Archive for March 5th, 2012

Why is there a hump in Greece yield curve?

March 5, 2012

An interesting piece from Christopher Neely of St Louis Fed.

There is a hump in the Greece bond yield curve with 2-year yields touching around 150% or so and 10 year yields at 20-25%. What causes this shape? There are two reasons:


Economics – Pre-Crisis Consensus vs vs. Post-Crisis Confusion

March 5, 2012

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

Why 2008 crisis is only compared to Great Depression?

March 5, 2012

A fascinating paper by Barry Eichengreen.

He says the 2008 crisis has led to surge in lessons and comparisons from economic history. Most of those lessons come from Great Depression. This has led to policy applications from great depression:

It is widely observed that the ―lessons of history‖ were influential in shaping the policy response. There were obvious parallels with the early stages of the Great Depression: an unusually sharp drop in asset prices, an unusually sharp drop in output, and then the failure of prominent financial institutions, all followed by generalized financial distress. There was the fact that this crisis, like that of the 1930s, was not just a U.S. economic and financial crisis but a global economic and financial crisis: the decline in global industrial production from the spring of 2008 closely tracked the decline that followed the peak in the summer of 1929. References to the Great Depression became widespread. References to articles referring to the Great Depression became widespread.

The analogy legitimated certain responses to the collapse of economic and financial activity while delegitimating others. It legitimized the notion that the Fed should respond aggressively to prevent the collapse of a few investment funds from precipitating a cascade of financial failures. This reflected the widespread currency of Friedman and Schwartz‘s interpretation of the Great Depression – that what had made the Depression great was the inadequate response of the Federal Reserve.3 Recall Ben Bernanke‘s remarks at the conference on the occasion of Milton Friedman‘s 90th birthday. ―You‘re right, Milton. We did it. We‘re very sorry. But thanks to you, we won‘t do it again.

But why Great Depression ? Why not other crises like the one in 1907 or many other crisis which have occurred in 20th century? Comparison with great depression led to over-responding in this crisis.

Some argue that the comparison with the Great Depression was exaggerated, leading to an exaggerated response by financial market participants and policy makers.11 Bringing us to the question of why the analogy was so widely invoked and influential An attempt to answer this question starts with the observation, from cognitive science, that analogical reasoning is central to human cognition.12 While resort to relational patterns is similarly evident in the cognitive behavior of other primate species like the chimpanzee, explicit relational matching is extremely difficult for chimpanzees that lack special training in symbol use. It is impossible, so far as we know, for monkeys.

The main idea behind the paper is this. Why do people/policymakers look for analogies? There are examples in foreign policy when such reference to historical analogy led to some big errors:

But this emphasis on pragmatics points to the possibility that cognitive scientists and others – not excluding yours truly – may be exaggerating the importance of analogical reasoning. Decision makers may simply be cherry-picking historical analogies as a way of justifying decisions taken on other grounds. Foreign policy specialists are alert to this possibility. Ernest May‘s 1973 classic “Lessons” of the Past: The Use and Misuse of History in American Foreign Policy (this time the quotation marks are his) focuses on the role of historical analogy in foreign policy decisions.May argued that foreign policy makers are powerfully influenced by their ―beliefs about what history teaches or portends.He illustrated the point with examples of how historical analogy influenced American policy making during World War II, in the opening phase of the Cold War, in the Korean intervention, and in the decision to go to war in Vietnam. May‘s work spawned a large subsequent literature, the capstone of which was Yuen Foong Khong‘s Analogies at War.

And contrarina examples when facts were put on the table and analogies not really looked into:

In thinking of what policy to adopt, President Kennedy thought not only of Pearl Harbor but also of the 1956 Suez Crisis, the 1948-9 Berlin blockade, the German invasion of Czechoslovakia prior to World War II, and the escalation of military tensions that followed the assassination of Archduke Ferdinand in Sarajevo. As May shows, Kennedy consciously sought multiple analogies, weighed their applicability, and contrasted their policy implications. The president was thereby able to move beyond the most readily available analogy and identify characteristics of several historical cases that applied to the crisis at hand. This led to the development of a consideration set that included not just air strike but naval blockade and negotiation.

Kennedy seems to have been aware of the bias toward ―searing‖ or ―molding‖ events. He was a student of history, having written a popular history that won the Pulitzer Prize. It did not hurt that among his advisors were academics who had taught history as well as social science courses with an historical dimension. Here it is tempting to echo the observation, not original to me, that we were enormously lucky in 2008-9 that several key policy makers were serious students of business cycles and financial crises.

 But then Kennedy was a special case. How does one ensure that leaders do not fall into analogy trap? There is a need to keep intitutional history in memory:

That one cannot always count on individuals points to the importance of developing institutionalized mechanisms so that policy makers, when reasoning by analogy, know where to turn to access the historical record.36 In the U.S., institutional memory is probably best developed in the State Department, Abraham Lincoln having established the Office of the Historian in 1861. That office‘s principal product, Foreign Relations of the United States, will be familiar to this audience.37 The Office of the Historian also prepares ―policy supportive‖ studies and memos for State Department principals and agencies.38 More broadly, the institutionalization of historical memory in the foreign policy context is of long standing. In preparation for the Paris Peace Conference of 1919, for example, the British government commissioned studies of previous peace conferences. Militaries in the U.S., UK and elsewhere have regularly commissioned histories of major wars.

Interesting. I did not know there is an office for historian in both US and UK. Though not much of a success as hardly valued much. Which is sad…And then leaders have to rely either on analogies or get historians. But latter is not always accessible.

How does all this fir with Great Depression? Well the same qs arise? Was the comparison appropriate? Have we oveerdone things?

Viewed in this way, the notion of a ―Great Depression‖ was invoked in 2008-9 both as metaphor and analogy. As a metaphor it helped to mobilize public support for extraordinary action of some, unspecified type. As an historical analogy, it pointed to specific steps.48
Where for political scientists the danger with historical analogy is that policy makers will use it injudiciously – they will fail to consider multiple analogies, weigh their correspondence with the current situation, and emphasize not just similarities but also differences – economic historians will recognize an additional issue: the existence of multiple interpretations of the same events. If history is the distilled, authoritative incapsulation of society‘s memory of its past, then the history of the Great Depression (like all history) is still being. Existing accounts, in other words, are less than fully distilled and authoritative.

And insofar as this was the case, the historical analogy to the Great Depression offered less guidance to policy. Did we need a new Neal Deal? Well, that depended on whether you sided with historians who argue that the New Deal helped to end the Depression or only prolonged it. Did we need a jolt to the exchange rate to vanquish deflationary expectations? The answer depended on whether your view was that Roosevelt‘s decision to take the U.S. off the gold standard in 1933 was the critical decision that transformed expectations and ended deflation or whether you thought it was a sideshow. For those attempting to move from metaphor to analogy, this was a reminder that the distilled, authoritative incapsulation of the period remains a work in progress.

So how will history see 2008 crisis?

This brings me to a final question: how the 2008-9 crisis will influence historical scholarship. This is the other dimension of historical analogy: not only does the base case shape perceptions of the target case, but mechanism operates also in reverse. It is likely that there will now be less Whig history of the Great Depression. 

He says the crisis will lead to some interesting research which others have also pointed. But what is different about this paper is this:

Finally, the widespread use of the Great Depression analogy in the recent crisis having reminded us that historical narratives are contested, we will see more explicit attention to the question of how such narratives are formed.

Superb stuff…

Very interesting literature review as well…

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