Archive for September, 2012

How inflation impacted lower marriages in Israel

September 28, 2012

A nice paper looking at how inflation impacts things like marriages.


Goethe and problems with fiat money…

September 28, 2012

A nice speech by Jens Weidmann of Bundesbank. One does get to read about Goethe whenever you read on literature etc. However, it seems even Goethe knew about dangers of fiat money:


Inside story on how Draghi convinced ECB to buy bonds?

September 28, 2012

A superb inside account from Reuters. It narrates how Draghi managed to convince ECB officials to agree to Sep-12 policy of   conditional  unlimited bond buying.

It all started on this surprise speech at London in late July (comments here):


Why shopping malls/hypermarts place candies/cigarettes on exit doors?

September 27, 2012

I am not sure about shopping mall designs in other countries.

But whatever little I see in Indian shopping malls is full of paradox. On one hand there are these advertisments/offers in these hypermarts on pushing healthy foods like brown bread, organic pulses, multi-grain flour, dental care etc.

On the other hand, on exits you have placements of sugar candies, potato chips, cigarettes etc. You cant escale exits as most payment desks are placed there. So the idea is to just tempt you in picking these things at the exit. You can escape them inside but we will chase you to the end. And it is not just on the floor which sells food, beverages etc. These are there even on floors which sell clothes, digital stuff and so on.


How Euroarea is nothing but Tragedy of commons..(how would Lin Ostrom respond to this?)

September 27, 2012

A superb article by Phillip Bagus of Universidad Rey Juan Carlos (He has written a super book as well on the issues in Euro) .

He calls it Euroarea a common, a kind of good which gets exploited because of lack of property rights.

The Eurosystem, the monetary system in the European Monetary Union (EMU), has brought the euro to the verge of collapse. We can understand how this situation arose in terms of the theory of negative external effects and the tragedy of the commons. Poorly defined property rights in money can cause negative external effects to be neglected. In practice, the EMU has evolved into a tragedy of the commons because several independent national governments have made use of the European Central Bank (ECB) to finance their deficits indirectly.

The theory of the tragedy of the commons states that a publicly owned good will tend to be overexploited and disappear. The euro and its purchasing power are following this course. The euro is threatened by independent states’ trying to finance their deficits via the ECB and to externalize part of their deficit costs in the form of higher prices in the EMU. This mechanism of a tragedy of the commons has contributed to the current sovereign-debt crisis in Europe. In this article, I explain how a tragedy of the commons exists in the EMU because of public property in money and how it is caused by the possibility of financing deficits through a single central bank.

A nice mixing of micro with macro ideas..

He says fiat money itself is like a commons problem:

External costs also occur when fiat money is issued. Fiat money is a medium of exchange that the issuer (the state) puts into circulation backed by no collateral except the paper on which the notes are printed. Residents are then forced to accept this kind of money as a means of payment (legal tender). Fiat money thus represents an encroachment on the principle of freedom of contract. People cannot do with their property what they want but are forced to accept fiat money in exchanges and to use it for tax payments. If no one had to accept public paper money, no external costs would be incurred. People could simply decide not to accept fiat money.

Given the absent private-property rights in money production and a monopolist producer of fiat money, the benefits of the production of money accrue to its producer, and external costs take the form of rising prices and, in most cases, a lower quality of money.2 These external costs are imposed on all users of fiat money. The additional monetary units allow their holders to bid up prices. 

The main beneficiary of the central bank’s increase in money supply is the government, for two reasons.3 First, increases in the money supply lead to profits called “seigniorage.” Central-bank profits are remitted to the government at the end of the year.  Second, central banks can finance government directly by buying government bonds or indirectly by accepting government bonds as collateral for loans to the banking system.

Hmm..Never really thought this way..

In eurozone this becomes even worse:

Although the external effects of a monopolistic money producer are common in the Western world, the euro’s establishment has created a unique layer of external effects and a tragedy of the commons. Within the EMU, all governments can use the ECB to finance their deficits indirectly. So there is a tragedy of the commons in base-money production. As already noted, a central bank can finance a single government’s deficits by buying government bonds or by accepting them as collateral for new loans to the banking system. Within the EMU, several governments can finance themselves via a single central bank, the ECB. 

When governments in the EMU run deficits and issue bonds, a large amount of these bonds are bought by the banking system. The banking system buys these bonds because they are accepted as collateral by the ECB in its lending operations  The banks presenting the government bonds as collateral receive new base money from the ECB. The banks then create new money by credit expansion, exchanging the money against government bonds and using the government bonds to refinance with the ECB. The end result is that the government has financed its deficits with new money, and the banks have received new base money by pledging the bonds as collateral.

This scheme’s incentives are clear. The first users of the new money benefit. Governments and banks have more money available; however, prices have not yet been bid up. When governments start spending the money, prices are bid up, and
incomes increase, mainly in the deficit countries. As prices and incomes increase in the deficit country, the new money flows abroad, where the effect on prices has not yet been felt. In this way, the new money spreads through the whole monetary union.

This asymmetric system leads deficit countries to be the first to exploit the commons:

The deficit countries that first use the new money win. They have a higher monetary income before prices start to rise. They benefit at the cost of the new money’s last receivers, who are mainly in foreign member states that do not run (such
high) deficits. The last receivers lose as their incomes start to rise only after prices have increased. The benefits of the increase in the money supply go to the first users, whereas all users of the currency share the damage to the monetary unit’s purchasing power. The consequence is a tragedy of the commons. Any governments running deficits can profit and offer the gift of a more balanced budget to its voters at other governments’ cost.

What is the solution? Regulating the commons:

For now, a !750 billion bailout plan and the ECB initiative to buy government bonds have stopped the rise of bond yields and contained the danger of sovereign insolvency. Yet the same incentives remain in place, and the euro’s future remains
bleak. For the euro to survive, the self-destructive tendencies of the tragedy of the commons must be contained. Government deficits must be controlled and effectively restricted by credible sanctions and penalties.

This is based on how tragedy of commons is prevented:

Overexploitation of public property can be restricted in several ways. The simplest way is to privatize public property and to define and defend private-property rights. Another solution is to use moral persuasion and to educate the actors who exploit the commons. For example, fishers can be persuaded to voluntarily restrict their exploitation of the school. A further option is to regulate the commons to restrict its overexploitation. Garrett Hardin (1968) calls such regulated commons “managed commons”: the government limits the exploitation. An example is the introduction of fishing quotas that provide every fisher a certain catch per year. Thus, each fisher receives a monopoly right that he will try to exploit fully. Because he is the only owner of this right, there are no external costs. Thus, overexploitation is prevented.

The question is who should make these rules? Should it be an agency like say government which makes these rules? Or should it be local people based on their  know-how as Elinor Ostrom has shown in her fab research. In this Euro common area this could imply having a central government asking making rules and asking all to comply. Or it would mean govts agreeing amongst themselves on the mechanisms to prevent rising deficits which is as per Ostrom.

Eurozone guys went for Ostrom approach (if I can call so) and tried to manage these deficits via SGP. However, SGP  was both developed and abused by its members. There were large violations leading to over-exploiting. This made the Euro commons even worse.

The problem with this commons is that after the crisis has errupted, the solution has been more and more exploitation. The govts  are finding it difficult to force internal devaluation ( lower exploitation) and ECB is creating more and more liquidity.

How to get this Euro commons working and restore its fisheries (confidence) and prevent externalities (contagion to other countries)?

Curious tale of econ development in Abu Dhabi

September 27, 2012

Acemoglu/Robinson in their recent post:

Nestling at the Southern end of the Persian Gulf is the modern nation of the United Arab Emirates (UAE). The UAE was formed in 1971 from the amalgamation of seven different independent sheikdoms which had previously been part of a British protectorate called the Trucial States. The largest of these seven are Abu Dhabi and Dubai. Today the UAE is an oil fueled development success with astonishing urban development in Abu Dhabi and Dubai, the latter currently boasting the world’s tallest building. You can see signs of the remarkable transformation in the city state in the last 50 years in this picture.

But this was not always the case, even after the oil came on stream…

Read the post for more details..Fab as always

Linking welfare economics with behavioral economics…impossible?

September 27, 2012

A superb post from . What a blog Worthwhile Canadian Initiative is..

We keep mentioning about the interesting findings and applications of behavioral economics. However, how does one really fit the findings in other economic streams? If one brings the irrationality assumption in say Price theory, how will graphs etc change.  You get  some idea here as Prof Woolley links to welfare economics.

The case here is banning large sodas. Typically welfare economics assumes rational behavior. So banning large sodas leads to demand being higher than supply, leading to deadweight loss:


If these are economic reforms, I’m Amitabh Bachchan…

September 26, 2012

A superb post from R. Jagannathn at (HT: TGS Blog).

One could not say it any better:


Can progressive economists join forces with the church/religion?

September 26, 2012

A superb post by Felix Salmon. He was reflecting his experiences from a talk given by Joseph Stiglitz on Economics and Theology, an initiative by INET.

BTW, I know of another economist who tried to speak to a church – Charles Calomiris of Columbia. Based on the speech he did a fair job. Do not know how the audience felt as is the case here. Meanwhile, WNF Blog is also linking how certain religion practices etc are because of political institutions etc.

Back to Joe. He thinks econ discipline does not really mix well with theology:


How psychology can assist non-car drivers..

September 26, 2012

A superb interview of Prof. Ian Walker, transport psychologist (HT: This blog supports urban initiatives to promote using bicycles for work, travel etc.

However, things are not as easy as this interview suggests. Cyclists are not wanted by either walkers or car people. Town planners never sure where to place them:


Tragedy on Honduras Charter Cities Project –Victory for Acemoglu/Robinson?

September 26, 2012

This blog was a supporter of the charter-cities project floated by Prof. Romer. It got some support from Honduras which became the first country to allow chart-cities. There were some grand plans to get the project going with things like transparency commission with people like George Akerlof, Romer, Nacy Birdsall of CGDEV etc. The region selected to develop charter-city was called REDs. The color RED got another  meaning…

There were sceptics from day one over the project which grew once Honduras was selected as the first country for experimentation.

Now, it seems Prof. Romer has resigned (HT: Gulzar) from the project at Honduras. He responded to qs asked by Prof. Cowen on his superblog:


One Europe, Many Tribes

September 25, 2012

A superb piece on Europe:

Italy, unified in 1870, is newer than Nevada. Spain was split down the middle by a civil war as recently as the 1930s. And reunited Germany, dating back only to 1990, is younger than two of the Jonas Brothers. Just a reminder that, for all their claims to antiquity, many of the nations of Europe have been nations for only the briefest of times. For most of history they were rivalrous territories, kingdoms, duchies, principalities, and city-states. They were bound by language and culture—and riven by tribalism.

As Europe’s financial crisis drags on, the tribes have returned with a vengeance. It’s not just Greece vs. Germany. Today it’s Sicily vs. Lombardy, Berlin vs. Bavaria, Andalusia vs. Catalonia. Keep this in mind as optimists point to the successes of the campaign for “more Europe,” such as the European Central Bank’s agreement on Sept. 6 to support the bonds of hard-pressed countries that comply with deficit reduction agreements. Europe is boiling over with regional grievances. Money is the issue—who gives it and who gets it. The 1999 launch of the euro has forced an unwanted intimacy on Europeans in flagrant disregard for Robert Frost’s poetic dictum: “Good fences make good neighbors.” And the euro entices separatists to strike out on their own, figuring even small nations can survive if they share a currency. (Malta, a euro-zone nation, has fewer people than Dublin or Dresden.)

The more you read on Europe politics and history the more intriguing and interesting it is..

Recent Evolution of India’s Fiscal Federalism

September 25, 2012

Fiscal union is nothing but Federalism by another name. It has become a huge area of interest for this blog. The idea is to understand the Indian federal system and figure how the union works. So expect a lot of posts on the matter going ahead.

In this regard, I found this superb speech by Dr Vijay Kelkar. Who better than Dr Kelkar who headed the 13th Finance Commission.  The speech is full of insights:

While describing federalism, people have described it in many ways. For instance, some scholars have described federalism as administrative federalism;” some have argued for “market preserving federalism” and some others have described it as “coming together federalism” vs. “holding together federalism”. Countries like USA are supposed to be examples of “coming together” federalism while India is supposed to be an example of “holding together” federalism.

In my view, the important feature of Indian federalism is what in India we call the “cooperative federalism” feature with formal and informal rules for maintaining the political system as well as for the peaceful change management. This is the feature that gives the “flexibility” to our Federation.

I think that it is this “flexibility” which helped the country to maintain unity while strengthening the democracy and I do believe that the democracy is one of the deep determinants of India’s growth performance. The U.S. constitution, over its 200 years or more of existence, has been amended only 27 times while in India, we have amended the Constitution 94 times in the first sixty years. In my view, this is the strength and not weakness of our system.


He explains the fiscal and horizontal imbalances. FinCom exists to ease these imbalances:

Since 1982, in the Canadian constitution, there is a clear mandate for horizontal “equalization”. Section 36(2) of the Canadian Constitution commits the federal government to the “principle of making equalization payments to ensure that provincial governments have sufficient revenues to provide reasonable levels of public services at reasonably competitive levels of taxation” and this exercise is done annually. In India, the Constitution does not give such clear instructions.

To meet these fiscal challenges of vertical and horizontal imbalances, our Constitution has created an institution called the Finance Commission, which is an independent Constitutional body, appointed every five years and which reports to the President of India.

Unlike the Constitutions of Canada or Australia, Indian Constitution does not give any precise guidance to the Finance Commission as to how horizontal equalization is to be achieved. In the absence of such guidance, each Finance Commission works out its own approach, devising a formula for sharing of the taxes, i.e. for vertical sharing and horizontal distribution. The recommendations are usually based on the Commission’s overall judgement for vertical devolution which takes into account the resource availability and needs of the Union government for fulfilling its own functions such as defence, internal security, debt repayment etc.

 How changes in FinCom assessment helped in 1991 reforms. Before 1991, basically the sharing formula was specified for indiv taxes like income tax, corporate tax etc. This created problems when economy was opening up:

Over time, India’s fiscal federalism has been flexible enough to change its structure. For instance, till 15 years ago, the Constitution envisaged sharing of revenues tax-wise; in other words, share could be at different rates for corporate tax, personal income tax or manufacturing taxes or import duties. This feature created a perverse incentive structure for India’s tax policy. For instance, this gave no incentive for central government to reduce import duties as constitutionally, it could retain all earnings from such import tariffs. When India embarked on its new economic policy in 1991, the Tenth Finance Commission recommended the pooling of all these taxes and have a common sharing formula in order to rationalize the fiscal system. In my view, this paved the way for India’s tariff reforms which saw one of the most dramatic reduction in tariffs when they came down from 150 per cent to 10 per cent. Similarly, the support to the third tier through Finance Commission grants has also given momentum to effective decentralization programme in India.

He then mentions how GST will help address the vertical imbalances..

Superb primer..Though lots to follow and read

Financial engineering is back: A feeling of Deja-vu..

September 25, 2012

It is deja-vu all over again. In the latter phase of UPA-I we had oil, fertilizer and food bonds. All these bonds were neatly kept off the government balance sheet masking the true fiscal deficit. Now we  have power bonds which will be structured differently and pose different challenges. In context of power sector, we had similar attempts in 2001 as well when we broke up utilities into generation, transmission& distribution legs. However, nothing much has changed since and we have another round of losses.

The new idea is a fascinating piece of financial engineering like earlier ideas. I was trying to make sense of the release. From whatever I could make out here it goes:


Has polarization increased in US politics?

September 24, 2012

A superb and much-needed paper on the topic. Apart from Jackson Hole, even Brookings conferences are much sought after.

In the recent edition, a very neat paper was presented on politics.

We are seeing rise in polarization amidst political parties world over. This paper uses Google Ngrams along with COngressional records to figure whether rising polarization in US economy is highest in these times.


Economics of Stolen bicycles

September 24, 2012

A superb post on Priceonomics (HT:

It seems lots of bicycles are stolen in US. What is the economic basis for such thievery? Applying Gary Becker’s ideas, the authors say the risks to stealing bikes are very low. There is hardly any punishment for stealing bicycles in US:


How Chinese prevented Latin America defaults in 2000s..

September 24, 2012

Chinese troubles everywhere.

Here is a speech from Sebastián Claro of the Central Bank of Chile on the Latam linkages with China. This one is interesting as apart from current Chinese woes it also mentions the importance of China factor in 2000s:

He says in start of 2000s most Latam economies were looking like defaulting on their debt.


Comparing SE Asian Crisis in 1997 with Eurozone crisis in 2010

September 24, 2012

A nice speech by Bank of Thailand Governor Prasarn Trairatvorakul.

He draws similarities and differences between SE Asian crisis and Eurozone crisis.

First similarities:


Eurozone crisis and ECB far

September 21, 2012

Nice paper reviewing all that has happened and the policies so far.

This article outlines the features of each phase of the crisis, describes the responses of the ECB, and explains the rationale for the main measures. Emphasising the natural correlation between financial, fiscal and price stability, the article also illustrates the need to strengthen the economic union in order to guarantee the sustainability of the monetary union.

In a simple and lucid manner..

The force of Indian economy…which way will the force go?

September 21, 2012

A nice paper by Prof. Abhay Pethe of Mumbai Univ. It was written in 2009 and a revised version would be great.

This paper is written with a slightly different perspective. Apart from macro issues it talks about Indian federal system as well:

The theme of this essay is ‘the Force or Strength’. Obviously given the size and age of the population, the type of polity, the diversity of her social fabric and the strength of the economy, Indian nation clearly is a potent force in the current global context. However, force by itself is a double edged sword, on one hand, it can become an instrument of transformation, positively influencing lives of millions and on the other hand it can be divisive force that tears the nation apart a la a storm with its destructive power. The challenge hence is to support this force with a sense of purpose and channel it into productive avenues through wise strategy – both in terms of conceptualization and delivery/ implementation. It also crucially requires commitment on the part of all the stake holders.

India thus is at the cross roads, on the one hand her time has surely and truly come on the other the internal tensions can rip apart the socio-economic and political fabric and set her back. Inheriting the age old heritage of culture, it has been built upon by freedom fighters with their enduring values and seeking unity within diversity. India has had the luxury of being blessed with relative macro-stability in terms of crucial macro-economic variables. There has been a remarkable continuity in her policies be they domestic or foreign. It is well to remember that India is essentially an idea and realizing it is a continuous process and we can ill afford to let our guard down – and take things for granted – even momentarily.

Nice stuff.