topic. He says:

People ask how I think introductory economics teaching should change as a result of the financial crisis. It’s an important question. At the upcoming American Economic Association Annual Meetings, my colleague Bob Hall, next AEA President and Program Director, has included on panel on the topic.

Clearly we need to include more on financial markets, but based on my experience teaching in the two-term introductory course at Stanford, I think the single most important change would be to stop splitting microeconomics and macroeconomics into two separate terms. The split has been common in economics teaching since the first edition of Paul Samuelson’s textbook, which put macro first. Many courses now have micro in the first term and then macro in the second.

But regardless of the order now used, I think a reform that integrates micro and macro throughout is worth considering. There were arguments for doing this before the crisis, including the fact that in research and graduate teaching the tools of micro have now been integrated into macro.

I have always found the distinction between macro and micro very confusing.

• You come across economists who say I am a macro person and don’t follow much of micro and vice versa. It is actually seen as a statement of prestige – what person (micro or macro that is) you are – and is followed by nods and appreciation by fellow economists. But there are so many linkages between the two, how can you possibly be from different fields. I can understand the area of research is different but that is where it ends.
• The distinction is appalling in the case of professors of finance. I mean why the distinction. You have professors of economics with specialisation in healthcare, international trade, agriculture, development etc. Same should be the case with finance as well. Clearly the academia has also been taken by the finance tide/wave. Then there are some professors of finance (atleast I have met them) who have a very limited know-how of economics especially macroeconomics. Much of financial markets move because of developments in economy, so you cannot ignore it. But Professors of finance can.
• Then you have students who study finance. Most have a very limited knowhow of economics. Infact, you can pass as an MBA in finance without understanding the linkages of economics. This clearly is a problem with the way they are taught and not really a problem of students.

Prof Taylor further explains:

The financial crisis clinches the case for full integration in my view. The crisis is the biggest economic event in decades and it can only be understood with a mix of micro and macro. To understand the crisis one must know about supply and demand for housing (micro), interest rates that may have been too low for too long (macro), moral hazard (micro), a stimulus package (macro) aimed at such things as health care (micro), a new type of monetary policy (macro) that focuses on specific sectors (micro), debates about the size of the multiplier (macro), excessive risk taking (micro), a great recession (macro), and so on. It you look at the 22 items that the Financial Crisis Inquiry Commission has been charged by the Congress to examine, you’ll see that it is a mix of micro and macro. Defining the first term as micro and the second term as macro, or visa versa, is no longer the best way to allocate topics.

This is precisely the problem with teaching finance without much attention to economics. They are not mutually exclusive subjects!

Prof Taylor is already trying to usher changes this time at Stanford. He also points to challenges that text-books are still carry micro-macro distinction. But it is not hard to mix and match. Read the post for details.

RBI’s upcoming 2 research conferences

I just noticed RBI’s website on its left side informs of two upcoming research conferences.

• First International Research Conference on 12-13 Feb 2010 at Mumbai. This conference is RBI celebrating  its 75th year (platinum jubilee) and will be a biennial event from 2010 onwards (once every 2 years).

The Reserve Bank of India which commenced its operations on April 1, 1935 has entered 75th year of establishment. In the Platinum Jubilee Year, the Reserve Bank is organising a series of knowledge-sharing events such as seminars, special memorial lectures, ‘Down the Memory Lane’ meetings as well as various ‘Outreach’ programmes. These initiatives are aimed at making the Reserve Bank a more responsive, relevant, professional and effective public institution. The foremost in these events is the inauguration of a new series of biennial International Research Conferences to be organised by the Bank regularly.

The Conference on “Challenges to Central Banking in the Context of Financial Crisis” is the first in the series and is topical as the global economy braves an extraordinary challenge today. The current global recession, a fall-out of the unprecedented financial crisis, is the most serious economic crisis that the world has faced since the Great Depression of the 1930s. While green shoots of revival are evident and the recovery may well strengthen in due course, the role of central banks in managing the crisis and minimising the pains of adjustment has been remarkable.

The programmme details are here.  It has some very big names coming over- Michael Spence, Charles Bean ( of Bank of England), Willam Poole (ex-President of St Louis Fed), Willam White (ex- BIS Chief Econ), Benjamin Friedman (of Harvard), Lars Svensson, Jaime Caruana (BIS chief), Stephen Roach etc etc. Looks very very exciting.

• Funding of Deposit Insurance Systems on 18-20 Jan 2010 at Goa. The Programme details are here. 

The Deposit Insurance and Credit Guarantee Corporation is hosting the 8th Annual Meeting of IADI Asia Regional Committee and International Conference at Goa, India during January 18-20, 2010.

The delegates of the IADI Asia Regional Committee (Bangladesh, Hong Kong, India, Indonesia, Japan, Kazakhstan, Korea, Malaysia,  Philippines, Russia, Singapore, Taiwan, Thailand and Vietnam) as also guests from IADI and some other IADI member countries will participate in the Conference. There will also be participants from the Reserve Bank of India.

The theme of the International Conference is “Funding of Deposit Insurance Systems”. The discussions will cover a wide range of issues including funding mechanism, management of deposit insurance funds and different perspectives on funding of deposit insurance systems. A session is also devoted to Guidelines for Effective Deposit Insurance Systems, including the guidance on funding.

Great initiatives from RBI. RBI does not have any such conferences happening on a regular basis. To see the first international conference becoming a biennial event is a great thing. It should put RBI conference as a place for infusing new ideas in economics.

Financial Crisis Inquiry Commission

Though I knew it was coming but was not aware that it has already been set up. John Taylor in his blog points that first public hearing of the commission is slated to be held on 13 January 2010.

That public hearings are about to start is excellent news. Without such an investigation, followed by a clear explanation to the American people of what went wrong, the Congress is unlikely to enact financial reforms that actually fix the problem. To repeat a phrase from the Chairman of the Brady Commission on the 1987 crash (their report took only 4 months to complete), “You cannot fix what you cannot explain.”

Though not part of its Congressional mandate, I recommend that the FCIC follow the approach of the Brady Commission and the 911 Commission and make some recommendations. It could then even issue a report card on how the recommendations are implemented. Such a Report Card was issued by the 911 Commission and it proved quite useful.

Wikipedia informs :

The Commission was created by section 5 of the Fraud Enforcement and Recovery Act of 2009 (Public Law 111-21), signed into law by President Barack Obama on May 20, 2009

It also has the objectives of the Commission and has 26 of them. The 10 members names are:

Speaker of the House Nancy Pelosi of California and Senate Majority Leader Harry Reid of Nevada each made three appointments, while House Minority Leader John Boehner of Ohio and Senate Minority Leader Mitch McConnell of Kentucky each made two appointments:

• Phil Angelides (chairman) – Pelosi (jointly chosen as chair by Pelosi and Reid)
• Bill Thomas (vice chairman) – Boehner (jointly chosen as vice chair by Boehner and McConnell)
• Brooksley Born (Pelosi)
• Byron Georgiou (Reid)
• Bob Graham (Reid)
• Keith Hennessey (McConnell)
• Douglas Holtz-Eakin (McConnell)
• Heather Murren (Reid)
• John W. Thompson (Pelosi)
• Peter Wallison (Boehner)

The resumes of 10 members of the commission are here.

Let’s see if the commission throws some more exciting insights of the crisis.

Crisis reading list from Menzie Chinn

Menzie Chinn who coauthors the superblog econbrowser is teaching a new course in Fall 2009 – Policy Responses to the Great Recession.  The course details are here:

This course will examine the hypotheses underlying the origins and propagation of the Great Recession of 2007, and the policy responses that have occurred along a variety of dimensions. The candidate causes include lax monetary policy, the “saving glut”, deregulation, securitization and the widespread use of derivatives, the activities of the Government Sponsored Enterprises (“Fannie Mae” and “Freddie Mac”), among others.

The discussion of responses will include the conduct of monetary policy and fiscal policy, the appropriateness of financial regulatory policy, the harmonization of international financial policy and trade policy. Other policies not typically thought to be related to the workings of the macro economy (housing, energy, sectoral/industrial policy, e.g., automobiles) will also be examined.

Chinn has provided links to the key papers/presentations for this course. It is a linkfest on the crisis.

Interview of Matthew Kahn

Matthew Kahn is an environment economist and teaches at UCLA. There is a very good interview of Kahn in Cleveland Fed publication. I liked the interview quite a bit.

Richter: We will start with your work on green cities. To begin with, what types of cities would you say have boomed over the past 35 years?

Kahn: Let me point to three big facts. In the United States, urban economists have noted—and everyone else has as well —that people seek out warm-weather cities. This is behind the boom of Phoenix, Las Vegas, and Dallas. Warm weather is one exogenous factor that people want. Second is a coastal city. Jordan Rappaport and Jeffrey Sachs have done some nice work documenting that the U.S. population wants to be on the coast rather than in “flyover” country. I was born in Chicago and I guess that’s part of the country they’re flying over. And finally, booming cities have been the skilled cities, those having more educated residents. Skill is usually measured by what percentage of adults are college graduates, and those cities with a lot of college graduates have greater wage growth and population growth than other cities.

Richter: And how do so-called green cities fare? How would you even define green cities?

Kahn: An example of a green city would be San Francisco, where a large chunk of its livability is from its climate. No government policy can get rid of humidity or cold winter temperatures. What goes right in San Francisco is that it has a feel of new urbanism, of having a walkable, outdoor life.

On local environmental criteria, San Francisco has clean air, clean water, no public health outbreaks. And then on global environmental criteria, while the United States has the largest carbon footprint per capita of any nation, San Francisco is one of our greener cities in terms of carbon dioxide per capita because people don’t use a lot of air conditioning there. The electricity they use is generated from natural gas-powered plants, which are cleaner than coal-fired plants. And people do use public transit there more than in other cities. So to finally answer your question, a green city scores high on local and global environmental criteria. But a mayor would really only care about the local criteria in terms of pleasing his or her constituents.

That said, green cities are not a free lunch. What happens in many cases, such as in Marin County in San Francisco, with open space initiatives—you’re taking that land out of the housing supply. So from a simple supply and demand angle, you’re going to get higher home prices in these communities. That’s because the community has become more desirable and also you’re making it harder to build on this chunk of desirable land. Homeowners become richer but renters (and minority households are often renters) get punished by gentrification and may not be able to afford to live in their old community. Some urban economists are studying this churning—getting priced out of your own neighborhood. This has been documented in Harlem as crime has fallen in Manhattan.

Read the whole thing. Very good insights.

It is just amazing to find so many economists doing such insightful work. He also writes a blog which has become a part of must read list already.  His voxeu columns are here.

Economics lessons from Sports/Sportspersons

Charles Plosser, President of Philadelphia Fed gave a speech recently. He says Ice Hockey great, Wayne Gretzky provides lessons for Monetary Policy.

This realization was driven home to me here in Rochester. As my children were growing up, I found that there was a way to combine all three of these things into one event — “early morning hockey practice.” Driving through the cold and snow to a 6:00 a.m. hockey practice at Lake Shore was always an exhilarating way to start the morning. Yet, as I learned more about the game of hockey, I found that hockey players could teach us things that are relevant and useful in other disciplines, including, believe it or not, monetary policy.

Hockey great Wayne Gretzky was once asked about his success on the ice. He responded by saying, “I skate to where the puck is going to be, not to where it has been.” He didn’t chase the puck. Instead, Gretzky wanted his hockey stick to be where the puck would be going next. He scored many goals with that strategy, and I believe monetary policymakers can better achieve their goals, too, if they follow the Gretzky strategy.

Good monetary policymakers, like good hockey players, must be forward-looking in their actions. Setting policy that is appropriate for where the economy is today, or has recently been, is not likely to deliver the kind of economic outcomes we desire. Anticipating where the economy is headed is important because monetary policy actions affect the economy with long and variable lags. The major impact of policy often comes only after several quarters, or sometimes several years.

Wayne Gretzky emphasized that anticipation was important to being a successful hockey player. Failing to anticipate in hockey means that you always end up chasing the puck and never catching it. Since monetary policy works with a lag, policymakers must also anticipate and be forward-looking in their actions. Failing to do so would mean that policy would always be behind the curve — playing catch-up so to speak. The result would be greater instability in the economy and a failure to achieve our policy objectives.

John Taylor in his blog has a nice anecdote on how Gretzky example would save some embarrassment in his monetary policy class.

There was a very interesting speech by Mervyn King on how monetary policy lessons can be drawn from Maradona. 

It is always interesting to draw lessons from sports arena. I r’ber Australian coach  John Buchanan giving lectures to company management on mentoring. Same is the case with Steve Waugh who gives leadership lectures once a while. Infact, we see quite a few sportsmen giving these kinds of lectures these days.

Though I think Plosser misses on not emphasizing importance of knowing history as well. Forward looking is all good and important but without a proper reference to history turns into a disaster. I am sure Gretzky goes for the puck based on his experience and lessons he has learnt from the past. Infact, the challenge for central banks is more backward looking right now as they have to figure out why they have been ignoring lessons from financial crisis for so long.

I was just wondering Ice Hockey is very popular in Philadelphia part of the world and Football/Soccer in UK. Hence the examples. Cricket is very popular in India. Say RBI official is giving a speech on similar lines drawing analogy from sports. Which cricketer helps draw some lessons for monetary policy? Here are some ideas:

• Sunil Gavaskar for his excellent concentration, focus and new ball skills
• Kapil Dev for his allround skills
• Saurav Ganguly for his leadership
• Anil Kumble for achieving most objectives and still keeping a low profile
• Rahul Dravid for excellent technique, commitment and a team player
• Sachin Tendulkar for being such a fine player for so many years and managing the expectations so well. I don’t really know how to describe Sachin.
• VVS Laxman for making batting look an art
• Virendra Sehwag for questioning the conventional and turning all cricketing theories on its heads.

I am sure the readers would have their own names. I have watched cricket only since 1985 so just named a few from this period onwards. Obviously, Indian central bankers would have their own favorites from cricket or other sports as well.

Balancing Multilingualism in Europe

I had written about the importance of understanding legal aspects of central banking (apart from economics). BoJ chief also gave a very interesting speech on importance of law in central banking. 

ECB has a legal working paper series and I am trying to catch up with a few papers here. Very interesting and different stuff. 

Like I have always wondered and thought how does ECB manage the multilingual aspects. There are 16 EMU countries each having a different language and each being very particular about the usage of its language. What is also interesting is the choice of language matters greatly as some countries might not understand the context. This was best highlighted by this paper in which authors do a interview of economists on ECB’s track record. Otmar Issing, the first chief econ of ECB says:

 

Otmar Issing: “Translation was, of course, linguistically always very good, but the same words and phrases may seem different against the background of different historical experiences. For example, one colleague once said to me, ‘Otmar, we have a paragraph containing three times a reference to price stability. I think this is too much for this argument. In my country, if you say three times why you seek price stability, it weakens your argument.’ And my argument was, if in Germany it’s only two times, they say, ‘Oh, is the ECB less stability oriented than the Bundesbank?’

There is a paper by Phoebus Athanassiou which looks at the multilingual aspects of European Union.

On 1 May 2004, 10 more countries acceded to the European Union (EU), bringing the total number of Member States to 25, increasing the EU’s population to over 450 million and, last but not least, nearly doubling the number of the official languages of the EU. The recent enlargement, a cornerstone in the continuing process of European integration, poses unprecedented challenges, also because of its linguistic implications for the EU and for the language regime applicable to the Community Institutions. In the case of the ECB, this challenge is all the more evident due to the very short deadlines within which some of its operational decisions need to be taken and implemented and the practical implications that their adoption in all the official languages of the EU would entail.

This paper is divided in two Parts.  Part I provides an overview of the rationale and of the legal basis underlying the EU’s current language policy, outlining the language regime applicable to the Community Institutions and bodies and discusses exceptions and limitations to multilingualism associated with the particular situation of Member States with more than one official language or stemming from some recent case-law on the Institutions’ language regime.  

Part II examines the issue of the name of the single currency and some of the reasons underlying the ECB’s stance on proposed national variations in its spelling.

It has some interesting case studies of Malta, Luxembourg, Ireland, Turkey, Cyprus etc where either national laws were made to accept second language as a working language (mostly English) or European Community laws were changed to accept a national language (like Irish). Super stuff. 

It discusses language regime separately of  

• European Parliament
• European Commission
• European Union
• European Court of Justice
• Court of Auditors
• community agencies and bodie
• ECB

In ECB the multilingual issue is more interesting.  

It should first of all be noted, as stated before, that the Regulation formally applies to the Community Institutions only. While the ECJ has relatively recently ruled that ‘the ECB, pursuant to the Treaty, falls squarely within the Community framework’ has since been ‘affirmed’ by Chapter II of Title IV of Part I of the European Constitution entitled ‘The other Union Institutions and advisory bodies’ is not, , an assessment that, it remains the case that the ECBstricto sensu, a Community Institution

A fundamental reason why the ECB’s emphasis on the application of the principles of the Regulation differs from that of the Community Institutions is because of the dichotomy of its structure as the ECB is, on the one hand, a specialized Community law organization and, on the other hand, the decision-making centre of the European System of Central Banks (‘ESCB’) and the ‘Eurosystem.’

So, ECB has broadly 2 kinds of communications. One internal communication – laws, regulations which need to be translated into all official languages. Two, external communication for financial markets which is mostly in English and translated into official languages of special cases (like policy rate changes).

Very insightful stuff on a very important issue in Europe. Though, the paper  could have been written more simply. It should also have offered more case studies on language issues in Europe and how they resolved it.

An account of Fed mistakes

Binyamin Appelbaum and David Cho have a nice write-up on where Fed went wrong in this crisis.

This one takes the cake:

In January 2005, National City’s chief economist had delivered a prescient warning to the Fed’s board of governors: An increasingly overvalued housing market posed a threat to the broader economy, not to mention his own bank and others deeply involved in writing mortgages.

The message wasn’t well received. One board member expressed particular skepticism — Ben Bernanke.

“Where do you think it will be the worst?” Bernanke asked, according to people who attended the meeting, one in a series of sessions the Fed holds with economists.

“I would have to say California,” said the economist, Richard Dekaser.

“They have been saying that about California since I bought my first house in 1979,” Bernanke replied.

This time the warnings were correct, and the collapse of the California real estate market would bring down the nation’s fourth-largest bank, the largest casualty of the financial crisis.

Complacency at its best (or worst??)

Krugman says he has lost more respect for his ex- head of department (i.e. Bernanke). THough, Bernanke has surely helped avoid second great depression, the initial errors and ignorance is grave.

Felix Salmon has a nice summary as well.

Comparing Fed and ECB—basics

Patricia Pollard has written a useful primer on differences and similarities between Fed and ECB.

This article examines modern central banking with a focus on the world’s two most prominent central banks—the Federal Reserve System and the European Central Bank.

First, it examines the structure and appointment process of the key policymakers at the central banks. Next, it highlights the tasks of the central banks, focusing on the monetary policy process. The goals and tools of monetary policy as well as the decision-making process and how they differ in each system are discussed. Finally, the article examines accountability and transparency in the Federal Reserve and the ECB.

 It is a good paper to refer from time to time on the organisational differences between ECB and Fed. Has short history of the two as well.