Archive for December 17th, 2009

Arthur Cecil Pigou- A great economist not given his due

December 17, 2009

John Cassidy of WSJ has a must-read profile of The British economist Arthur Cecil Pigou.

He begins the article interestingly:

At the Heavenly Models home for deceased economists, an award is being presented to the resident whose work best explains financial crises, global warming, and other pressing issues of today. The favored candidates include John Maynard Keynes, the patron saint of stimulus programs; Hyman Minsky, an American disciple of Mr. Keynes who warned about the dangers of financial deregulation; and Milton Friedman, the late Chicago economist. (Mr. Friedman’s free market principles are out of vogue, but Federal Reserve Chairman Ben Bernanke recently took his advice on how to prevent depressions by pumping money into the economy.)

The winner’s name, however, turns out to be much less familiar: Arthur Cecil Pigou (pronounced “Arthur See-sil Pig-oo”). Stepping from the wings, a strapping Englishman with fair, wavy hair and a luxuriant moustache, smiles awkwardly and accepts his prize. A contemporary of Mr. Keynes at Cambridge University, Mr. Pigou was, for a long time, the forgotten man of economics. In the years leading up to his death, in 1959, he was a reclusive figure, rarely venturing from his rooms at King’s College. His novel ideas on taxing polluters and making health insurance compulsory were met with indifference: Keynesianism was all the rage.

 It is just amazing how much Pigou’s ideas effect our lives. His central idea of managing spillovers or externalities is present in every walk of life. Especially in financial regulation. Anything the fin regulators do- raising capital requirements, clampdown on bonuses etc are attempts to mitigate negative impacts of spillovers. Similarly recent health care policy can be viewed as a counter-spillover policy. Better health facilities lead people to be healthy and productive.

 And then the recent climate change debates is all about spillovers and understanding Pigou or Pigovian economics as it is called.

Global warming presents perhaps the most dramatic example of what can happen if spillovers are ignored. It was the growing public concern over global warming that resurrected Mr. Pigou from obscurity. In 2006, the British government published an official report on climate change by Sir Nicholas Stern, a well-known English economist, which relied extensively on Mr. Pigou’s analytical framework. “In common with many other environmental problems, human-induced climate change is at its most basic level an externality,” Mr. Stern wrote. And he went on: “It is the greatest and widest-ranging market failure ever seen.”

In addition to referencing Mr. Pigou’s work directly several times, Mr. Stern recommended the imposition of one of his extraordinary restraints: a substantial carbon tax. This proposal remains controversial, but a number of Republican economists have endorsed it. Harvard’s Greg Mankiw has founded an informal Pigou Club for economists and pundits that support a carbon tax.

The read reminds me of the SAIL (Steel Authority of India Ltd) advertisement which said – There is a little bit of SAIL in everyone’s life. One can reword it to say – There is a liittle bit of Pigou in everyone’s life.

A look at Riksbank’s Monetary Policy Committee Decisions

December 17, 2009

Bul Ekici of Riksbank has written a short note analyzing the decisions of various board members in the monetary policy meeting. They call it Executive Board meeting in Riksbank.

 It gives you good insights into how Riksbank board is constituted and takes decisions.

 The summary is:

  • A summary of the Executive Board’s composition and voting patterns since 1999, among other data, reveals the following:
  • All in all, thirteen different members have served in the Executive Board, under three different Governors, in six different (complete) compositions.
  • At least one member has entered a reservation against an interest rate decision at approximately one-third of the 95 monetary policy meetings held.
  • On four occasions, voting has been completely even, with the final decision resting with the Governor’s deciding vote.
  • A Governor in office has never entered a reservation, but has always belonged to the majority.
  • Most members entering reservations have consistently done so in a certain manner in relation to the majority – they have consistently advocated either a higher or a lower interest rate. Only two members have entered reservations in both directions

 Not much differences between board members.

Basics of Currency Crisis: 3 generation models and Russian 1998 crisis case study

December 17, 2009

St. Louis Fed economists Abbigail Chiodo and Michael Owyang, have a super paper on currency crisis.

They begin to discuss what a currency crisis is and its impact of the economy. They then discuss the 3 generation currency crisis models: 

  • First Generation: It was developed by Krugman (1979) and developed by Flood and Garber (1984). This model explains that a currency crisis will result if the govt has huge deficits and there is a fixed exchange rate. If expectations start to build that govts will be unable to finance the deficit and could monetize the deficit. The monetization could result in high inflation. This could lead to foreign outflows and a speculative attack on the domestic currency. The attack could initially be defended by forex reserves. But if the attack grows and central bank is unable to defend the currency and does not have adequate reserves, it could result in devaluation. A sudden devaluation of a fixed exchange rate leads to collapse of the exchange rate system and leads to a crisis
  • Second Generation: First G model could not explain the contagious currency crisis. For instance, we saw South East Asian crisis becoming a contagious crisis spreading from one region to the other. The 2nd generation model explains these events via trade channel or via neighbouring trade partners or via having similar macroeconomic attributes or via financial channel.
  • Third Generation: First G and Second G models did not provide policy prescriptions. First G model actually says crisis cannot be thwarted once expectations of devaluation sets in.  Typical prescription for a currency crisis is to raise interest rates and prevent capital outflows. However, Third G model says a currency crisis leads to number of problems in the economy and higher interest rates would create more damage to the economy. The 3 G models instead suggest to keep real interest rates low and keep financial system functioning in the crisis (make banks give credit etc)

The 3 models together tell you 4 factors that lead to a currency crisis:

  • Domestic Public and Private debt
  • Expectations
  • State of financial markets
  • Pegged exchange rate

The authors then use the lessons learnt from the 3 models and apply to Russian crisis of 1998. All the 3 models and the four factors help explain the crisis.

Wonderful reading. It tells you so much about currency crisis in so few pages.

Bernanke – Time Person of the Year

December 17, 2009

Foreign Policy recently named Bernanke the top thinker in the world. And now Time has named him as the person of the year.

The cover story is here

Very Long interview of Bernanke is here

There are some excellent photogalleries:

One of them says Bernanke married his wife Anna via a blind date:

After Harvard, Bernanke went on to pursue a Ph.D. at MIT, where he met — on a blind date — Anna, a student at Wellesley, who would become his wife. They have two children, a son in medical school and a daughter who has just finished college.
I read the same story for Robert Merton as well.
Paul Krugman says Bernanke should be worried. There is a golden rule that business guys who make it to cover stories of a famous magazine, their companies stocks should be shorted. He points to a previous Time magazine cover which has Greenspan, Summers and Rubin….:-)
Delong also has a nice post

%d bloggers like this: