Archive for December, 2009

Chile the next developed economy..??

December 23, 2009

Juan Forero of Washington Post has a write-up on Chile economy (HT: Marginal Revolution).  He says:

This week, the Organization for Economic Cooperation and Development, a club of rich nations that includes the United States, Japan and several European countries, formally invited Chile to join. Becoming the first South American nation in the 30-member group would be among the tangible signs of Chile’s steady rise since the 1980s, when it was in the grip of dictatorship.

Such a transition from developing to developed country last happened more than a generation ago — think Ireland and South Korea. No one is exactly sure of the timing for Chile. But economists say this country of 17 million will become the first Latin American country to switch categories sometime in the next decade.

“It’s well on its way to becoming a developed country, and it’s not just because we see numbers that look very promising,” said Marcelo Giugale, director for poverty reduction and economic management in Latin America at the World Bank. “I think there are more profound transformations happening in Chilean society that point to a very promising developed country very soon.”

The article discusses briefly how Chile has managed to grow despite initial concerns:

On the surface, Chile might seem an unlikely country for fast development. It is so isolated on the continent’s fringe that Henry Kissinger once famously disparaged Chile as “a dagger pointed at the heart of Antarctica.” For much of the 20th century, its copper-based economy was hobbled by boom-bust cycles.

Today, Pinochet-era reforms such as a policy of privatizations and low import tariffs remain in place.

Chile’s openness to trade is combined with generous social spending. In recent years, Chile has accelerated spending on education and day care. Forty percent of youths now go on to universities or other institutions beyond high school, authorities say, and 70 percent of those are the first in their families to do so.

Prudent economic management, officials here say, not only helped Chile go from being a debtor nation to a net creditor, but also protected it from the worldwide economic meltdown. Velasco, the finance minister, said Chile created a rainy-day account funded with the billions generated by a commodities boom earlier this decade.

Chile has posted Latin America’s fastest economic growth over a generation, and poverty has dropped from 45 percent before the demise of Gen. Augusto Pinochet’s government to a regional low of 14 percent today. But Giugale and other economists say Chile has advanced in areas more difficult to measure, such as strengthening state institutions like the courts and fighting corruption.

Chile also has a stable and robust democracy, ruled since 1990 by a coalition of Socialists and Christian Democrats that unseated Pinochet. The current president, Michelle Bachelet, has a popularity rate hovering at nearly 80 percent.

Hmmm. …interesting stuff.

Chile had a countercyclical measure prepared much before to handle any crisis

Prudent economic management, officials here say, not only helped Chile go from being a debtor nation to a net creditor, but also protected it from the worldwide economic meltdown. Velasco, the finance minister, said Chile created a rainy-day account funded with the billions generated by a commodities boom earlier this decade.

When the financial crisis spread, that money was used to help realize one of the world’s most ambitious stimulus programs, Velasco said. Chile’s economy will contract this year but is expected to grow 4.5 percent in 2010.

Velasco is Andres Velasco, their finance minister. He was a professor of economics at Kennedy School at Harvard. He was criticised for setting this fund but is now a very popular minister for helping Chile weather the crisis.

During a three-year copper boom he and central bank President Jose De Gregorio set aside $48.6 billion, more than 30 percent of the country’s gross domestic product, that he is now using for tax cuts, subsidies and cash handouts to poor families.

So, they actually practiced what others have preached so long – save some for bad times. This is especially the case for natural resource rich econs like Chile.

Velasco is a very good economist as well and has written some excellent papers on crisis and emerging economies. I covered one paper here.

I have also been a fan of Central Bank of Chile and its research work. It’s current Governor Jose De Gregorio is very good as well. So, overall Chile is in very good policy hands.


A very comprehensive paper on Chile’s economic development.

Two e-books on financial reform and trade in this crisis

December 23, 2009

NYU Stern econs have prepared a e-book on financial reform. The chapter summaries are here.

November 2008 saw the global financial system on the brink of collapse; the crisis – which began in 2007 – had entered a new and dangerous phase. That time we responded by gathering a group of world-renown financial market experts to evaluate:

  • The roots of the crisis and where things stood,
  • The measures needed to prevent future crises, and
  • How the key policies – the massive creation of liquidity, the TARP, the auto bailouts, the financial bailouts – were being used to address the crisis.

The result was a collection of 18 “white papers” that were bound, reproduced and circulated before the end of December and subsequently published in March 2009 by John Wiley and Son, entitled Restoring Financial Stability: How to Repair a Failed System

There is another e-book on trade in this crisis:

A new Ebook aims to inform the world trade ministers what the economists know about the trade collapse.

I have read parts of the trade e-book. Very good stuff on how trade fared in this crisis.

There is just so much to read…Thinking about the huge volume of things pending to read alone is enough to stress. The reading has still not begun…

World Bank’s Knowledge in Development Notes

December 23, 2009

I came across this very valuable short research notes section on World Bank website – Knowledge in Development Notes

These notes, prepared in 2009, provide background on current development issues based on research from inside and outside the World Bank. They ask What works? What doesn’t? Why? and What’s next?

It has notes on variety of topics- climate change, finance and development, policies for crisis, impact of crisis on social development etc.

Very useful resource.


Politics in economics departments

December 22, 2009

I wrote a blogpost a while ago covering Montek Ahluwalia’s speech. He pointed to the role Amartya Sen played in forming Planning Commission. Just reproducing them:


Political Influence of Financial Industry

December 22, 2009

IMF Research Bulletin for Dec 2009 has very interesting stuff.

  1. Discussion by Prakash Kannan on Financial crisis and recovery.
  2. Inflation targeting in emerging economies by Turgut Kisinbay
  3. Seven questions on political influence of financial industry
The first two are excellent discussions and a must read. Very rich literature surveys.

I would just briefly cover the seven questions on political influence of financial industry:

  • Question 1: How did we get here? One of the reason is failure of regulators. Why did regulators fail? Political influence and lobbying by finance  firms is one of the reasons
  • Question 2: What is lobbying and how does it work in the United States? Lobbying is rent seeking by firms through personal connections with politicians to obtain private benefits.

    In US, lobbying is done via paying for election campaigns or hiring lobbying firms to lobby with senators etc

  • Question 3: Was lobbying by the finance, insurance, and real estate industry associated with loosening lending standards? Yes, research shows lobbying led to weaker laws in mortgages and which led to loose standards
  • Question 4: How effective was lobbying by financial institutions during the crisis? Yes, lobbying lenders were more badly effected in the initial crisis wave.
  • Question 5: What links lobbying to lending and performance? Lobbying leads to riskier loans
  • Question 6: What are the policy implications of a link between lobbying and lending? Difficult to estimate clearly as many channels
  • Question 7: Can regulatory reform succeed? There is hope and time will tell. Though just to add, seeing recent reactions, all hope is lost really. It just gets worse and worse. 

Super stuff. Political economy of finance is a hot topic for PhD.

Turner again says it is a crisis of economic theory

December 22, 2009

Just a couple of months ago, Adair Turner created a stir with his review of financial crisis. He had blamed the efficient markets hypothesis and other ideas on financial economics for the crisis.

In a recent speech he revisits the issues:

This afternoon I will therefore do three things:

  • First, review the causes of the crisis.
  • Second, highlight that this was not just a crisis of specific institutions or regulations, but of economic theory.
  • Third, explore two issues where we have more thinking to do.


Red Ink Rising… a case for rising US debt levels

December 21, 2009

Peterson-Pew Commission on Budget Reform has been set up recently for the following:

To modernize an outdated Congressional budget process in light of the daunting economic challenges facing the nation, the Peter G. Peterson Foundation, The Pew Charitable Trusts and the Committee for a Responsible Federal Budget have launched a landmark partnership to build bipartisan consensus for a core set of reforms.  The Peterson-Pew Commission on Budget Reform has convened the nation’s preeminent experts to make recommendations for how best to  improve the nation’s fiscal future and how best to strengthen the federal budget process.

To begin with the commission has released a nice report on state and future of US debt and deficit levels. They call it – Red Ink Rising: A Call to Action to Stem the Mounting Federal Debt.

Though much of it is known – US has high deficits and needs to be curbed, possible choices, paths ahead etc. It still serves as a nice primer on the topic. It is a good read.

Great Depression Analogy

December 21, 2009

Michael Bordo and Harold James have written a super paper comparing Great depression with this crisis. Though there have been many papers on this track,  anything extra from Bordo and James is always welcome. Both are exceptional economic historians.

Unfortunately, the paper is a paid NBER version. I am yet to find a free version.

This paper examines three areas in which analogies have been made between the interwar depression and the financial crisis of 2007 which reached a dramatic climax in September 2008 with the collapse of Lehman Brothers and the rescue of AIG: they can be labeled macro-economic, micro-economic, and geo-political. First, the paper considers the story of monetary policy failures; second, there follows an examination of the micro-economic issues concerned with bank regulation and the reorganization of banking following the failure of one or more major financial institutions and the threat of systemic collapse; third, the paper turns to the issue of global imbalances and asks whether there are parallels that might be found in this domain too between the 1930s and the events of today.

The big difference in this paper is also gives a European perspective on the GD. Much of the papers only give US side of the story. This one has case studies from Germany and Austria as well.

What is particularly interesting is Germans were quick to act to falling banks and was seen to have efficient policies  – bad banks, reorganization and merging of banks, buying bills from banks as interbank money markets had frozen etc. So today’s policies are anything but modern. It was all tried earlier as well.

However, just like today, the bailouts became controversial as they were seen as socializing losses and initial bailouts were seen as helping politicians and their constituencies. Same was seen in Austria as well where bailouts were seen as massively corrupt. There was a big public hostility to bailouts just like today.

The authors then raise concerns of growing nationalism as happened in GD. The authors  say China has reasons to close itself more to the rest of the world.

Insightful stuff.

Inflation first Monetray Policy

December 21, 2009

Daniel L. Thornton of St Louis Fed in a short paper makes a case for inflation first monetary policy. There is a big discussion post-crisis on what should a central bank target – inflation,  growth, financial stability etc. 

He says monetary policymakers must pursue a hierarchical target with price stability at tops 

I argue that there are several reasons central banks might want to operate under what Laurence Meyer calls a “hierarchical mandate,” that is, where the principal objective is price stability and policymakers do not pursue economic stabilization policy unless their price stability objective has been achieved. 


The first reason monetary policymakers might be well served to operate under a hierarchical mandate is that changes in the money supply have no long-run effects on the economy. 

The second reason is that the policy option faced by policymakers is a function of the structure of the economy, the source of the shock, and whether the shock is temporary When faced with a supply shock, an attempt to mitigate its effect on prices exacerbates the effect on output and an attempt to mitigate its effect on output exacerbates the effect on prices. A hierarchical mandate would alleviate concerns that policymakers might jeopardize their long-run price stability objective for some short-run gain in economic stability because of political pressure or for other reasons. 

Finally, policymakers might prefer a hierarchical mandate because the more firmly anchored are inflation expectations, the more aggressively policymakers will be able to pursue economic stability. 

Though am not sure whether there will be many takers for this inflation first idea.Before crisis, the basic idea was that price stability is a necessary condition (some even thought it as sufficient condition as well) for financial stability. Hence focus was on price stability and pre crisis inflation levels were really stable and non-volatile. Hence, it was thought that financial markets are stable as well. Central Bankers either just practiced price stability or asked others to follow it. 

We all know what followed was anything but stable. 

What is also ironical is how quickly price stability became a vogue. Just after Volcker showed in late 1970s that inflation could be tamed by monetary policy all central banks jumped onto it. But think about financial instability. It has been there since ages but nobody wants to do something meaningful in this area.

This does not imply price instability can be tolerated. Price Stability is a very important goal. But financial stability is a very important objective as well. You cannot ignore it anymore.  

Whether central banks like it or not they will always be responsible for financial stability. One major reason is central banks act as lender of last resort. So in case of any problem in fin markets the attention is always going to be on central banks. So, it is always better to give them proper responsibility. They should be given more tools apart from interest rates to manage financial stability. The tools should be sharper and not just involve writing financial stability reports (or issuing sermons as Mervyn King calls it).

I don’t think hierarchical mandates would work. Price Stability and Financial Stability would go hand in hand. This makes things complicated but that is reality for you. We were thinking monetary policy is so simple (again boring as Mervyn King called it)- just look at price stability. Economics is pretty complicated and policymaking is also going to be complicated.

It is useful to simplify things but not oversell it. I think everything was oversold before this crisis – inflation targeting, price stability, monetary policy only, efficient financial markets etc.

Can US inflate to reduce the debt?

December 19, 2009

Joshua Aizenman and Nancy Marion have written a very timely paper on US debt and measures to reduce it. Paper is pretty simple but still might take time. Voxeu has  a nice summary of the paper. I just love voxeu for this purpose. Not getting time to read a important paper, search in voxeu for a quick summary.

So can US inflate the debt?

As the US debt-to-GDP ratio rises towards 100%, policymakers will be tempted to inflate away the debt. This column examines that option and suggests that it is not far-fetched. US inflation of 6% for four years would reduce the debt-to-GDP ratio by 20%, a scenario similar to what happened following WWII.


Attitudes and views of German economists…increasingly leaning towards AngloSaxon economics

December 18, 2009

I came across this paper by Europe based econs- Bruno S. Frey, Silke Humbert and Friedrich Schneider. 

The abstract says: 

Which schools of thought are favored by German economists? What makes a good economist and which economists have been most influential? These questions were addressed in a survey, conducted in the summer of 2006 among the members of the ‘Verein für Socialpolitik’, the association of German speaking economists. An econometric analysis is used to identify to what extent ideological preferences or personal factors determine the respondents’ answers. Our results suggest that = 

  • German economists favor Neoclassics as a school of thought and appreciate the contributions of their Anglo-Saxon colleagues much more than their fellow compatriots’ contributions. 

  • Furthermore, a ‘good’ economist should have expertise in a certain field, as well as a broader knowledge of general economics. Some of the results can be compared to Colander (2008). 

  • The results indicate that graduate programs noted for their American style greatly influence a student’s opinion as to what attributes a good economist must have. 



Should, or Can, Central banks target prices?

December 18, 2009

The evergreen topic on central banking. Jeff Frankel in his blogpost points to 20 experts views on the issue.

I have summarised the views in this table. Overall, there is still a wide divergence of views.


A guide to Mutual Fund Brochures

December 18, 2009

Finance Clipping Blog points to this very funny guide on understanding Mutual Fund brochures.

Fund Brochure Says… What It Really Means…
Ultra Leveraged to the Hilt
Global Growth We’ll Chase Stocks For You in Whichever Country is Most Overheated Right Now
Clean/ Green A Basket of Government-Subsidized Experiments and Some Shares of GE
Deep Value We Will Invest in Sewing Machine and Typewriter Companies
Premium We Will Pay Up for High-Multiple Stocks/ You Will Pay Up in Fees
Socially Responsible No Such Thing – All Corporations are Evil, Sucker
Diversified We Will Basically Buy the Index and Go Golfing
Enhanced Uses Exotic Derivatives You’ve Never Heard Of
Balanced We Will Underperform Both the Bond AND the Stock Market.  You’re Welcome.
Aggressive Growth Collection of Chinese Online Gaming Stocks and New Jersey Biotech Startups
Lifecycle We Can See 20 Years Into the Future, Only Putnam Knows When and How You Will Die
Moderate Allocation Gutless Fund Manager
Quantitative Manager Will Take Credit for Up Years, Blame Computers for Down Years
Endeavor/ Opportunities We Will Throw Darts
Core No Need to Spread it Out, Send Us Everything You Have

Bernanke voted for second term

December 18, 2009

Finally after much hype and speculation, Senate Banking Committee has voted Ben Bernanke as Chairman of Federal Reserve for the second term. The vote was in favor of Bernanke at 16-7.

Today the Senate Banking Committee approved the nomination of Ben Bernanke to continue as Chairman of the Board of Governors of the Federal Reserve System on a vote of 16 to 7. 

President Obama announced Bernanke’s reappointment on August 25th.  The nomination will now be sent to the full Senate for consideration.   
 “As I have said, I will vote to pass that nomination out of this committee and to the full Senate,” said Chris Dodd (D-CT), Chairman of the Senate Banking Committee.  “Some of the criticisms of the Fed under Chairman Bernanke that have been voiced during this confirmation process have merit.”

WSJ Economics Blog has an account of members that voted Yes and No. It also has a few senate members comments.

It divides the list as Democrats and Republicans. I just did a bit of calculation and found something very interesting:

  • 13 Democrats voted and 10 Republicans voted
  • Out of 13 democrats, 12 voted for Bernanke and 1 said no
  • Out of 10 Republicans, 10 said No and only 3 said yes

Why is this interesting? Well Bernanke is Republican. You first see a Democrat president nominating Bernanke for 2nd term and now you see majority of ayes coming from Democrat senate members. If Republicans had their way, they would have wanted Bernanke out.  

You only see these amazing things in US politics. I haven’t seen it happen anywhere else. A public policy person is always backed by the party you believe in and vice-versa. In US, it doesn’t really matter.

In this huge political economy exercise, it is nice to see some win for economic policies. Most economists now say. without Bernanke the 2nd depression was a given. The economy may still be very bad, but without Bernanke and his quick decisions (backed by his studies on Great Depression) , the world economy would have been far worse. Some even say if they were in Bernanke’s position, they also would not have taken decisions like he did. He was slow to begin, but once he saw depression like situation he acted real fast.

What a career path for Bernanke. He studied Great Depression all his life and then was in a position to act to prevent the second one. I mean it doesn’t get better than this. It is like a fairy tale really.

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

Would Bundesbank have helped US escape Great Inflation of 1970s?

December 16, 2009

Keeping Jurgen Stark’s criticism aside that Americans always call economic events great, let us look at this interesting paper

The Great Inflation of 1970s led to the monetary policy revolution and we saw much lower inflation rates from thereon. There were papers which asked if we brought Greenspan back to 1970s would America escape the great inflation? The papers largely said no Greenspan would not have helped and blamed the extraordinary economic situation which led to the inflation then. 

This paper looks at the problem from the other angle. Bundesbank’s track record in Great Inflation was admirable. Its track record overall was exemplary. So what if Bundesbank was made incharge of America’s monetary policy. Would it have helped? Ideally, it should lead to lower inflation. 

However, the author finds this is not the case which is a big surprise. We never know what Greenspan would have done in 1970s as America only learnt its monetary policy lessons after Volcker showed how Fed could lower inflation. But we surely know what Bundesbank would have done as we know its strategy. So to see Bundesbank not being effective is a surprise. 

The conclusions the author draws are more interesting. These kinds of studies use a technique called Structural VAR (SVAR) to evaluate these situations. The author says instead of thinking that Bundesbank would not have helped; we should instead see the results from SVAR with some suspicion. 

Since the structural VAR methodology came to essentially dominate applied macroeconomic research, around mid-1980s, policy counterfactuals have been one of its
main applications. As we have discussed, the outcome of such counterfactuals is seldom questioned, and the results they produce are usually taken at face value. In this
paper we have shown that standard structural VAR methodology, when applied to a specific policy counterfactual–‘bringing the Bundesbank to the post-WWII United
States’–produces a result which the vast majority of macroeconomists would likely find extremely hard to believe: the very same central bank which burnished its ‘hardmoney’,
anti-inflation reputation by successfully countering the 1970s’ inflationary impulses in West Germany would not have been able to deliver a comparable performance
had it been put in charge of U.S. monetary policy. The fact that (i) such counterfactual is a ‘standard’ one–in the specific sense that, instead of being performed
within a single country and across time, it is performed across countries–and (ii) it has been produced based on ‘off-the-shelf’ methods (in terms of both estimation
 and identification), sounds a cautionary note on taking the outcome of SVAR-based policy counterfactuals at face value, and raises questions on their very reliability.  

So the key issue here, in our view, is the mapping between the underlying true model of the economy and its structural VAR representation, and in particular the ability of counterfactuals based on the latter to correctly capture the true counterfactuals based on the former. Both issues are currently being investigated in our work in progress.

Exciting stuff. What amazing research these guys end up doing.


To read how Bundesbank avoided Great Inflation see this Otmar Issing piece


History of Central Banks … originated for financing wars

December 16, 2009

J. Lawrence Broz has written a fascinating paper on history of central banking. He points most central banks were developed to finance wars – Riksbank in 1688, Bank of England in 1698, Bank of France in 1800, First Bank of United States etc. 

The main idea goes  like this. The Governments were always under war with someone else and incurred huge expenditure. So, people were worried that govts would default. The Govts faced both credibility and time consistency issues (whether govt will honor its debts). Hence, central banks were set up that served as institutions to lend to governments. The central banks in turn solved both the credibility and time consistency issues. Hence, it was a win-win situation for both – The Government gained credibility that it would not default and Central banks got privileged rights to be the banker to the government.

Over a period of time wars declined. Then central banks leveraged their privileged status to become the central banks as we know them now.

There is another paper I pointed out which looked at reasons why politicians decided to delegate powers to  central banks to determine their own goals. This was a more current situation perspective.  In the era of wars, the above paper tells you why central banks came into being.

I don’t have the time to discuss the paper in entirety. But it is a must read. Excellent discussion on political economy

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