Archive for September, 2010

How Useful are DSGE Model Forecasts for Central Bankers?

September 19, 2010

Brooking conducted its Fall 2010 Conference. THere are some excellent papers there as always.

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Major public debt reductions: Lessons from the past, lessons for the future

September 19, 2010

This is title of a new paper by ECB economists – Christiane Nickel, Philipp Rother and Lilli Zimmermann. 

The financial crisis of 2008/2009 has left European economies with a sizeable public debt stock bringing back the question what factors help to reduce these fiscal imbalances. Using data for the period 1985- 2009 this paper identifies factors determining major public debt reductions. On average, the total debt reduction per country amounted to almost 37 percentage points of GDP.We estimate several specifications of a logistic probability model.

Our findings suggest that, first, major debt reductions are mainly driven by decisive and lasting (rather than timid and short-lived) fiscal consolidation efforts focused on reducing government expenditure, in particular, cuts in social benefits and public wages. Second, robust real GDP growth also increases the likelihood of a major debt reduction because it helps countries to grow their way out” of indebtedness. Third, high debt servicing costs play a disciplinary role strengthened by market forces and require governments to set up credible plans to stop and reverse the increasing debt ratios.

 

Interesting paper.

Rajan vs Krugman..

September 17, 2010

He doesn’t leave anyone does he??

Krugman has been criticising Raghu Rajan lately. In this book review in The New York Review of Books Krugman and Wells critiques three books.  Rajan’s Fault Lines is one pf the three books. Needless to say Krugman does not like the book and is quite open about it. Rajan clarifies in this blog post.

More fireworks to follow.

Addendum:

I was reading this free chapter of the Fault Lines book. On reading it, I felt Rajan has also lost the plot. He is singing his own trumpet.He recalls how he foresaw that things were wrong by presenting a paper in Jakson Hole conference in 2005.  An economist like Rajan does not need to get into such games at all. Let others decide…

Brookings Briefs on development

September 17, 2010

Brookings has some good stuff on development economics:

Can Aid Catalyze Development? » (PDF)

Homi Kharas offers recommendations on how to link aid effectiveness more firmly to development strategies through a new multilateralism, a more transparent aid system, differentiated strategies for recipient countries and a longer-term focus for aid.

U.S. Government Support for Development Outcomes: Toward Systemic Reform » (PDF)

Noam Unger highlights the current pivotal moment for revamping U.S. global development efforts and outlines potential improvements to aid operations and fundamental reforms related to overarching strategy, organizational structures and underlying statutes.

The Private Sector and Aid Effectiveness: Toward New Models of Engagement » (PDF)

With an emphasis on business, Jane Nelson discusses the role of the private sector in development and proposes various ways to scale up the collaboration between these actors and official donors.

International NGOs and Foundations: Essential Partners in Creating an Effective Architecture for Aid » (PDF)

With a focus on international nonprofit organizations, Samuel A. Worthington (InterAction) and Tony Pipa (independent consultant) analyze the relationship between official aid and private development assistance, suggesting that the role of civil society must evolve as part of the international dialogue on aid effectiveness.

Responding to a Changing Climate: Challenges in Financing Climate-Resilient Development Assistance » (PDF)

Kemal Derviş and Sarah Puritz Milsom (Brookings Global) underline key finance-related challenges in achieving climate-resilient growth in developing countries and propose steps to ensure progress in responding to the climate change challenge.

Civilian–Military Cooperation in Achieving Aid Effectiveness: Lessons from Recent Stabilization Contexts » (PDF)

Margaret L. Taylor (Council on Foreign Relations) explores civilian and military roles and the right balance between them for delivering effective international assistance, offering lessons that are critical for further analysis of foreign militaries as aid providers.

Rethinking the Roles of Multilaterals in the Global Aid Architecture » (PDF)

Homi Kharas probes key issues, including the appropriate multilateral share of total aid, the proliferation of multilateral agencies, knowledge exchange among development professionals and the financial leveraging of loans to capital.

These policy briefs were commissioned for the 2010 Brookings Blum Roundtable, which annually invites government officials, academics, development practitioners and leaders from businesses, foundations and international organizations to together consider new ways to alleviate global poverty through cross-sector collaboration.

Will central banks lose focus as they also become financial supervisors?

September 17, 2010

Not really as per Lucia Dalla Pellegrina, Donato Masciandaro and Rosaria Vega Pansini. They actually become more specialised. In this voxeu article they say: 

The global crisis has led policymakers in the EU and the US to broaden their central banks’ mandates to include greater banking supervision. This column argues that this new responsibility should be seen as an evolution of the central bank specialisation as a monetary agent rather than a reversal of the specialisation trend.

RBI’s Mid-Quarter Monetary Policy Review: September 2010

September 16, 2010

As RBI annnounced in last monetary policy that now between the two mon pol meetings there will be reviews. So in a way, there will be 8 monetary policy meetings.

In its first such review held between Jul-10 and Nov-10 monetary policy meetings, RBI raised both repo and reverse repo rates.

  • increase the repo rate under the Liquidity Adjustment Facility (LAF) by 25 basis points from 5.75 per cent to 6.0 per cent with immediate effect.

  • increase the reverse repo rate under the LAF by 50 basis points from 4.5 per cent to 5.0 per cent with immediate effect.

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    Does WPI Inflation lead to CPI Inflation or CPI Inflation lead to WPI Inflation?

    September 15, 2010

    Ashima Goyal and Shruti Tripathi of IGIDR have written a must read paper on the question.

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    Was Cash for Clunkers scheme useful?

    September 15, 2010

    I recall reading a CEA report on this topic.

    The Car Allowance Rebate System (CARS) 1 is one of several stimulus programs whose purpose is to shift expenditures by households, businesses, and governments from the future to the present. (Other programs with the same motivation include support for bringing forward future infrastructure investments, and accelerated depreciation to bring forward business investment.) Such time-shifting is valuable in a recession, when the economy has an abundance of unemployed resources that can be put to work at low net economic cost; even conservative economists such as Martin Feldstein, Chairman of the Council of Economic Advisers (CEA) under President Reagan, have endorsed this logic for stimulus spending. The benefits of such expenditure-shifting programs are particularly clear when the induced spending is in an industry (like the automotive industry) with a disproportionately large amount of unemployed resources. An additional benefit specific to the CARS program is that bringing forward the replacement of dirty (high-polluting) “clunker” motor vehicles by cleaner, high-efficiency vehicles means there will be less pollution over some time period.

    The program provided $3,500 or $4,500 bonuses to buyers who traded in light motor vehicles with mileage ratings of 18 miles per gallon or less, who purchased a new car or truck with an improved mileage rating, and whose trade-ins and new purchases met certain other criteria. In order to get the maximum amount of $4,500, the mileage had to improve by 10 mpg for new cars and 5 mpg for new light trucks. (There were separate criteria for medium trucks.)

    It did scenario analysis for its impact:

    • On auto sales: In our baseline scenario, the program will increase car sales in 2009 by about 330,000. In our pessimistic scenario, the increase will be about 210,000, and in the optimistic one, it will be about 560,000.
    • Under the pessimistic scenario, the program raises GDP growth by about 0.1 percentage points in 2009:Q3; under the baseline scenario, it raises growth by 0.2 percentage points; and under the optimistic one, it increases growth by almost 0.4 percentage points. To put it another way, the estimates imply that the $3 billion program will increase output in the automobile sector in the second half of the year by between about $2.5 billion and $6 billion – a substantial direct effect. It is important to note, however, that the boost to the level of GDP is temporary, and is followed by a drop that slightly more than reverses the increase, reflecting the slightly lower level of sales in the “payback” period.
    • the baseline scenario suggests that CARS will create about 35,000 job-years in the second half of 2009, followed by small offsetting decrements when the “payback” period arrives (for production) in 2010. In the pessimistic scenario, the figure is a bit over 20,000, and in the optimistic one, it is about 60,000. Thus, these estimates imply that employment in the second half of 2009 will be between about 40,000 (double the pessimistic 20,000 job-years) and 120,000 (double the optimistic 60,000) higher than it otherwise would have been. Our “baseline” estimate is that, because of the CARS program, employment in the second half of 2009 will be roughly 70,000 higher than it otherwise would have been.

    Though the study adds the results are not as robust as it is difficult to project car sales without the program.

    In a recent study (not read so far), authors  Atif Mian and Amir Sufi are more sceptical of the program. A short note is here:

    Our estimates of the speed at which consumers undo the effect of the program are in contrast to research from the Obama Administration. For example, the Council of Economic Advisors and National Highway Traffic Safety Administration argued that cash for clunkers pulled auto purchases forward from between 3 to 7 years after the program. Our estimates suggest that consumers reversed the effect of cash for clunkers in only 7 to 10 months.

    There is an argument to be made that bringing forward auto purchases by even a few months may be useful during a recession. However, we find no evidence that cities with a large number of clunkers experienced disproportionate rebounds in economic activity in the year after the program. We find suggestive evidence that employment in the auto sector increased after the cash for clunkers program. But this effect is hard to attribute to cash for clunkers alone given the federal bailout of General Motors and Chrysler in the spring of 2009.

    The most important take-away from our research is that short-term subsidies for durable goods only pull purchases forward from the very near future. However, our results do not imply that every form of fiscal stimulus suffers from this pattern. For example, unemployment benefits may lead to a less temporary effect on purchases. Research by other scholars on the economic stimulus payments of 2008 finds no evidence that consumers purchased fewer goods in the three to six months after disbursement. But policy-makers must understand that programs designed to induce the purchase of durable goods—housing, washing machines, or automobiles—will likely steal those purchases from the near future. \

    Interesting event studies..

    Which Comes First: Inflation or the FOMC’s Funds Rate Target?

    September 15, 2010

    Daniel L. Thornton of St Louis Fed puts this interesting question in this short note.

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    WPI Inflation August 2010 Update –change of base and lowering of inflation

    September 14, 2010

    The government has changed the base year for WPI Inflation from 1993-94 to 2004-05. This means inflation so far was calculated keeping April 1993 as base. Now it will be April 2004-05. The governments revise the base year to incorporate changes in the economy. The index revision has been in news for a while and finally it has happened. Each time the base year became backdated. I think first it was decided to change it to 1999-00 but time passed and whole thing got delayed. Then 2004-05 was decided but time again passed and series could not be prepared. There were talks of releasing it for 2009-10 but final;ly they decided to release it on 2004-05 base. Even GDP is on 2004-05 base. So, slowly all time series will be brought on 2004-05 base year.

    Key features are:

    1. The index has been expanded and will include 676 items compared to 435 in 1993-94 series.
    2. 176 items have been deleted and 417 items have been added
    3. Most of addition/deletion in manufacturing sector. —169 deleted and 406 added…makinjg total of 555 items
    4. Within mfg maximum deletions/additions in chemicals, machinery, transport equipment etc.
    5. Below table summarises weights and items:
      1993-94 2004-05
    Weights    
    WPI 100 100
    primary Articles 22.03 20.12
    Fuel Products 14.23 14.91
    Mfg products 63.75 64.97
         
    Items    
    WPI 435 676
    primary Articles 98 102
    Fuel Products 19 19
    Mfg products 318 555

    I am still reading the details of the whole exercise. However, this table is very interesting. It compares the inflation with 1993-94 ands 2004-05 base years. Here is how it looks:

      All Commodities
      2004-05 1993-94 Difference
    Apr-09 0.9 1.3 -0.4
    May-09 1.2 1.4 -0.2
    Jun-09 -0.7 -1 0.3
    Jul-09 -0.6 -0.5 -0.1
    Aug-09 0.3 -0.2 0.5
    Sep-09 1.1 0.5 0.6
    Oct-09 1.5 1.5 0
    Nov-09 4.5 5.6 -1.1
    Dec-09 6.9 8.1 -1.2
    Jan-10 8.5 9.4 -0.9
    Feb-10 9.7 10.1 -0.4
    Mar-10 10.2 11 -0.8
    Apr-10 11 11.2 -0.2
    May-10 10.6 11.1 -0.5
    Jun-10 10.3 11 -0.7
    Jul-10 9.8 10 -0.2
    Aug-10 8.5 9.5 -1

     WPI Inflation is lower in 2004-05 series for all the months. So July 10 inflation was 10% on 1993-94 base and 9.8% on 2004-05 base. In Aug-10, inflation was 9.5% on 1993-94 base and 8.5% on 2004-05 base.

    On a closer look, it is seen that in case of Primary articles inflation is higher for 2004-05 series. There are not much changes in fuel but in case of mfd products, the 2004-05 inflation is lower. As mfd products contributes more than 60% to inflation, it also leads to the overall trend as well. Hence, you see lower inflation for 2004-05 comapred to 1993-94.

      Primary Articles Fuel Products Mfd Products
      2004-05 1993-94 2004-05 1993-94 2004-05 1993-94
    Apr-09 6.6 6.6 -4.6 -5.7 0.4 1.8
    May-09 6.8 6.3 -5 -6.1 0.8 2.2
    Jun-09 5.9 6.5 -11.3 -12.5 -0.2 0.6
    Jul-09 5.8 7.6 -8.9 -10.4 -0.7 0.1
    Aug-09 9.8 8 -9.7 -9.3 -0.3 0.1
    Sep-09 10.6 8.4 -8.1 -8.2 0.2 0.5
    Oct-09 10.3 8.7 -6.8 -6.7 0.6 1.6
    Nov-09 14.3 13.9 -1.1 -0.7 2.3 4.3
    Dec-09 18 16.1 4.6 5.9 3.6 5.4
    Jan-10 20.2 15.4 6.8 8.1 4.8 7.3
    Feb-10 21.7 16 10.2 10.2 5.2 7.5
    Mar-10 22.2 18.3 13.8 12.7 5.2 7.4
    Apr-10 21.4 17.1 13.6 12.9 6.4 8.2
    May-10 20.4 18.5 14.4 14.4 6 6.9
    Jun-10 20.1 18.1 13.9 14 5.6 6.9
    Jul-10 18.9 14.9 13.3 14.3 5.4 6.2
    Aug-10 15.8 15.4 12.5 12.7 4.8 5.8

    All this is pretty interesting. Financial market players have seen this coming for sometime now. People were so fed up with high inflation and even higher revision in provisional figures. With no real measures coming from government and on top government also kept projecting lower inflation for the year-end compared to the trend. So targets were mixed in 2008-09 and 2009-10. Again for 2010-11 lower inflation has been projected. A number of market experts said only way government could show lower inflation was by changing base year. And this is what has happened!

    Though, it isn’t just a political exercise. This change if base was a long pending exercise. Good it has happened and now we have inflation index which resembles Indian economy more closely than 1993-94 series.

    Another important finding is no matter what you do you cannot do away with huge upward revisions. August 2010 press release says:

    For the month of June, 2010 the final Wholesale Price Index for ‘All Commodities’ (Base:1993-94=100) stood at 261.0 as compared to 259.8 (Provisional) and annual rate of inflation based on final index stood at 11.06% as compared to 10.55 percent (Provisional) reported earlier vide press note dated 16.08.10.

    Will read up and come back if I find something more interesting.

    European bank stress tests…..hiding unpleasant details

    September 12, 2010

    One always feard about veracity of European bank stress tests. Even before they were released, few people said they are not being done properly, it will jut be a coverting act etc. As the results were released, not surprisingly only few banks were found in trouble. THough, some people kept saying the tests are fake, sham etc.

    Now, this news is heating up. First WSJ article says that its analysis shows some banks did not give its true exposure to government bonds.

    An examination of the banks’ disclosures indicates that some banks didn’t provide as comprehensive a picture of their government-debt holdings as regulators claimed. Some banks excluded certain bonds, and many reduced the sums to account for “short” positions they held—facts that neither regulators nor most banks disclosed when the test results were published in late July.

    Because of the limited nature of most banks’ disclosures, it is impossible to gauge the number of banks that excluded portions of their sovereign portfolios from their disclosures, or the overall effect of that practice.

    But the exposure to government debt of at least some banks, such as Barclays PLC and Crédit Agricole SA, was reduced by a significant amount, according to industry officials and financial filings made by the banks. Adding to the haziness, the stress tests’ reported sovereign-debt levels differed, sometimes widely, from other international tallies and from some banks’ own financial statements.

    The findings undermine a primary goal of the stress tests—namely, to reassure investors and bankers world-wide the soundness of Europe’s financial system. “That would certainly be unhelpful to people’s perceptions” of the tests’ credibility, said UBS banking analyst Alastair Ryan. Reducing banks’ reported holdings of government debt “was clearly helpful for the thing [regulators] were trying to achieve: convincing you that there’s not a problem.”

    As eurointelligence says reported gap in bank holdings between the BIS and the stress tests is very high.

    WSJ Blog points to a paper which says banks only included governemnt debt which was in trading books. They excluded bonds held in banking books which are much larger in size.

    The stress tests ignored bonds held in financial institutions’ much larger banking books. The reasoning: Bonds in the banking book are assumed to be held to maturity, so banks don’t have to recognize losses unless the issuer defaults — an outcome the regulators see as unlikely over the stress tests’ two-year horizon, given the European Union’s creation of a 750-billion-euro fund to bail out troubled governments.

    The paper, penned by Adrian Blundell-Wignall and Patrick Slovik, provides a useful accounting of just how much the stress tests ignored. The banking books contain more than 1.6 trillion euros in EU government bonds, compared to only 336 billion euros on the trading books, for a grand total of more than 1.9 trillion euros. Using the stress tests’ own worst-case scenario, the authors estimate that banks’ total losses would be 165 billion euros, compared to the stress tests’ estimate of only 26 billion euros.

    Those numbers — which might still be understated — aren’t as meaningless as European regulators assume. Just because banks don’t have to recognize drops in the market value of bonds on their banking books, that doesn’t mean they haven’t lost money. Market prices reflect investors’ assessment of the chances that governments will eventually default on the bonds, and that the banks will eventually suffer a loss. Even if those losses come more than two years down the road, they are relevant to the banks’ value today.

    As I was reading various sources, the risk spreads have again risen in European countries reacting to these developments.

    If true, why would policymakers do this at first place? It would eventually be found out leading to worse problems later on.

    Got a New Idea for Monetary Policy?

    September 11, 2010

    John Taylor has this very interesting post – Got a New Idea for Monetary Policy?

    Do you have a new proposal for monetary policy? Perhaps a new policy rule? If so, it would be good to try out your idea first on a model of the economy. See how it works. Better yet, since economic models are different and economists frequently disagree, try it out in several models to be sure your rule is robust. But what models and how ?

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    Macroprudential policies alone are not enough..lessons from Japan

    September 11, 2010

    This is a nice speech from Kiyohiko G. Nishimura, Deputy Governor of the Bank of Japan. First he compares the current recession with Japan’s in 1990s and shows the similarities. And then he says macroprudential policies alone are unlikely to help. It needs to be combined with monetary policy. He does not clarify how but my guess is he is suggesting to raise rates a little along with pushing macroprudential tools.

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    Growth convergence among Indian States

    September 11, 2010

    Sanjay Kalra and Piyaporn Sodsriwiboonhave this interesting paper on growth performance of Indian states:

    Convergence and spillovers across countries and within countries are old, but recurrent policy concerns, and India is no exception to this rule. This paper examines convergence and spillovers across Indian states using non-stationary panel data techniques. Results on convergence among Indian states are generally found to be similar, but more nuanced, than previous studies. Generally speaking, there is evidence of divergence over the entire sample period, convergence during sub-periods corresponding to structural breaks, and club convergence. There is strong evidence of club convergence among the high- and low-income states; the evidence for middle-income states is mixed. Dynamic spillover effects among states are small.

    I don’t have time to get into details of the study. But state-wise differences and similarities are interesting.

    Seven myths on immigration

    September 10, 2010

    I pointed out this short paper which looks at impact of immigration on economy. Not surprisingly (for an economist), imigration is beneficial. In another paper also not surprisingly, governments have restricted immigration in this crisis.

    In this article, Darrell M. West of Brookings points to 7 myths surrounding immigration:

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    Fiscal multipliers vary over business cycle

    September 10, 2010

    Debate over fiscal policy and fiscal miultipliers just keeps getting interested. Gulzar summarises debate on fiscal policy institutions. And now this recent paper by Alan J. Auerbach, Yuriy Gorodnichenko says that fiscal multipliers differe depending on what part of business cxycle you are on. The multiplier is around 1-1.5 in recessions and 0-0.5 in expansions.

    In Voxeu, they summarise their paper:

    Plainly, the size of the multiplier varies considerably over the business cycle. For example, in 1985 an increase in government spending would have barely increased output. In contrast, a dollar increase in government spending in 2009 could raise output by about $1.75. Typically, the multiplier is between 0 and 0.5 in expansions and between 1 and 1.5 in recessions.

    Note the size of the multiplier tends to change relatively quickly as the economy starts to grow after reaching a trough. Thus, the timing of changes in discretionary government spending is critical for effectiveness of countercyclical fiscal policies.

    Second, to measure the effects of a broader range of policies, we estimate multipliers for more disaggregate spending variables, which often behave quite differently in relation to aggregate fiscal policy shocks.

    Specifically, we find that defence spending has the largest multiplier, with the maximum response of output being $3.56 for every dollar in defence spending in a recession.

    Fascinating stuff.

    Why did Lehman fail? Facts vs Myths

    September 10, 2010

    Thomas C. Baxter, Jr. of Federal Reserve Bank of New York gives a superb testimony to FCIC on the topic. As per his words, Fed and Treasury tried theior best to support Lehman but could not prevent the failure. In amother speech at the same venue, Richard Fuld, CEO of ex-Lehman gives an opposite picture.

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    Mankiw’s advice to students going to college

    September 10, 2010

    Greg Mankiw gives some valuable advice to students going to college. He

    AS a Harvard professor who teaches introductory economics, I have the delightful assignment of greeting about 700 first-year students every fall. And this year, I am sending the first of my own children off to college. Which raises these questions: What should they be learning? And what kind of foundation is needed to understand and be prepared for the modern economy?

    He points to 4 things to learn:

    • Learn some economics
    • Learn some finance
    • Learn some psychology
    • Ignore advice as you see fit (follow your own path)

    Read the article for more details. Interesting to see psychology making to the list. I would add economic history as well. For a more detailed write-up  in what to include in basic economics textbook  see this by Blinder

    Comparing 1938 Depression with 2010

    September 8, 2010

    Paul Krugman points how we are facing similar situation as seen in   1938. Even then FDR pulled out fiscal stimulus leading to second round of depression. And now Obama is facing the same situation.

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    Blame economists not economics

    September 8, 2010

    Dani Rodrik in his blog points to his new article. He says the problem is not with state of economics but the overconfidence of economists:

    The problem is that economists (and those who listen to them) became over-confident in their preferred models of the moment: markets are efficient, financial innovation transfers risk to those best able to bear it, self-regulation works best, and government intervention is ineffective and harmful.

    They forgot that there were many other models that led in radically different directions. Hubris creates blind spots. If anything needs fixing, it is the sociology of the profession. The textbooks — at least those used in advanced courses — are fine.

    He says non-economists think that econs are only interested in free markets theory. This is not the case:

    Labor economists focus not only on how trade unions can distort markets, but also how, under certain conditions, they can enhance productivity. Trade economists study the implications of globalization on inequality within and across countries. Finance theorists have written reams on the consequences of the failure of the “efficient markets” hypothesis. Open-economy macroeconomists examine the instabilities of international finance. Advanced training in economics requires learning about market failures in detail, and about the myriad ways in which governments can help markets work better.

    Macroeconomics may be the only applied field within economics in which more training puts greater distance between the specialist and the real world, owing to its reliance on highly unrealistic models that sacrifice relevance to technical rigor. Sadly, in view of today’s needs, macroeconomists have made little progress on policy since John Maynard Keynes explained how economies could get stuck in unemployment due to deficient aggregate demand. Some, like Brad DeLong and Paul Krugman, would say that the field has actually regressed.

    He says economists have preferred to give their preferences when they should just be presenting choices and menu options:

    Economics’ richness has not been reflected in public debate because economists have taken far too much license. Instead of presenting menus of options and listing the relevant trade-offs – which is what economics is about – economists have too often conveyed their own social and political preferences. Instead of being analysts, they have been ideologues, favoring one set of social arrangements over others.

    Furthermore, economists have been reluctant to share their intellectual doubts with the public, lest they “empower the barbarians.” No economist can be entirely sure that his preferred model is correct. But when he and others advocate it to the exclusion of alternatives, they end up communicating a vastly exaggerated degree of confidence about what course of action is required.

    One can only agree with what Rodrik has said. As this blog has pointed numerous times, flow of economic thought matters a lot and leads to economic policies. So economists need to be careful when giving an extreme viewpoint. The problem has been that the powerful economists of these times – Fama, Lucas etc- have taken an extreme view on economy and this led to much of the problems.


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