Archive for the ‘Economist’ Category

Politicians too benefited from toxic loans before the 2008 crisis…

February 12, 2015

HBSWK discusses a paper on the topic.

It is based on French politicians who have used fancy finance to make political inroads:

Talk of the recent financial crisis often falls into a simplistic narrative of villainous banks, marketing toxic financial products to innocent customers who did not understand their risks. Among the storied victims are municipal governments that took out loans with initially low interest rates, only to see the rates skyrocket when the crisis hit. Many mayors cried foul, insisting that they had been hoodwinked.

But were the local politicians really unwitting fools? “There is no doubt the transactions were very risky, as interest rates on these loans frequently exceeded 20 percent,” says Boris Vallée, an assistant professor in the Finance unit at Harvard Business School. “The question is, Did local politicians get fooled into engaging in risky transactions, or did they take the risks knowingly, opting for the short-term benefits in spite of the risks?”

Vallée recently tackled that question in the paper The Political Economy of Financial Innovation: Evidence from Local Governments, cowritten with Christophe Pérignon, a finance professor at HEC Paris. The study offers empirical evidence that politicians routinely used high-risk loans on purpose, for political gain, in spite of the risks. Furthermore, the strategy worked: Toxic loans helped incumbent mayors get reelected.

The researchers focused their study on France, having gained access to two valuable data sets: The first contained the entire debt portfolio for most of the 300 largest French local governments as of December 31, 2007; and the second contained the loan-level data for all the outstanding structured transactions of Dexia, the leading bank in the market as of December 31, 2009. (Shortly thereafter, Dexia fell apart in the European debt crisis.) The data showed that so-called structured loans accounted for 20.1 percent of the 52 billion euros in total debt for the municipal sample.

Similar to subprime mortgages, structured loans usually carry a few years of guaranteed low interest, which allows local governments to reduce the cost of their debt quickly and obviously. But after the honeymoon period, these loans end up carrying highly variable interest rates resulting from exotic exposures. For example, the City of Saint-Etienne saw the interest rates on one of its major loans rise from 4 percent to 24 percent in 2010, due to the depreciation of the pound sterling. In total, losses on toxic loans doubled the city’s debt levels.

The politicians reaped rewards till gains were made. Post-crisis they blamed it on banks for misselling:

Vallée and Pérignon analyzed how the politicians used the loans—whether they had invested the money in equipment or services for the city, or used the cash to lower taxes for their constituents, or both. It turned out that for the most part, they had used the short-term savings from the loans to lower taxes. “This action is consistent with politicians seeking reelection by catering to taxpayers’ preference for low taxes, which represents a likely channel for the previous result on the effects on reelection,” the researchers write.

The strategy apparently worked. Controlling for potential selection effects, the researchers found that using structured loans led to an increase in the likelihood that a politician was reelected.

“These financial innovative products appear, therefore, to have aligned banks’ incentives, as the transactions were highly profitable, with local politicians [who] had an interest in getting reelected,” Vallée says. “However, this happened at a large cost to the taxpayer, as the positive effects of the loans were short-lived, and interest on toxic loans ballooned when the crisis hit.”

In the wake of the financial crisis, many local politicians filed suits against their banks, claiming that they had not comprehended the risky nature of the loans they undertook.

“Local politicians have been vocal ex post both in the media and in [the] French Congress,” the researchers write. “For instance, in his testimony before the French Congress’s committee on toxic loans, the deputy mayor of the City of Saint-Etienne, who originally decided to take on some toxic loans, stated that ‘[he] was not able to read the information [he] received because [he was] not a financial expert.’ “

Vallée, who holds a doctorate in finance from HEC Paris, is currently working on a study of byzantine banking behavior toward individual investors. But in the case of structured loans, he argues that a borrower need not be a financial expert to realize the stakes. “They are not that complex, and after spending 10 minutes on it, someone with a college education will be able to understand the risks,” he says.

As this blog keeps should be weary of anything in high and sophisticated finance. Whes it bites back, it bites hard..

Transformative Rise of Austrian Economics…

February 9, 2015

Superb interview of Prof Peter Boettke of GMU.

One major loss of the economic teaching is this school is hardly taught. At best someone is going to mention it randomly or some book will have a box briefing about the school. It is a pity that with economists talking so much about free markets , do not give much space to the school which is freest of them all.

But then as Prof Boettke says, the school is finding a resurgence in popularity given massive failures of the current economic thinking. I mean it is not about figuring who is right and who is wrong. Students have to first know what the ideas of various schools are before they can decide the right and wrong.

How to translate research to policy and become a country economist…

February 4, 2015

Shantayanan Devarajan  of World Bank reviews this interesting looking book by his colleague Brian Pinto- How Does My Country Grow? Economic Advice through Storytelling.

So what is it about?


Reading Brian Pinto’s book, How Does My Country Grow? Economic Advice through Storytelling, is refreshing because it brings “middle-brow” economics back into policymaking. In a profession that is increasingly dominated either by randomised control trials of micro interventions or dynamic stochastic general-equilibrium models of macro phenomena (and I confess to having engaged in both), Pinto’s stories of Russia, Poland, Kenya, Nigeria and India remind us how simple economic models can help solve complex problems. To those who got their PhD more than 20 years ago, the book’s reassuring message is: The economics you learned in graduate school is still valid.

In addition, the book teaches three important lessons – for everybody.

(1) How to Go from Research to Policy: Most macroeconomic research involves some form of cross-country regressions. (If it is a single-country analysis, it is unlikely to be about a developing country, as Das and Do (2013) have shown.) As Pinto notes in the first part of the book, these cross-country regressions often give ambiguous, and even conflicting, results. For instance, growth regressions can yield very different implications depending on whether a neoclassical or endogenous-growth model is being estimated. Likewise, the large number of regressions linking debt and growth have not solved the problem of causality: does debt slow growth, or does growth slow debt? What the book teaches us, though, is that this ambiguity and conflict is a good thing. Since you never know which result applies to your country at a particular point in time, it is better to keep the ambiguity in your head as you approach the problem at hand – rather than come in with a preconceived notion of how the world works, based on a fragile cross-country regression.

(2) How to Give Policy Advice: Policy advice should be neither too bland nor too restrictive. An example of the former are the recommendations from international high-level panels such as the Growth Commission with which nobody would disagree; examples of the latter, sometimes labelled prior actions in World Bank loans, arethose that say “the country should adopt a new investment code by November 30th”. Pinto hits the sweet spot by offering three pieces of policy advice that are selective, prioritised and “edgy”. They are: (i) always have a hard inter-temporal budget constraint; (ii) promote competition, including competitive exchange rates; and (iii) manage volatility. Out of the litany of policies, Pinto has chosen these as the most important. Moreover, they are not innocent. Promoting competition in countries where certain industries were captured by the president’s family (as was the case in Tunisia under Ben Ali [Rijkers et al (2014)]) is tricky and possibly dangerous. Similarly, it is difficult to maintain a hard inter-temporal budget constraint when people are rioting in the streets. But that is precisely why this kind of advice is useful. It gives policymakers, who are often navigating in turbulent waters, a distilled set of guideposts that can keep their economy on an even keel, without excessively tying their hands.

(3) How To Be a Country Economist: Many people find themselves, at some point in their careers, looking over the economy of a country. Based on his long experience as a country economist at the World Bank, Pinto shows (by example) how to do the job well. First, make sure you cover both macro and micro aspects of the economy. As Pinto found in Poland, Leszek Balcerowicz’s “shock therapy” quickly produced good macroeconomic results but their sustainability depended completely on the micro: in particular, the large state-owned firms’ ability to adapt to the market. Most predicted catastrophe because the privatisation of these politically powerful firms had been held up. The surprise was that the directors nevertheless restructured their enterprises instead of stealing from them because of competitive pressure from imports and a clear signal from the government that there would be no bailout. Budgets were credibly hardened.

Second, if the underlying problem is firms’ behaviour and performance, listen to firms. The book is replete with stories of Pinto and his colleagues visiting factories, talking to the foremen, looking around – and realising the issue was different from what the macro data showed. This method of listening to firms complements and enriches the use of cross-country data such as the Doing Business indicators. I would add that, in addition to firms, country economists would benefit from speaking with workers, informal traders, farmers and households. The third lesson for country economists is to make sure you cover all sectors of the economy, even if your specialty is macroeconomics.

The last point, as well as the use of economic analysis to solve complex problems, is illustrated with a series of vignettes – “stories” – that make up the core of the book. I particularly liked two that led to counterintuitive, but ultimately convincing, results


For becoming a country economist, it is also critical that they are well versed with the country. They should be made to travel across the country and understand the issues. However, most of the time the idea is to grab a degree from selected universities and then just coolly slip in as a country economist whoever takes you. The idea should be to test how well an applicant understands the country rather than just degrees..

Persistent overoptimism about economic growth….

February 3, 2015

Kevin Lansing and Benjamin Pyle look at this perennial issue of being overoptimistic on economic growth.

They question the dominant rational expectations theory:


History of Greece’s Syriza Party and whether it can change Europe?

January 30, 2015

Yanis Varoufakis, Greece’s new Finance Minister has this interesting article on his party.

SYRIZA, a growing political party in Greece, is an acronym that stands for “Coalition of the Radical Left.” For Americans, the idea that a party on the radical left could gain power is unthinkable, and it was for Greeks, too—until very recently. But the harsh austerity measures that the European Union imposed on Greece after its economic collapse have created extreme conditions in Greece: six in ten young people are unemployed, wages and pensions have been cut, national income has fallen by one quarter.

Europe is currently caught in a negative feedback loop, from which the established political process is unable to escape. For three years now, an endless stream of spending cuts and tax hikes has dominated the Greek Parliament’s agenda. A SYRIZA win may be the jolt that Europe needs: a victory by a pro-European party committed to keeping the country both in the Eurozone and in the European Union, but a party that, importantly, because of its radical disposition, is prepared to open up the conversation at the level of the European Council so that, at long last, European leaders address the problems they have been ignoring over the past five years. Back in June, in a New York Times op-ed, James K. Galbraith and I alleged that “SYRIZA may be Europe’s best hope,” and six months later this still holds true.

Though SYRIZA has existed in some form since the early nineties, its popularity has exploded amidst the Euro Crisis, now polling somewhere between 20 and 30 percent. Since June, it has begun to take a lead in opinion polls, as the governing coalition’s promises of ‘Greek-covery’ are turning sour. Elections are not due until June 2016, but the present government has a wafer-thin majority that may dissolve after a likely electoral defeat in the May 2014 European Parliament elections. If a general election is called, SYRIZA could become the largest party in Greek Parliament.

The question then arises: what effect would such a victory have on SYRIZA itself? Can a radical party of the left maintain its cohesion in the face of neoliberal central bankers and their conservative counterparts in Germany, the Netherlands, Finland, France, and Spain? Under such circumstances, any government of the left would be short-lived. If European officials and political leaders anticipate the power SYRIZA might have, SYRIZA’s capacity to bargain, to forge new alliances, and to shatter the eerie silence in the European Union’s Brussels headquarters will be severely circumscribed.

He explains some history of the party and compares the task to Odysseus’s:

SYRIZA may have the opportunity to transform Greece and change the course of European history, but this is a task that makes Odysseus’s journey look like a walk in the park. It will not be easy to take power while remaining faithful to its radical agenda and maintaining its cohesion on the ground. It remains to be seen whether SYRIZA’s leaders can pull off this miracle. I think they can, as long as they do not issue silly promises before the next election, and maintain a truly radical agenda aimed at changing Europe by steadfastly standing their ground, proposing to German, Spanish, Dutch citizens a European agenda that restores the dream of a shared European prosperity. 

What times..

Would Keynes Have Been Fired as a Money Manager Today?

January 30, 2015

Interesting post by Ben Carlson.

Keynes managed an average return of 13.2% in the period 1928-45. The markets gave a return of -0.5% in the same period. This was an exceptional performance albeit came with much higher volatility. So would he have been fired for this performance?


The Fall and Rise of Economic History..

January 28, 2015

Brilliant and thought provoking essay by Jeremy Adelman and Jonathan Levy.

I mean this is as good as it gets. Most articles are around rise and decline of economic history. But with the recent crisis, lack of history know-how has come to haunt most econs. This is leading to a surge in interest in the subject. But how does this new love for historic economic history shape itself for future?

So the authors discuss both qs . Why the subject declined and what lies for its future..

Does Microcredit work? it depends…

January 28, 2015

There are a series of papers evaluating impact of microcredit in 6 countries.

Justin Sandefur of CGDEV sums them further:


Is bancassurance model horribly anti-consumer?

January 27, 2015

Debashish Basu reflects on the recent policy on bancassurance model. He says banks anyway fleece customers for all kinds of fin products including insurance. The new guidelines give them a bigger licence to continue doing the same:


What’s the most fiscally responsible country in the developed world? Italy!!

January 20, 2015

Laurence Kotlikoff says so.

The new PM is changing things big time:


Will $20-$50 be the new price range for oil? Some insights from micro and game theory

January 20, 2015

Good piece by Anatole Kaletsky (Chief Economist and Co-Chairman of Gavekal Dragonomics and Chairman of the Institute for New Economic Thinking).

Even if his prediction of $20-$50 goes false, one can always apply micro concepts (and game theory) on oil industry as he has done:

Having fallen from $100 to $50, the oil price is now hovering at exactly this critical level. So should we expect $50 to be the floor or the ceiling of the new trading range for oil?

Most analysts still see $50 as a floor – or even a springboard, because positioning in the futures market suggests expectations of a fairly quick rebound to $70 or $80. But economics and history suggest that today’s price should be viewed as a probable ceiling for a much lower trading range, which may stretch all the way down toward $20.

To see why, first consider the ideological irony at the heart of today’s energy economics. The oil market has always been marked by a struggle between monopoly and competition. But what most Western commentators refuse to acknowledge is that the champion of competition nowadays is Saudi Arabia, while the freedom-loving oilmen of Texas are praying for OPEC to reassert its monopoly power.

Now let’s turn to history – specifically, the history of inflation-adjusted oil prices since 1974, when OPEC first emerged. That history reveals two distinct pricing regimes. From 1974 to 1985, the US benchmark oil price fluctuated between $50 and $120 in today’s money. From 1986 to 2004, it ranged from $20 to $50 (apart from two brief aberrations after the 1990 invasion of Kuwait and the 1998 Russian devaluation). Finally, from 2005 until 2014, oil again traded in the 1974-1985 range of roughly $50 to $120, apart from two very brief spikes during the 2008-09 financial crisis.

In other words, the trading range of the past ten years was similar to that of OPEC’s first decade, whereas the 19 years from 1986 to 2004 represented a totally different regime. It seems plausible that the difference between these two regimes can be explained by the breakdown of OPEC power in 1985, owing to North Sea and Alaskan oil development, causing a shift from monopolistic to competitive pricing. This period ended in 2005, when surging Chinese demand temporarily created a global oil shortage, allowing OPEC’s price “discipline” to be restored.

This record points to $50 as a possible demarcation line between the monopolistic and competitive regimes. And the economics of competitive markets versus monopoly pricing suggests why $50 will be a ceiling, not a floor.


In a competitive market, prices should equal marginal costs. Simply put, the price will reflect the costs that an efficient supplier must recoup in producing the last barrel of oil required to meet global demand. In a monopoly price regime, by contrast, the monopolist can choose a price well above marginal costs and then restrict production to ensure that supply does not exceed demand (which it otherwise would because of the artificially high price).

Until last summer, oil operated under a monopoly price regime, because Saudi Arabia became a “swing producer,” restricting supply whenever it exceeded demand. But this regime created powerful incentives for other oil producers, especially in the US and Canada, to expand output sharply. Despite facing much higher production costs, North American producers of shale oil and gas could make big profits, thanks to the Saudi price guarantee.

The Saudis, however, could maintain high prices only by reducing their own output to make room in the global market for ever-increasing US production. By last autumn, Saudi leaders apparently decided that this was a losing strategy – and they were right. Its logical conclusion would have been America’s emergence as the world’s top oil producer, while Saudi Arabia faded into insignificance, not only as an oil exporter but also perhaps as a country that the US felt obliged to defend.

The Middle East’s oil potentates are now determined to reverse this loss of status, as their recent behavior in OPEC makes clear. But the only way for OPEC to restore, or even preserve, its market share is by pushing prices down to the point that US producers drastically reduce their output to balance global supply and demand. In short, the Saudis must stop being a “swing producer” and instead force US frackers into this role.

Any economics textbook would recommend exactly this outcome. Shale oil is expensive to extract and should therefore remain in the ground until all of the world’s low-cost conventional oilfields are pumping at maximum output. Moreover, shale production can be cheaply turned on and off.

Competitive market conditions would therefore dictate that Saudi Arabia and other low-cost producers always operate at full capacity, while US frackers would experience the boom-bust cycles typical of commodity markets, shutting down when global demand is weak or new low-cost supplies come onstream from Iraq, Libya, Iran, or Russia, and ramping up production only during global booms when oil demand is at a peak.

Under this competitive logic, the marginal cost of US shale oil would become a ceiling for global oil prices, whereas the costs of relatively remote and marginal conventional oilfields in OPEC and Russia would set a floor. As it happens, estimates of shale-oil production costs are mostly around $50, while marginal conventional oilfields generally break even at around $20. Thus, the trading range in the brave new world of competitive oil should be roughly $20 to $50.

Nice bit..

Only time will tell which predictions are right on oil..

How the SNB rollback has a historical precedent which ended dangerously..

January 20, 2015

Nice article by Markus Brunnermeier and Harold James.

They say sudden Swiss rollback of peg was due to political pressures. And this was nothing new. Similar pressures piled on Germany in 1971 too leading to breakdown of BW:


Some answers on the Harvard 1953 economics exam..

January 19, 2015

This is by far the most read post on ME. The total visits to the blog in a month (0r more) were done in one day. Clearly, most people feel quite a bit about how econ education has changed over the years. On the twitter handle, there were comments like whether students can answer any of those questions, how economics has ignored what matters and so on.

Prof. Holt has written on the various questions posed to him regarding the q-paper:


Of Indian Prime Ministers and their economic advisers..

January 19, 2015

India born economists (as most are not based here) perhaps lead their counterparts in their efforts to become advisers to the government. More importantly to the Prime Minister. The double standards are just all over the place. On one hand, they criticise the government for all ills of Indian economy and on the other just jump at the first opportunity to join the government as adviser adding brownie points on their CVs.

TCA Srinivasa Raghavan has a nice piece on Indian PMs and their pet economists. He goes into history and points to the various combos of PM and pet advisers.


The Swiss shock…

January 16, 2015

There seems to be something brewing given two central banks made policy changes outside of their policy days. The disillusionment over growing powers of central banks is rising with every passing day. With governments in equal shambles, one does not know what really is the way out.

Swiss National Bank which had pegged its currency against expectations decided to remove the peg in a knee-jerk reaction. It also pushed the interst rates to a negative zone of -1.25% to -0,25%:


Nine economics concepts that economists don’t understand and their explanations..

January 16, 2015

Matt Yglesias of Vox hasposted a list of “9 things only neoclassical economists will understand.” In other words, other economists either don’t understand or don’t make a big deal of it.

Noah Smith, the neighbourhood economist explains these 9 things..


How an economist trains for a marathon?

January 15, 2015

Here is a funny cartoon strip on the topic.

Is US shale oil discovery the main reason for decline in global oil prices?

January 14, 2015

The decline in crude oil prices has once again humbled our forecasters. How quickly the prices have declined from $100 plus levels to $50 levels and continued to decline is amazing. There are many reasons suggested for the decline and major one being  US shale oil revolution. People say due to shale oil, US has become a net supplier of crude oil in the world and this has dampened prices.

Prof. Lutz Kilian of Michigan Univ, an oil expert has a different take on the shale story:


How a perfect storm is brewing in your financial future

January 9, 2015

It is amazing to note how things change. Before the crisis, econs talked really big about financial development, role of credit etc. Careers were made in area of finance in a big way. Credit growth was seen as a way for financial deepening and all kinds of things.

Cometh the crisis and all has changed. Now these trends are seen as a serious concern not just in present context but future one as well. Alan Taylor who with his coauthors has been researching these historic credit trends speaks on the dangers ahead:

Alan Taylor, a professor and Director of the Center for the Evolution of the Global Economy at the University of California, Davis, has conducted, along with Moritz Schularick, ground-breaking research on the history and role of credit, partly funded by the Institute for New Economic Thinking. He finds that today’s advanced economies depend on private sector credit more than anything we have ever seen before. His work and that of his colleagues call into question the assumption that was commonplace before 2008, that private credit flows are primarily forces for stability and predictability in economies.

If current trends continue, Taylor warns, our economic future could be very different from our recent past, when financial crises were relatively rare. Crises could become more commonplace, which will impact every stage of our financial lives, from cradle to retirement. Do we just fasten our seatbelts for a bumpy ride, or is there a way to smooth the path ahead? Taylor discusses his findings and thoughts about how to safeguard the financial system in the interview that follows.

He says how credit has risen and what that means:

Lynn Parramore: Looking back in history at 17 countries, you discovered something interesting about the private sector financial credit market. What did you find?

Alan Taylor: Our project compiled, for the first time, comprehensive aggregate credit data in the form of bank lending in 17 advanced countries since 1870, in addition to some important categories of lending like mortgages.

What we found was quite striking. Up until the 1970s, the ratio of credit to GDP in the advanced economies had been stable over the quite long run. There had been upswings and downswings, to be sure: from 1870 to 1900, some countries were still in early stages of financial sector development, an up trend that tapered off in the early 20th century; then in the 1930s most countries saw credit to GDP fall after the financial crises of the Great Depression, and this continued in WWII. The postwar era began with a return to previously normal levels by the 1960s, but after that credit to GDP ratios continued an unstoppable rise to new heights not seen before, reaching a peak at almost double their pre-WWII levels by 2008.

LP: How is the world of credit different today than in the past?

AT: The first time we plotted credit levels, well, we were almost shocked by our own data. It was a bit like finding the banking sector equivalent of the “hockey stick” chart (a plot of historic temperature that shows the emergence of dramatic uptrend in modern times). It tells us that we live in a different financial world than any of our ancestors.

This basic aggregate measure of gearing or leverage is telling us that today’s advanced economies’ operating systems are more heavily dependent on private sector credit than anything we have ever seen before. Furthermore, this pattern is seen across all the advanced economies, and isn’t just a feature of some special subset (e.g. the Anglo-Saxons). It’s also a little bit of a conservative estimate of the divergent trend, since it excludes the market-based financial flows (e.g., securitized debt) which bypass banks for the most part, and which have become so sizeable in the last 10-20 years.

LP: You’ve mentioned a “perfect storm” brewing around the explosion of credit. What are some of the conditions you have observed?

We have been able to show that this trend matters: in the data, when we observe a sharp run-up in this kind of leverage measure, financial crises have tended to become more likely; and when those crises strike, recessions tend to be worse, and even more painful in the cases where a large run-up in leverage was observed.

These are findings from 200+ recessions over a century or more of experience, and they are some of the most robust pieces of evidence found to date concerning the drivers of financial instability and the fallout that results. Once we look at the current crisis through this lens, it starts to look comprehensible: a bad event, certainly, but not outside historical norms once we take into account the preceding explosion of credit. Under those conditions, it turns out, a deep recession followed by a long sub-par recovery should not be seen as surprising at all. Sadly, nobody had put together this sort of empirical work before the crisis, but now at least we have a better guide going forward.


Student politics: a game-theoretic exploration..

January 2, 2015

An interesting paper by Soumyanetra Munshi of IGIDR (technical though).

She applies game theory to understand the linkages between political parties and student unions:



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