Archive for May, 2011

Is New Economic Geography (or Krugman) right….

May 31, 2011


Jessie H. Handbury and David E. Weinstein of Columbia University have this superb paper.

Crux of New Economic Geography (or NEG) developed by Krugman is:

Economies of scale may lead to rapid urbanization. Since 2007, for the first time in history, more than half of the world’s population live in cities. Paul Krugman has shown how economies of scale along with falling transportation costs can trigger a self-reinforcing process whereby a growing urban population gives rise to more large-scale production, higher real wages and a more diversified supply of goods. This, in turn, stimulates further migration to cities. The end result may well be that regions become divided into an urbanized core and a less developed “periphery”.

This paper looks at this issue of whether larger cities lead to higher varieties and lower costs:



How Vernon Smith has helped us understand Adam Smith better…

May 30, 2011


Maria Pia Paganelli of Yeshiva University has this nice paper on the topic.

She says most economics bases itself on self-interest. However, this is not always the case as we see humans valuing cooperation and fairness as well. Adam Smith’s The Theory of Moral Sentiments was based on these ideas. AS said humans value other things as well- sympathy, and innate desire to be both praised and praiseworthy.

Vernonm Smith extended Adam Smith’s ideas and showed via experiments that indeed people valued cooperation and fairplay and were sympathetic to others. This led to people monitoring and giving punishment for non-cooperative behaviors or by following internalized rules of conduct that promote fair and cooperative behaviors.

In experimental results in industrialized countries, cooperation and fairness are routinely observed. Cooperation and fairness may vary with the degree of anonymity, because subjects do respond to incentives. Nevertheless, even with complete  anonymity, a relevant amount of cooperation and fairness is observed. For example, using undergraduate subjects from the University of Arizona, even with double blind procedures, 29% of second movers choose $25 for self and $15 for other, over $40 for self and $0 for other, after the first movers have forgone $10 for self and $10 for other (Cox and Deck 2005). Additionally, cooperation and fairness are also observable in many foraging societies across the globe, although in different forms from the ones observed in industrialized countries.

Fairness seems to be universally present among humans, even if it varies with different incentives and across cultures (Henrich et al. 2004). Interestingly, similar experiments done with non-human primates also show some level of cooperation and “fairness.” Non-human primates help each other in getting food and reciprocate the help received. They get upset if one gets an “unfair” share: if one primate undeservedly gets a larger portion or tastier food, the other primate screams in protest (de Waal 1996 and 2003 de Waal and Berger 2000, de Waal and Luttrell 1988, Brosnan and de Waal 2003, Jansen, Hare, Call and Tomasello 2006).

The paper looks at this linkage of Adam Smith thoughts to Vernos Smith’s experiments:

This paper develops as follows. The first section describes some of the hypotheses used to explain cooperative behaviors in the existing literature. It is followed by the explanation of how Adam Smith may help us understand the mechanism through which  we may be able to move from personal to impersonal exchange, namely the internalization of rules of cooperation achieved through sympathy, reducing the transaction costs present in complex anonymous societies. The Smithian explanation is  subdivided in three sections: the generation and internalization of cooperation at the individual level, at the social level, the institutionalization of the rules of cooperation which may be seen as a feedback mechanism  caused by and causing increasing cooperation. The final section of the paper briefly  examines some limitations for developing cooperation.

Superb paper. How economists are interested in so many aspects….

Resilience of emerging economies in 2007 crisis

May 30, 2011

World Bank economists in this paper look at EME economies in the 2007 crisis.

They say against common perception, emerging economies suffered as badly as the developed economies during crisis (no decoupling please). However, their recovery was faster on account of better policies and measures taken before the crisis. These policies in turn were taken after some severe emerging market crisis broke in the past.

Reasons for better EME performance in recovery:


Tullock challenges for Facebook

May 30, 2011

Bruno Frey of University of Zurich has this superb paper giving two Gordon Tullock challenges to mainstream thinking.

Tullock believed – What is important, will be manipulated by the government. He was always sceptical of innovations which believed that they could undermine government’s role.

In this regard, Frey throws two Tullock challenges to the recent innovations/new ideas in public choice theory:


Financial Protectionism??

May 27, 2011

Andrew K Rose  of UC Berkeley and Tomasz Wieladek of BoE have this nice paper on the topic. It is perhaps the first paper on the topic (the authors also say so).

In the paper authors point to this interesting idea call protectionism measures by banks. When a bank gets nationalised does it lower its lending to international players? Does it charge higher interest rates?


Wharton hosts a tournament to reward innovations!

May 27, 2011

Wharton School hosts tournament to reward innovations which help better human lives in some or the other way. The idea is proposed by Christian Terwiesch and Karl Ulrich and here is their interview explaining the idea.

Knowledge@Wharton: Your book is about innovation tournaments. A logical question to start with would be what exactly an innovation tournament is, and how can companies use such tournaments to identify exceptional opportunities?

Ulrich: A tournament is an organizational problem-solving process in which a large number of opportunities are identified and then systematically evaluated and filtered until only a few exceptional ones remain. A tournament, like its counterpart in sports, is one in which you have a large number of candidates who enter a competition, but only very few emerge as truly exceptional. The challenge is how to evaluate the candidates without going out of business, without spending a lot of resources.

Terwiesch: It’s like the TV show, American Idol. You start with many aspiring winners. You have a round of filters. And at the end, depending on whether you like their singing, you have some remarkable personalities left. That’s a powerful metaphor to think about tournaments.

In 2011 tournament there were some amazing innovations. Here is an explanation of the winners. For instance, there is something called human hair mat to treat oil spills:


RBI’s new research centre – CAFRAL

May 27, 2011

I just missed this development completely. ET alerts me to this story of a new RBI centre – Centre for Advanced Financial Research and Learning – or CAFRAL. It is headed by ex RBI Deputy Governor Ms. USha Thorat. Website of CAFRAL is here.

Her interview is here. She says CAFRAL would like to be a kind of interface between academia, practitioners and bankers:

What is CAFRAL about? What is its mandate?


Teaching monetary policy after the crisis

May 27, 2011

Andrew Hill and William Wood of Philadelphia Fed have a  nice write-up on the topic. After mentioning about changes in general economic teaching economists are getting more specific. First there were some proposed changes in teaching of finance (this and this). Now let us look at monetary policy.

Hill and Wood say current monetary policy is not your mother and father’s monetary policy anymore. In order to make it realistic, profs need to teach monetary policy in both good and bad times.

There is a nice discussion on how textbooks have treated mon pol so far. They would mention three tools for mon pol:

  • Reserves — The text would explain that commercial banks are required to hold funds in reserve against their deposits, and that the Federal Reserve can change the quantity of money to achieve economic goals. For example, if the Federal Reserve reduces the reserves that banks are required to hold, banks have a greater ability to lend, and can expand lending, creating multiple new deposits through the process summarized in the “money multiplier.”
  • Discount Rate — Next, students would be shown how the Federal Reserve can encourage lending through changes in the discount rate, or the interest rate it charges member banks for loans.
  • Open Market Operations — Finally, students would see how the Federal Reserve’s purchases and sales of government securities, called open market operations, can change bank reserves and therefore the quantity of money.

OMOs in turn determine the fed funds rate. Unlike other central banks which just announce the policy rate, Fed actually achieves its announced rate by conducting OMOs.

Books mention it in the same order implying reserves would be very important. However, Fed hardly uses this tool in normal times. Same with discount rates. It is OMOs which is the most important tool but is less talked about:

The order in which textbooks present the elements of monetary policy makes sense because reserve requirements, coming first, are the easiest of the Fed’s policy tools to understand. Open market operations are the hardest. And yet the textbook treatment leaves the impression that changes in reserve requirements are a viable monetary policy option for the Federal Reserve in ordinary times. In fact, reserve requirements have not been changed since the 1990s, and were not changed during the crisis that began in 2007. The textbook treatment also tends to leave students believing that discount rate changes are important. In fact, discount rate policy has become passive in ordinary times, in that the discount rate only reflects other Federal Reserve policies — rather than being an independent way of influencing the quantity of money.

As the Federal Reserve Board states on its website, open market operations are the Fed’s “principal tool for implementing monetary policy.”1 For teachers, the implication is that the most important tool of monetary policy is the hardest one for students to learn. The Federal Open Market Committee (FOMC) guides open market operations by specifying targets for an important short-term interest rate, the federal funds rate. It is open market transactions, usually carried out on a daily basis, which affect the amount of money and credit available in the banking system. In turn, these changes in the supply of money and credit affect interest rates, which in turn affect the spending decisions of households and businesses and ultimately the overall performance of the U.S. economy.

So there were problems even before the crisis.

Post crisis, authors say many changes need to be explained. This business of interest rates reaching zero and introducing so many programs to support markets has never been done before. Post-crisis main idea which needs to be explained is liquidity:

The most important idea for students to understand about financial crisis management is the concept of liquidity. Liquidity is the ability to quickly convert something of value into spendable money. For example, a savings account has a great deal of liquidity for an individual bank depositor. The depositor can get cash with a quick visit to the bank — or can convert the savings to checking money with the click of a mouse. A home has much lower liquidity, in that an individual could convert its value to spendable cash only with a long process of selling the real estate.

Just like individuals, banks and other financial institutions sometimes need more liquidity. Think about a bank that has valuable holdings, such as sound and well-secured loans. Because the payments on the loan come in periodically over time, the bank does not have immediate access to the amount of the loan. It can therefore face liquidity troubles if it is confronted by sudden demands. In ordinary times, banks and the Federal Reserve work together to ensure sufficient amounts of liquidity. In a crisis, however, liquidity can dry up. At such a point, the Federal Reserve will almost certainly be called on to restore liquidity.

They explain in plain english the various programs started by Fed. Superbly done.

In sum, one needs to teach following:

  • We need to continue to teach students about the Federal Reserve’s conduct of monetary policy, implemented, in ordinary times, day-to-day through open-market operations.
  • In addition to making certain that our students understand the causes of the financial crisis that began in 2007, we need to ensure that we teach them about the importance of liquidity in a time of crisis. This provides the foundation for teaching about the extraordinary measures that the Fed took as lender of last resort to increase liquidity in specific credit markets and the economy as a whole.
  • We need to emphasize to our students that providing liquidity in times of crisis can reduce financial damage and increase overall stability.
  • We need to ensure that our students understand how and why the Federal Reserve expanded its balance sheet, making it possible to increase liquidity through lending programs during the height of the crisis and to implement so-called quantitative easing during the lingering period of weak economic growth.
  • We need to present our students with comparisons to other times in our nation’s history (i.e., the Panic of 1907 or the Great Depression) when, with less understanding of monetary economics, policymakers had few tools to mitigate the effects of a financial crisis or used the wrong policy for the economic conditions.

Hmm…A nice simple note…Teachers could use it right away…

But this is too US specific. Students would also need to know what other/their central banks did in brief. Profs need to just add that as well in brief to give a better perspective.

How Hollywood explains the 2007 crisis and does it explain well?

May 26, 2011

Nicole Gelinas and Judith Miller of  City Journal discuss and review the two movies on the global crisis – Too Big to Fail, HBO Movies, 2011 and Inside Job, Sony Pictures Classics, 2010.

Miller says:


Do income levels determine SAT scores?

May 26, 2011

Prof Mankiw raises a super question on the topic.

He points to a Leonhardt article who looks at how low income individuals are not really accepted by top colleges in US. The low incomes lead students to study at homes and lower SAT scores. Whereas rich ones get a better tuition and other facilities leading to higher SAT scores and acceptance in colleges. This leads to colleges underappreciating the effort put in by low-income people. This leads to wastage of human capital as good students who don’t have the opportunity are sidelined by the system. As good education usually leads to good income in future, it is kind of vicious cycle as well.

Leonhardt says:


Did increase in competition help make better electricity markets and lower prices?

May 26, 2011

Adam Swadley and Mine Yücel of Dallas Fed write this nice paper on the topic. It is always great to read such papers on competition and efficiency.

The paper focuses on retail electricity market. In 2000s US reformed its retail electricity market and allowed competition. People could choose their suppliers and so on. What was the impact of such reforms? Did it help consumers? Did it lower prices?

This paper looks at these issues.


When US defaulted on its debt…

May 26, 2011

Donald Marron has this super post linking to a paper (gated though). It mentions how US defaulted temporarily on its T-bills in 1979. It did pay but alongwith interest for the period it remained unpaid.

Actually one comes across three such instances (see this as well) of US debt default:


India’s business cycle is getting similar to that of advanced economies

May 25, 2011

Chetan Ghate, Radhika Pandey, and Ila Patnaik  write this nice paper on the topic (HT Ajay Shah Blog). The paper has some amazing findings as suggested by the title itself.

The paper begins with a superb discussion of business cycles in emerging and developed. I am yet to see a paper write so clearly about such complex topic in plain english.

Basic idea is that business cycles of emerging/developing economies are more volatile. This leads to more volatile output, consumption, investment etc. As an economy develops, one should see lower volatility in all these dimensions. The paper finds similar thing happening for India.


Government’s role in promoting research

May 25, 2011

Superb speech by Chairman Bernanke (he is too good on topics like these, becomes  a Prof which is so natural to him).

For sustained growth one needs to promote research and innovation. Governments should help build environments which promote these innovations and help sustain growth.


The growing myopia in investments (or most of the things we do)

May 25, 2011

Andy Haldane again. He has made it a nice habit of giving papers which are amazingly insightful.

In this speech/paper, he along with Richard Davies discuss the effects of short-termism in investment decision-making.  Because of lack of time, am not able to discuss the paper in details. The summary is here as well.

Drawing on evidence across time and industrial sectors, they argue that short-term behaviour is significant among investors in capital markets and is rising over time.  They present some nice insights from history to present and conclude:


Should we borrow in US Dollar?

May 24, 2011

A nice speech from Lars Nyberg of Riksbank. He discussed the banks’ funding in foreign currency and the risks and costs associated with this dollar funding.


Core inflation is rotten

May 24, 2011

Says James Bullard of St Louis Fed in this provocatively titled and insightful speech. The list of readings on headline vs core just keep rising. This ppt gives a nice overview as well

In this speech, Bullard clarifies why core inflation is not the right measure for inflation. By focusing on core we are going to underestimate inflation. Instead of looking at headline vs core debate, Fed should fix headline inflation as its target inflation and announce it like the inflation target central banks:


Taylor’s Rule versus Taylor Rules

May 24, 2011

Taylor’s rule means the original rule proposed by John Taylor in 1993. Taylor rules means various versions of the rule that have come up since the original rule.

What is the right Taylor rules has been a topic of great interest in the crisis (see this for an overview). John Taylor on his blog has been suggesting to look at his original rule not the other variants which have people have been looking into. Choice of Taylor rule variants is critical as it leads to following policy choices

Taylor Rule says:


How Fed communicated in 1920s via posters…

May 23, 2011

Liberty Street Economics Blog has a superb post on this.

Over the years, the Federal Reserve System has used many methods to communicate about the role it plays in support of stable prices, full employment, and financial stability. Current communication tools include the new press conferences by the Chairman, speeches by Bank presidents, public websites, economic education programs, local outreach efforts, publications, and blogs like this one.

Ninety years ago, however, the options were more limited. The Fed was still new and the nation’s economy was plagued by a growing number of bank failures. The five posters below (from the mid-1920s), with their images of strength and stability, were part of a larger series designed for display at member banks. They were likely intended to inform the public about the Federal Reserve System and foster confidence in its member banks.

Thanks to the San Francisco Fed archive for making the posters available.

Check the link.

Are India’s Cities in a Housing Bubble?

May 23, 2011

This is the title of my new paper. Comments/suggestions are welcome..

%d bloggers like this: