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Showing posts from April, 2012

"Redistributive austerity"

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I ran across an interesting quote the other day on Economix (NY Times economics blog). It’s from a text by Casey Mulligan of the University of Chicago, entitled “The varying impact of austerity and stimulus”: The interplay of the social good of helping the poor and providing them incentives creates tough policy choices for governments looking to reduce their deficits. The more resources available to those living below the poverty line, the less incentive they have to raise their income above that line. More research is needed to quantify work incentives in various countries, but I suspect that Western European nations have been pursuing exactly such redistributive austerity and will continue to do so, which means that they can expect austerity to depress their economies. He makes an excellent point on Eurozone dependency, coining a phrase 'redistributive austerity'. The welfare state strategy pursued by a majority of Europe’s economies before the onset of the crisis resulted i…

John Bates Clark Medal awarded

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The winner of this year's AEA John Bates Clark Medal (as of 2010 awarded annually) is MIT economist Amy Finkelstein, for her contributions in the research on health insurance markets, in particular on "the presence of selection and asymmetric information in insurance markets."

The John Bates Clark Medal is the second most prestigious award in the field of economics. It is awarded only to American economists under the age of 40, who were already able to make a great contribution to the economics science. It is said to be a good predictor of future Nobel Prize winners. In fact, 12 Clark Medal winners  (out of 34) went on to become Nobel laureates (including Friedman, Samuelson, Arrow, Sollow, Tobin, Stiglitz, Spence, Krugman etc.). The average lag for these economists to win the Nobel Prize was 22 years. Among the non-winners stand out some impressive names like Acemoglu, Feldstein, Shleifer, Summers, Murphy, Grossman, Levitt or Saez, many of which carry a high probabilit…

If something is repeated loud and frequent enough, it’s bound to be true

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The same reasoning goes for the bond purchases and monetary easing of the ECB. 
By the beginning of the year, the ECB provided unlimited funds for the next 36 months under the newly adjusted 1% interest rate. The first December auction released €489bn of funds (even though the net increase in liquidity was reported to be lower according to the ECB) which reduced long term bond yields for every Eurozone country apart from Greece and Portugal. Banks used the released cash to buy government bonds which kept long term interest rates low.
But EU banks still have around €500bn on overnight deposits with the ECB, on an interest of 0.25% (this means, as I noted earlier in October, that banks would rather accept a loss by borrowing at 1% and depositing at 0.25%, then to take a risk and lend to the private sector). On the other hand these banks are facing higher capital ratios enforced by the EBA, when the value of their still held peripheral sovereign debt is falling (especially after the Gre…

IEA: "After default: options for recovery in Greece"

My blog post on the recovery options for Greece is published at the Institute of Economic Affairs blog.

Here's an excerpt:
"Institutional reform starts with political stability. Greeks have little confidence in their government. In order to address this, the politicians need to restore belief in the system and the rule of law. The government must act as an enforcer of contracts to signal greater stability to both domestic businesses and foreign investors. After this, it has to continue with public sector reforms and liberalisation of the labour market (both are closely tied since the public sector unions are the ones with the highest level of rigidity). It must show strength in the bargaining process and create favourable incentives for businesses. Signals for new specialisation, trade and production should be left to the market - to bring about the necessary restructuring process supported by the new institutional setting. This is the only way to enable an efficient allocati…

Graph of the week: Eurozone dependency

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This week's graph comes from the Economist as another verification of my earlier ideas on the causes of eurozone contagion.

Here's what it says:
"Borrowing too much from foreigners can imperil your nation's health LOTS of countries in the rich world ran pro-cyclical current-account deficits before the financial crisis hit, which is to say they borrowed heavily when times were good. Yet only a handful have seen yields on their sovereign debt spike to alarming levels. One reason for this, as the chart below shows, may be an over-reliance on fickle foreigners to finance those deficits. Italy, which has a high rate of domestic savings (and thus is less reliant on finance from abroad) and yet also suffers from high yields on its debt, is an outlier." (Daily chart, The Economist, 13th April 2012) I would add that the key reason why foreigners financed the CA deficit is linked to the common currency and the banking regulations which led to a levelling of spreads across…

Beware of real-life analogies

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Readers usually enjoy it when economists (or experts in other fields) use real-life analogies to try and explain things more clearly. You will very often hear of economists using medical terminology in trying to explain the situation in the economy ("the medicine is harsh, but the patient requires it" - this one is actually from Margaret Thatcher), or automotive analogies ("pulling the economy into the faster gear"), sporting analogies (numerous examples, usually referring to boxing but also first halfs and second halfs) and so on.
I ran into another interesting one a few months back but I completley forgot about it before I read today's post by Scott Sumner, quoting George Soros. I meant to write something about it back then on the essence of Soros plans to fix the eurozone but I was preoccupied with other subjects. Besides, since then I covered the eurozone topic quite thoroughly (see here, here and here).
What I'm drawing my attention to now is this par…

Modern consumption theory - temporary vs permanent income

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One of the main arguments in favour of a fiscal stimulus include the idea that tax rebates will work towards encouraging consumption, and hence aggregate demand. If the people suddenly gain unanticipated funds which will increase their disposable income, this should encourage them to spend this money immediately. On the supply side the argument is to cut personal income taxes in order to increase the disposable income and then consumption. The real problem is that both of these policies won't do much help to temporary consumption especially if confidence in the economy is low. Even though a tax decrease has a positive effect on disposable income, it will yield the same effect on consumption only if the tax decrease is considered to be credible. 
The distinction between temporary and permanent income is an important parameter in determining the real effects of tax policy. If citizens find themselves suddenly with more cash back than they expected, logic permits that they spend thi…

Why Nations Fail

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Here is a lecture by Prof. Daron Acemoglu on his new book co-authored with Prof. James Robinson; "Why Nations Fail", for which I am preparing a book review on. 

The book is an excellent read and I highly recommend it to anyone interested in the role of institutions in comparative development. It answers the central question that interests anyone studying economics: 'why some nations are rich while others are poor?' In praising the book I even came across opinions that its contribution is as important as Smith's "Wealth of Nations". 
Here is Acemoglu and Robinson's blog on the book and other issues covered in it, here is a podcast of Acemoglu talking to Russ Roberts on Econlog, and here is a good review from the NYT's Thomas Friedman. 

Graph of the week: A crisis of confidence driven by policy decisions

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Following up on the Economic policy uncertainty research done by Baker, Bloom and Davis (on which I wrote about earlier), here is a graph from them on the movements in the S&P 500 index:

Notice how the majority of movements in the last period (both upwards and downwards) were policy-related. A possible conclusion from this could be that bad policy-making decisions (particularly towards the end of last year - see here, here and here) are the main drivers behind high levels of uncertainty. In the years during the crisis, it was obvious that other events were driving stock market swings much more than political decisions. But the sluggishness of the recovery can only be blamed on inadequate policy measures and misplaced signals sent by politicians to the market (such as the debt ceiling quarrel in August in America, or the eurozone faulty attempts to reform). 
On the methodological point, the way the authors come up with these movements is by reviewing newspaper articles, where they…

To Greece and back

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In the last month I briefly drifted apart from the eurozone and its problems (amid some interesting graphs), and by doing so I overlooked the Greek default situation. For those who are unsure, Greece did actually default on its debt. After agreeing on the second bailout in February (€130bn) and forcing private holders of Greek debt to accept a larger haircut, in March Greece experienced the largest sovereign-debt restructuring in history (€100bn of its total debt of €350bn will be included in the debt restructuring deal). The debt swap means that current debt holders (mostly EU banks) will exchange their existing debt for new bonds, which pay a lower interest and have a lower face value. This made Moody’s declare that Greece did actually negotiate a default, since that's what a debt swap implies. Another reason why this clearly was a default is that it wasn’t voluntary, as those private holders of debt that didn’t sign up for the bond swap were forced to do so. Anyway, this made …