« September 2015 | Main | November 2015 »

Wednesday, October 07, 2015

'The Papal Encyclical and Climate Change Policy'

Robert Stavins:

The Papal Encyclical and Climate Change Policy: ...I’m inspired by a marvelous essay by Yale professor William Nordhaus, “The Pope & the Market,”... However, my thoughts are completely independent from his...
With that preamble out of the way, here are the reactions of one environmental economist, yours truly, to Laudato Si’...
The Pope is to be commended for taking global climate change seriously, and for drawing more world attention to the issue. There is much about the encyclical that is commendable, but where it drifts into matters of public policy, I fear that it is – unfortunately – not helpful.
The long encyclical ignores the causes of global climate change: it is an externality, an unintended negative consequence of otherwise meritorious activity by producers producing the goods and services people want, and consumers using those goods and services. ... There may well be ethical dimensions of the problem, but it is much more than a simple consequence of some immoral actions by corrupt capitalists.
The document also ignores the global commons nature of the problem, which is why international cooperation is necessary. If the causes of the problem are not recognized, it is very difficult – or impossible – to come up with truly meaningful and feasible policy solutions.
So, yes, the problem is indeed caused by a failure of markets, as the Pope might say, or – in the language of economics – a “market failure”. But that is precisely why sound economic analysis of the problem is important and can be very helpful. Such analysis points the way to working through the market for solutions...
Should Carbon Markets be Condemned?
In surprisingly specific and unambiguous language, the encyclical rejects outright “carbon credits” as part of a solution to the problem. It says they “could give rise to a new form of speculation and would not help to reduce the overall emission of polluting gases”. The encyclical asserts that such an approach would help “support the super-consumption of certain countries and sectors”.
That misleading and fundamentally misguided rhetoric is straight out of the playbook of the ALBA countries, the small set of socialist Latin American countries that are opposed to the world economic order, fearful of free markets, and have been utterly dismissive and uncooperative in the international climate negotiations. Those countries have been strongly opposed to any market-based approaches to climate change...
By incorporating the anti-market rhetoric of the ALBA countries, the encyclical [is] emphasizing a perspective that is not progressive and enlightened, and would – I fear – ultimately work against meaningful climate policy at the international, regional, national, and sub-national levels.
That is why I said that although there is much about the encyclical that is commendable, where it drifts into matters of public policy it is – unfortunately – not helpful.

    Posted by on Wednesday, October 7, 2015 at 12:15 AM in Economics, Environment | Permalink  Comments (73) 


    Links for 10-07-15

      Posted by on Wednesday, October 7, 2015 at 12:06 AM in Economics, Links | Permalink  Comments (141) 


      Tuesday, October 06, 2015

      The Club for Growth, Equity, and Social Insurance

      I have a new column:

      Economic Growth vs. Social Insurance—Why Can’t We Have Both?: Why do Republicans on the campaign trail tend to emphasize policies that are focused on enhancing long-run economic growth while Democrats tend to focus more on immediate problems such as high unemployment? Republicans have a Club for Growth that grades politicians on their support of “free-market, limited government” policies they believe are the key to economic growth. Democrats are more likely to pay attention to institutions such as the Economic Policy Institute where “policies that protect and improve the economic conditions of low- and middle-income workers” are promoted. In general, Democrats seem much more focused on short-run economic problems than Republicans. Is there any basis within economics for this difference in emphasis on which type of policy is most important?
      As I’ll explain shortly, there is, or more precisely, there was.
      Some Republicans use the promise of economic growth as a ruse for their real goal, lower taxes on the wealthy. For them, it’s really a “Club to Lower Taxes and Cut Social Programs.” But today I want to focus on the economics rather than the politics.
      What is the source of the idea that we cannot address both long-run growth and problems such as high unemployment and rising inequality at the same time? Why have economists and politicians chosen sides on which of the two is most important? There are two reasons for this. ...

        Posted by on Tuesday, October 6, 2015 at 09:09 AM in Economics, Politics | Permalink  Comments (87) 


        'Marco Rubio is Insisting That His Massive Tax Cuts Will Pay for Themselves'

        Ezra Klein:

        Why Marco Rubio is insisting that his massive tax cuts will pay for themselves, explained: On Tuesday, Marco Rubio told CNBC's John Harwood that his massive tax cuts — which estimates have found would blow a roughly $4 trillion to $5 trillion hole in the deficit — creates a surplus "within the 10-year window."
        It is worth slowing down to make clear exactly what Rubio said there. Rubio's plan cuts corporate taxes, capital gains taxes, taxes on the rich, taxes on the middle class — it cuts taxes on everyone. The cuts are so large that the New York Times called it "the puppies and rainbows plan." And what Rubio is saying is that his massive tax cut is actually going to mean more tax revenue for the government — that two minus one will equal four. ...
        Rubio's assurance will, to most tax analysts, sound like nonsense. And it is nonsense. A plan that massively cuts taxes isn't going to lead to budget surpluses. But it's nonsense that has been validated by an important conservative tax group, that shows the kind of candidate Rubio is looking to be, and that speaks to why the debate over taxes in Washington has become so dysfunctional. ...

         

          Posted by on Tuesday, October 6, 2015 at 09:07 AM in Budget Deficit, Economics, Politics, Taxes | Permalink  Comments (17) 


          'TPP Take Two'

          Paul Krugman:

          TPP Take Two: I’ve described myself as a lukewarm opponent of the Trans-Pacific Partnership; although I don’t share the intense dislike of many progressives, I’ve seen it as an agreement not really so much about trade as about strengthening intellectual property monopolies and corporate clout in dispute settlement — both arguably bad things... But the WH is telling me that the agreement just reached is significantly different from what we were hearing before, and the angry reaction of industry and Republicans seems to confirm that.
          What I know so far: pharma is mad because the extension of property rights in biologics is much shorter than it wanted, tobacco is mad because it has been carved out of the dispute settlement deal, and Rs in general are mad because the labor protection stuff is stronger than expected. All of these are good things from my point of view. I’ll need to do much more homework once the details are clearer. ...

            Posted by on Tuesday, October 6, 2015 at 09:03 AM in Economics, International Trade, Politics | Permalink  Comments (8) 


            'Demand Deniers'

            Chris Dillow:

            Demand deniers: The Tories seem ... oblivious to problems of weak demand. ...
            Jeremy Hunt tries to justify cutting tax credits by claiming that he wants to create a culture of hard work.
            Let's leave aside the fact that working long hours is often a sign a economic failure - of low productivity - and ask: what would happen if people offered to work longer?
            The answer is that, in many cases their employers would reject their offers. There are already 1.28 million people who are working part-time because they cannot find full-time work. This tells us that, for very many people, the problem isn't a lack of culture of hard work but a lack of demand for their services. ...
            These ... examples raise the question: why are the Tories demand-deniers? Alex offers one answer: it's because they still believe that poverty is the fault of the individual - they are committing the fundamental attribution error.
            The counterpart to this is a perhaps willful failure to see that there are also systemic reasons for low pay - not just bad policy, but fundamental properties of the capitalist economy.

              Posted by on Tuesday, October 6, 2015 at 09:00 AM in Economics, Politics | Permalink  Comments (12) 


              Links for 10-06-15

                Posted by on Tuesday, October 6, 2015 at 12:06 AM in Economics, Links | Permalink  Comments (197) 


                Monday, October 05, 2015

                'Is Economics Research Replicable? Usually Not.'

                Andrew Chang and Phillip Li:

                Is Economics Research Replicable? Sixty Published Papers from Thirteen Journals Say “Usually Not”, by Andrew C. Chang and Phillip Li, Finance and Economics Discussion Series 2015-083. Washington: Board of Governors of the Federal Reserve System: Abstract We attempt to replicate 67 papers published in 13 well-regarded economics journals using author-provided replication files that include both data and code. Some journals in our sample require data and code replication files, and other journals do not require such files. Aside from 6 papers that use confidential data, we obtain data and code replication files for 29 of 35 papers (83%) that are required to provide such files as a condition of publication, compared to 11 of 26 papers (42%) that are not required to provide data and code replication files. We successfully replicate the key qualitative result of 22 of 67 papers (33%) without contacting the authors. Excluding the 6 papers that use confidential data and the 2 papers that use software we do not possess, we replicate 29 of 59 papers (49%) with assistance from the authors. Because we are able to replicate less than half of the papers in our sample even with help from the authors, we assert that economics research is usually not replicable. We conclude with recommendations on improving replication of economics research.

                  Posted by on Monday, October 5, 2015 at 10:39 AM in Economics, Methodology | Permalink  Comments (40) 


                  Is Donald Trump Right to Call NAFTA a ''Disaster''?

                  At MoneyWatch

                  Is Donald Trump right to call NAFTA a "disaster"?: Recently, Donald Trump made a strong claim about the North American Free Trade Agreement (NAFTA) in an interview on CBS 60 Minutes:
                  "It's a disaster. ... We will either renegotiate it, or we will break it. Because, you know, every agreement has an end. ... Every agreement has to be fair. Every agreement has a defraud clause. We're being defrauded by all these countries."
                  Is he right? Was NAFTA a disaster? ...

                  I also talk about immigration.

                    Posted by on Monday, October 5, 2015 at 05:22 AM in Economics, Immigration, International Trade, Politics | Permalink  Comments (94) 


                    Paul Krugman: Enemies of the Sun

                    Why are Republicans hostile to initiatives that promote wind and solar energy?:

                    Enemies of the Sun, by Paul Krugman, Commentary, NY Times: Does anyone remember the Cheney energy task force? Early in the George W. Bush administration, Vice President Dick Cheney released a report that was widely derided as a document written by and for Big Energy — because it was...
                    But here’s the thing: by the standards of today’s Republican Party, the Cheney report was enlightened, even left-leaning. One whole chapter was devoted to conservation, another to renewable energy. By contrast, recent speeches by Jeb Bush and Marco Rubio — still the most likely Republican presidential nominees — barely address either topic. When it comes to energy policy, the G.O.P. has become fossilized. That is, it’s fossil fuels, and only fossil fuels, all the way.
                    And that’s a remarkable development, because ... we’re ... living in an era of spectacular progress in wind and solar energy. Why has the right become so hostile to technologies that look more and more like the wave of the future? ...
                    Part of the answer is surely that promotion of renewable energy is linked in many people’s minds with attempts to limit climate change — and ... the association with climate science evokes visceral hostility on the right.
                    Beyond that,... follow the money. We used to say that the G.O.P. was the party of Big Energy, but these days it would be more accurate to say that it’s the party of Old Energy. In the 2014 election cycle the oil and gas industry gave 87 percent of its political contributions to Republicans; for coal mining the figure was 96, that’s right, 96 percent. Meanwhile, alternative energy went 56 percent for Democrats.
                    And Old Energy is engaged in a systematic effort to blacken the image of renewable energy, one that closely resembles the way it has supported “experts” willing to help create a cloud of doubt about climate science. An example: Earlier this year Newsweek published an op-ed article purporting to show that the true cost of wind power was much higher than it seems. But ... the article contained major factual errors, and its author had failed to disclose that he was the Charles W. Koch professor at Utah State, and a fellow of a Koch- and ExxonMobil-backed think tank. ...
                    While politicians on the right may talk about encouraging innovation and promoting an energy revolution, they’re actually defenders of the energy status quo, part of a movement trying to block anything that might disrupt the reign of fossil fuels.

                      Posted by on Monday, October 5, 2015 at 12:33 AM in Economics, Environment, Politics | Permalink  Comments (56) 


                      Ben Bernanke: Execs Should Have Gone to Jail

                      From an interview in USA Today:

                      The decision about whether to prosecute individuals wasn't up to him, [Bernanke] says. "The Fed is not a law-enforcement agency," he says. "The Department of Justice and others are responsible for that, and a lot of their efforts have been to indict or threaten to indict financial firms. Now a financial firm is of course a legal fiction; it's not a person. You can't put a financial firm in jail."

                      From another report:

                      Asked if someone should have gone to jail, he replied, "Yeah, I think so."

                      There's a video of the interview at the first link.

                        Posted by on Monday, October 5, 2015 at 12:24 AM in Economics, Financial System | Permalink  Comments (42) 


                        Links for 10-05-15

                          Posted by on Monday, October 5, 2015 at 12:06 AM in Economics, Links | Permalink  Comments (162) 


                          Sunday, October 04, 2015

                          'Paying CEOs Fat Bonuses for Stock Performance Doesn't Work'

                          People on Twitter seemed interested in this:

                          Paying CEOs fat bonuses for stock performance doesn't work, by Lawrence Lewitinn, Yahoo Finance: It turns out offering CEOs huge bonuses to boost shareholder returns doesn’t actually work, according to a new study from Cornell University.
                          The analysis, done in conjunction with consultants Pearl Meyer & Partners, examined a decade’s worth of data from every company in the S&P 500. It compared companies that offer their top brass a total shareholder return (TSR) plan to those that don’t and found the increasingly popular pay plans haven't significantly boosted any of a number of key metrics. ...

                          To be fair, I should note that this is qualified. The end of the article points out that this "doesn’t rule out other performance bonuses" that avoid the problems associated with this particular method of trying to align the preferences of CEOs with those of stockholders. Nevertheless, I'm skeptical.

                            Posted by on Sunday, October 4, 2015 at 05:43 PM in Economics, Market Failure | Permalink  Comments (8) 


                            'Nonrival Goods After 25 Years'

                            Paul Romer:

                            Nonrival Goods After 25 Years: Joshua Gans has a generous post that notes the 25th anniversary of the publication of my 1900 JPE article. I could not agree more with his observation that “there is more to be done …” in understanding the economics of ideas.
                            His post helped me see how to respond to a conversation I had this summer. I’ll use the excuse of the anniversary to focus for the month on such basics as the meaning of nonrival good. Doing so will be a shift for this blog, which until now has been concerned primarily with economics as a science and incidentally with my day job, which focuses on the interaction between urbanization and development.
                            I’m looking forward to revisiting these basics. ...

                            [He goes on to talk about excludability and nonrival goods.]

                              Posted by on Sunday, October 4, 2015 at 05:29 PM in Economics | Permalink  Comments (1) 


                              Worries about a Global Economic Slowdown

                              Jim Hamilton:

                              ... What evidence is there that worries about a global economic slowdown are figuring prominently in recent oil prices? Exhibit one is the remarkable comovement between commodity and asset prices. Concerns about global economic weakness show up in commodity prices and asset markets across the board. ...

                              Gavyn Davies:

                              The turbulence in the global financial markets in the past few weeks has been widely attributed to a “China shock” that has increased the risks of a major downturn in global activity. Last month, this blog concluded that our regular “nowcasts” for global activity had not yet corroborated this narrative.
                              This month, we have identified the first clear evidence that the global economy has slowed down since mid year, with emerging markets and advanced economies both now growing more slowly. ...

                                Posted by on Sunday, October 4, 2015 at 10:24 AM in Economics | Permalink  Comments (41) 


                                Links for 10-04-15

                                  Posted by on Sunday, October 4, 2015 at 12:06 AM in Economics, Links | Permalink  Comments (142) 


                                  Saturday, October 03, 2015

                                  'How Poverty Affects Children’s Brains'

                                  We need to do more to "inoculate young children’s pliable brains against the ravages of poverty":

                                  How poverty affects children’s brains, Washington Post: ... In a study published this year in Nature Neuroscience, several co-authors and I found that family income is significantly correlated with children’s brain size — specifically, the surface area of the cerebral cortex, which ... does most of the cognitive heavy lifting. Further, we found that increases in income were associated with the greatest increases in brain surface area among the poorest children. ...
                                  Some feared the study would be used to reinforce the notion that people remain in poverty because they are less capable than those with higher incomes. As neuroscientists, we interpret the results very differently. We know that the brain is most malleable in the early years of life...
                                  Our [new] clinical trial is designed to provide strong evidence regarding whether and how poverty reduction promotes cognitive and brain development. This study, however, will take at least five years to complete — far too long for young children living in poverty today. We should not wait until then to push for policies that can help inoculate young children’s pliable brains against the ravages of poverty. ...

                                    Posted by on Saturday, October 3, 2015 at 03:52 PM in Economics, Income Distribution | Permalink  Comments (54) 


                                    'The Romer Model Turns 25'

                                    Joshua Gans:

                                    The Romer Model turns 25: 25 years ago this month Paul Romer‘s paper, “Endogenous Technological Change” was published in the Journal of Political Economy. After over 20,000 citations, it is one of the most influential economics papers of that period. The short version of what that paper did was to provide a fully specified model whereby technological change (i.e., the growth of productivity) was driven not be outside (or exogenous) forces but, instead, by the allocation of resources to knowledge creation and with a complete description of the incentives involved that provided for that allocation. Other papers had attempted this in the past — as outlined in David Warsh’s great book of 2006 — and others provided alternatives at the same time (including Aghion, Howitt, Grossman, Helpman, Acemoglu and Weitzman) but Romer’s model became the primary engine that fueled a decade-long re-examination of long-term growth in economics; a re-examination that I was involved in back in my student days.
                                    Recently, Romer himself has taken on others who, more recently, have continued to provide models of endogenous economic growth (most notably Robert Lucas) for not building on the work of himself and others that grounded the new growth theory in imperfect competition but instead trying to formulate models based on perfect competition instead. I don’t want to revisit that issue here but do want to note that “The Romer Model” is decidedly non-mathy. As a work of theoretical scholarship, every equation and assumption is carefully justified. The paper is laid out with as much text as there is mathematics. And in the end, you know how the model works, why it works and what drives its conclusions. ...

                                    After explaining the contributions in detail, he also covers:

                                    So why has work in this area somewhat petered out? ...

                                    And ends with:

                                    In summary, the Romer model was a milestone and led to much progress. It is a stunningly beautiful work of economic theory. But there is more to be done and my hope is we will see that happen in the future as the cumulative process that drives new knowledge can drive new economic knowledge as well.

                                      Posted by on Saturday, October 3, 2015 at 11:46 AM in Economics, Productivity, Technology | Permalink  Comments (4) 


                                      Where Have all the Teachers Gone?

                                      The people who say "think of the children!" when stoking unfounded fears about the debt seem to have no problem with this. Maybe the children aren't really their main concern:

                                      9599
                                      [Source]

                                        Posted by on Saturday, October 3, 2015 at 11:16 AM in Economics, Education | Permalink  Comments (79) 


                                        Links for 10-03-15

                                          Posted by on Saturday, October 3, 2015 at 12:06 AM in Economics, Links | Permalink  Comments (138) 


                                          Friday, October 02, 2015

                                          ''You Just Don’t See the Positive Side'' of High Managerial Compensation

                                          From an interview with Thomas Piketty during a trip to South Africa:

                                          ...I think in all cases there is always a lot to learn from these historical experiences and probably the one … lesson is we don’t want, we don’t need 19th-century inequality to grow in the 21st century. We find the role of inequality may be justified by incentive and growth considerations, but certainly no extreme and sometimes obscene level of inequality of pay that we’ve seen in recent days, with top managerial compensation going to millions of dollars. You just don’t see the positive side of this in the performance, in the job creation. ... The idea that you need to pay top managers 100, 200 times the minimum wage to get them to work and otherwise they will just not do the work. That ideology is not consistent at all with the historical data that we have, which shows that you can develop with reasonable, not extreme inequality levels. ...

                                          The comments on the interview, at least when I read them, were not supportive.

                                            Posted by on Friday, October 2, 2015 at 06:57 PM in Economics, Income Distribution | Permalink  Comments (15) 


                                            'Job Growth Weakens in September'

                                            Dean Baker:

                                            Job Growth Weakens in September: The Labor Department reported the economy created just 142,000 jobs in September, well below most forecasts. Furthermore, the prior two months' numbers were revised down as well, bringing the average for the last three months to 167,000. In addition, there was a drop in the length of the average workweek of 0.1 hour causing the index of aggregate hours to decline by 0.2 percent. The household survey also showed a weak picture of the labor market. While the unemployment rate was unchanged at 5.1 percent there was a drop of 0.2 percentage points in both the labor force participation rate and the employment-to-population (EPOP) ratio. The drop in the EPOP brought the ratio back to its level of October 2014.

                                            The weakness in job growth in the establishment survey was spread widely across sectors. ...

                                            The average hourly wage dropped slightly in September, bringing the annual rate of growth over the last three months compared with the prior three to 2.2 percent, the same as its rate over the last year. The drop in the hourly wage, combined with the fall in hours, led to a 0.3 percent drop in the average weekly wage.

                                            The household survey also showed a weak picture of the labor market. While the unemployment rate was unchanged there was a drop of 0.2 percentage points in both the labor force participation rate and the employment to population ratio. The low EPOP is not primarily a demographic story. The EPOP for prime-age (25–54) men is still 3.5 percentage points below its pre-recession peak and 5.0 percentage points below its 2000 high. For prime-age women the September EPOP is 2.7 percentage points below the pre-recession peak and 4.7 percentage points below the high hit in 2000. Clearly this is not a story of people leaving the labor force to retire.
                                            Other news in the household survey was mixed. The share of unemployment due to people who voluntarily quit their jobs remained at the low 9.8 percent rate of August, a level typically seen in recessions. The duration measures all fell slightly, reversing some increases in the prior two months. The one piece of clear good news in the survey was a drop of 447,000 in the number of people working part-time for economic reasons. This number is erratic, but this is an unusually large one-month decline.

                                            On the whole this report suggests the labor market is considerably weaker than had been generally believed. The plunge in oil prices is taking a large toll on the formerly booming mining sector. In addition, the high dollar and the resulting trade deficit is a major hit to manufacturing. The 138,000 three-month average rate of private sector job growth is the lowest since February of 2011. The strong growth in government jobs is not likely to continue with budgets still tight. With GDP growth hovering near 2.0 percent, weaker job growth is to be expected, but it will make it much more difficult for the Federal Reserve Board to raise rates this year.

                                              Posted by on Friday, October 2, 2015 at 09:14 AM in Economics, Unemployment | Permalink  Comments (157) 


                                              Paul Krugman: Voodoo Never Dies

                                              Why do Republican politicians support tax cuts for the wealthy despite their unpopularity (as documented in a part I left out), and their failure to spur economic growth?:

                                              Voodoo Never Dies, by Paul Krugman, Commentary, NY Times: So Donald Trump has unveiled his tax plan. It would, it turns out, lavish huge cuts on the wealthy while blowing up the deficit.
                                              This is in contrast to Jeb Bush’s plan, which would lavish huge cuts on the wealthy while blowing up the deficit, and Marco Rubio’s plan, which would lavish huge cuts on the wealthy while blowing up the deficit.
                                              For what it’s worth, it looks as if Trump’s plan would make an even bigger hole in the budget than Jeb’s. Jeb justifies his plan by claiming that it would double America’s rate of growth; The Donald, ahem, trumps this by claiming that he would triple the rate of growth. But really, why sweat the details? It’s all voodoo. The interesting question is why every Republican candidate feels compelled to go down this path.
                                              You might think that there was a defensible economic case for the obsession with cutting taxes on the rich. That is, you might think that if you’d spent the past 20 years in a cave (or a conservative think tank). ...
                                              True, you can find self-proclaimed economic experts claiming to find overall evidence that low tax rates spur economic growth, but such experts invariably turn out to be on the payroll of right-wing pressure groups (and have an interesting habit of getting their numbers wrong)... There is no serious economic case for the tax-cut obsession.
                                              Still,... every Republican who would be president is committed to a policy that is both demonstrably bad economics and deeply unpopular. What’s going on?
                                              Well,..., it’s straightforward and quite stark: Republicans support big tax cuts for the wealthy because that’s what wealthy donors want. No doubt most of those donors have managed to convince themselves that what’s good for them is good for America. But at root it’s about rich people supporting politicians who will make them richer. Everything else is just rationalization.
                                              Of course, once the Republicans settle on a nominee, an army of hired guns will be mobilized to obscure this stark truth. We’ll see claims that it’s really a middle-class tax cut, that it will too do great things for economic growth, and look over there — emails! And given the conventions of he-said-she-said journalism, this campaign of obfuscation may work.
                                              But never forget that what it’s really about is top-down class warfare. That may sound simplistic, but it’s the way the world works.

                                                Posted by on Friday, October 2, 2015 at 12:42 AM in Economics, Politics, Taxes | Permalink  Comments (69) 


                                                'Volatility, Financial Crises and Minsky's Hypothesis'

                                                For the Minsky fans:

                                                Volatility, financial crises and Minsky's hypothesis, by Jon Danielsson, Marcela Valenzuela, Ilknur Zer, Vox EU: Received wisdom maintains that financial market volatility has a direct impact on the likelihood of financial crisis.

                                                Perhaps the best expression of this is Minsky's (1982) hypothesis that economic agents observing low financial risk are induced to increase risk-taking, which in turn may lead to a crisis. This is the foundation of his famous statement, "stability is destabilizing".

                                                More recently, this sentiment has found support amongst policymakers:

                                                “Volatility in markets is at low levels, both actual and expected... to the extent that low levels of volatility may induce risk-taking behavior is a concern to me and to the Committee” -- Federal Reserve Chair Janet Yellen, 18 June 2014.

                                                Such views find support in the recent theoretical literature, where economic agents react to volatility deviating from what they become to expect it to be.

                                                Low volatility induces economic agents to take more risk, endogenously increasing the likelihood of future shocks. If the economic conditions deteriorate and the resulting bad investment decisions start to sour, volatility then increases, signaling a pending crisis.

                                                However, we could not find any empirical literature documenting such a relationship between financial market volatility, risk taking, the real economy and crises. Perhaps we have made little empirical progress since Paul Samuelson's famous quip in 1966 that “Wall Street indexes predicted nine out of the last five recessions”!

                                                The decomposition of volatility

                                                This lack of empirical clarity has motivates us to take a new approach to verify the volatility-crisis relationship, focusing on unexpectedly high and unexpectedly low volatility.

                                                Crises are rare events – recent history notwithstanding, an OECD member country suffers a banking crisis only once every 35 years, on average. Consequently, in order to obtain a meaningful statistical relationship between volatility and crises, it is helpful to take the long-term historical view.

                                                Since no comprehensive data on historical volatilities is available, we constructed such a database from primary sources, one that spans 1800 to 2010 and covers 60 countries.

                                                We make use of Reinhart and Rogoff’s (2009) banking and stock market dataset as our crisis indicator and use GDP per capita, inflation, change in government debt to GDP ratio, institution quality and fixed effects as controls.

                                                We then ran a binomial regression model on the incidence of financial crises with lagged averages of volatility and controls as explanatory variables, finding little significance.

                                                We surmise that this is due in part to the theoretical literature emphasizing volatility expectations and deviations therefrom, not the contemporaneous level of volatility.

                                                Furthermore, volatility has a trend that evolves slowly over time, where one can identify regimes of high or low volatiles that last for many years and decades. Consequently, the expected level of volatility can be quite different across countries and time, weakening any empirical analysis focused solely on volatility levels.

                                                We address this by decomposing volatility into unexpectedly low and high volatilities and using these as explanatory variables in the regression model.

                                                In particular, borrowing terminology from the literature on output gap, we interpret the slow running volatility trend, calculated by a one-sided Hodrick-Prescott filter, as long-term expected volatility. Unexpectedly high and low volatility is then the deviation of volatility from above and below its trend, respectively.

                                                Validating Minsky

                                                We find a strong and significant relationship between unexpected volatilities and the likelihood of financial crises.

                                                Unexpectedly low volatility increases the probability of both banking and stock market crises. This holds especially strongly if low volatility persists half a decade or longer.

                                                We further investigate this by using the credit-to-GDP gap as a proxy for risk-taking, finding that unexpectedly low volatility significantly increases risk-taking. This result complements that of Taylor and Schularick (2009), where credit booms are destabilizing, leading to a banking crisis.

                                                For stock market crises, but not banking crises, high volatility also increases the likelihood of a crisis, but only with much shorter lags, up to two or three years.

                                                This is very much in line with what theory predicts and provides strong evidence for Minsky’s instability hypothesis. Low volatility induces risk-taking that leads to riskier investments. When those turn sour, the resulting high volatility signals a pending crisis.

                                                These results are robust to a number of alternative specifications, for example on the definition of volatility, filtering, lag lengths, sample selections and model specifications.

                                                We find that the relationship between unexpected volatility and the likelihood of a future crisis becomes stronger over time. This is not surprising since the importance of stock markets and the prevalence of limited liability corporations have steadily been increasing.

                                                The main exception to this is the Bretton Woods era when financial markets were tightly regulated and capital flows controlled, causing the volatility-crisis relationship to weaken significantly.

                                                Conclusion

                                                While the common view maintains that volatility directly affects the probability of a crisis, this has been proven difficult to verify empirically.

                                                In what we believe is the first study to do so, we find direct empirical evidence that the level of volatility is not a good indicator of crisis, but that unexpectedly high and low volatilities are.

                                                This is directly in line with what is predicted by theory and provides a validation of Minsky's hypothesis – stability is destabilizing.

                                                Market volatility is of clear interest to policymakers, with the quote of chairwoman Yellen above just one example.

                                                By documenting how volatility can affect the risk-taking behavior of economic agents and hence, the incidence of financial crises, policymakers and market participants alike would gain a valuable tool in understanding crises, tail events and systemic risk.

                                                Author's note: Jon Danielsson thanks the Economic and Social Research Council (UK). Marcela Valenzuela thanks Fondecyt and Instituto Milenio.
                                                Disclaimer: The views in this column are solely those of the authors and should not be interpreted as reflecting the views of the Board of Governors of the Federal Reserve System or of any other person associated with the Federal Reserve System.

                                                Bibliography

                                                Danielsson, J, M Valenzuela, and I Zer (2015), “Learning from History: Volatility and Financial Crises”, SSRN.

                                                Minsky, H (1992), “The financial instability hypothesis”, Working Paper.

                                                Reinhart, C M and K S Rogoff (2009), “This Time is Different: Eight Centuries of Financial Folly”, Princeton University Press.

                                                Samuelson, P (1966), “Science and stocks”, Newsweek.

                                                Taylor, S (2009), “Credit booms go wrong”, VoxEU, 8 December.

                                                Yellen, J (2014), press conference, Federal Reserve Board, 18 June.

                                                  Posted by on Friday, October 2, 2015 at 12:15 AM in Economics | Permalink  Comments (44) 


                                                  Links for 10-02-15

                                                    Posted by on Friday, October 2, 2015 at 12:06 AM in Economics, Links | Permalink  Comments (88) 


                                                    Thursday, October 01, 2015

                                                    Market Power, Labor's Share of Income, and Measured Productivity

                                                    For a long time, I have been making the argument that part of the reason for the inequality problem is distortions in the distribution of income driven by market imperfections such as monopoly power that allows prices to exceed marginal costs. What I didn't realize is that this can also affect measurements of productivity growth:

                                                    The relationship between U.S. productivity growth and the decline in the labor share of national income, by Nick Bunker: One of the ongoing debates about the state of the U.S. economy is the extent to which the profits from productivity gains are increasingly going to the owners of capital instead of wage earners. These researchers are debating the extent to which the labor share of income, once considered a constant by economists, is on the decline.
                                                    But what if the decline of national income going to labor actually affects the measured rate of U.S. productivity growth? In a blog post published last week, University of Houston economist Dietz Vollrath sketches out a model showing just that scenario. ...
                                                    Vollrath argues that businesses with more market power are able to charge higher markups on their goods and services, meaning their pricing is higher than the cost of producing an additional goods or services compared to pricing in a perfectly competitive market. So in this situation where markups are high, goods and services are being produced less efficiently, with the increased profits going to the owners of capital.
                                                    Vollrath argues that this is how measured productivity growth is affected by the decline of the labor share of income. Market power is important for thinking about measured productivity growth because, as Vollrath says, it “dictates how efficiently we use our inputs.” ... Impeding the most efficient use of capital and labor via marked-up prices will reduce measured productivity. ... Perhaps this could explain some of the reason why measured productivity growth looks so meager in the seeming age of innovation...
                                                    But Vollrath’s story isn’t a complete explanation of the fall in measured productivity, as he acknowledges...
                                                    But Vollrath’s market power explanation for falling productivity growth, alongside the falling share of national income going to wage earners, is supported by some evidence.  Work by Massachusetts Institute of Technology graduate student Matt Rognlie, for example, found evidence of higher markups.
                                                    Whether and how the decline of the labor share of income affects productivity growth is obviously a topic far too large for a couple of blog posts. But Vollrath’s model is especially interesting for connecting two important trends in recent years: the slowdown in productivity growth and the declining labor share. It’s worth, at the very least, a bit more investigation.

                                                      Posted by on Thursday, October 1, 2015 at 09:29 AM in Econometrics, Income Distribution, Productivity | Permalink  Comments (30) 


                                                      'The Costs of Interest Rate Liftoff for Homeowner'

                                                      Two posts on housing. First, how will an increase in interest rates impact mortgage markets?:

                                                      The costs of interest rate liftoff for homeowners: Why central bankers should focus on inflation, by Carlos Garriga, Finn Kydland, and Roman Šustek: The Federal Reserve Bank and the Bank of England left their policy interest rates unchanged this month... But an interest rate liftoff in the near future remains on the table in both the US and the UK, provided the headwinds from China ease off and there is further evidence of improvements in the domestic economy. Inflation, however, still hovers in both economies stubbornly around zero percent. 
                                                      Interest rates set by central banks influence the economy through various transmission mechanisms. But one channel affects the typical household directly – the cost of servicing mortgage debt. ... Changes in the interest rate set by the central bank affect the size of mortgage payments, but differently for different types of loans. In addition, the real value of these payments depends on inflation. ...
                                                      Policy implications
                                                      To sum up, the effects of the liftoff on homeowners depend on three factors:
                                                      • The prevalent mortgage type in the economy (fixed or adjustable rate mortgages);
                                                      • The speed of the liftoff; and
                                                      • What happens to inflation during the course of the liftoff.
                                                      If inflation stays constant at near zero then in the US, where fixed rate mortgage loans dominate, the liftoff will affect only new homeowners. In the UK, where adjustable rate mortgage loans dominate, the negative effects will in contrast be felt strongly by both new and existing homeowners.
                                                      However, if the liftoff is accompanied by sufficiently high inflation as in our examples, the negative effects will be weaker in both countries. In the US, the initial negative effect on new homeowners will be compensated by gradual positive effects on existing homeowners. And in the UK, provided the liftoff is sufficiently slow, neither existing nor new homeowners may face significantly higher real costs of servicing their mortgage debt. But if the liftoff is too fast, both types of homeowners in the UK will face higher real mortgage costs in the medium term, even if the liftoff is accompanied by positive inflation with no change in real rates.
                                                      Therefore, if the purpose of the liftoff is to ‘normalize’ nominal interest rates without derailing the recovery, central bankers in both the US and the UK should wait until the economies convincingly show signs of inflation taking off. Furthermore, the liftoff should be gradual and in line with inflation.

                                                      Second, allowing less creditworthy borrowers to refinance could stimulate the economy:

                                                      ‘Home Affordable Refinancing Program’: Impact on borrowers, by Sumit Agarwal, Gene Amromin, Souphala Chomsisengphet, Tomasz Piskorski, Amit Seru, and Vincent Yao: Mortgage refinancing is one of the main ways households can benefit from a decline in the cost of credit. This column uses the US Government’s Home Affordable Refinancing Program (HARP) as a laboratory to examine the government’s ability to impact refinancing activity and spur household consumption. The results suggest that less creditworthy borrowers significantly increase their spending following refinancing. To the extent that such borrowers have the largest marginal propensity to consume, allowing them to refinance under the program could increase overall consumption and alleviate uneven economic outcomes across the country.

                                                        Posted by on Thursday, October 1, 2015 at 09:27 AM in Economics, Fiscal Policy, Housing | Permalink  Comments (38) 


                                                        'Marx on Peasant Consciousness'

                                                        Daniel Little:

                                                        Marx on peasant consciousness: One of Marx's more important pieces of political writing is the The Eighteenth maire of Louis Bonaparte (1851) (pdf). Here is his analysis of the causes of the specific nature of peasant political consciousness leading to the election of Napoleon III:

                                                        The small-holding peasants form an enormous mass whose members live in similar conditions but without entering into manifold relations with each other. Their mode of production isolates them from one another instead of bringing them into mutual intercourse. The isolation is furthered by France‘s poor means of communication and the poverty of the peasants. Their field of production, the small holding, permits no division of labor in its cultivation, no application of science, and therefore no multifariousness of development, no diversity of talent, no wealth of social relationships. Each individual peasant family is almost self-sufficient, directly produces most of its consumer needs, and thus acquires its means of life more through an exchange with nature than in intercourse with society. A small holding, the peasant and his family; beside it another small holding, another peasant and another family. A few score of these constitute a village, and a few score villages constitute a department. Thus the great mass of the French nation is formed by the simple addition of homologous magnitudes, much as potatoes in a sack form a sack of potatoes. Insofar as millions of families live under conditions of existence that separate their mode of life, their interests, and their culture from those of the other classes, and put them in hostile opposition to the latter, they form a class. Insofar as there is merely a local interconnection among these small-holding peasants, and the identity of their interests forms no community, no national bond, and no political organization among them, they do not constitute a class. They are therefore incapable of asserting their class interest in their own name, whether through a parliament or a convention. They cannot represent themselves, they must be represented. Their representative must at the same time appear as their master, as an authority over them, an unlimited governmental power which protects them from the other classes and sends them rain and sunshine from above. The political influence of the small-holding peasants, therefore, finds its final expression in the executive power which subordinates society to itself.

                                                        This a particularly interesting analysis of the social psychology of group solidarity, and one that has contemporary significance as well. It sheds a lot of light on how Marx thinks about the formation of class consciousness -- even as it significantly misunderstands the agency of rural people.

                                                        What are the limitations of the French peasantry, according to Marx here? They are isolated, burdened, unsophisticated, primitive, apolitical, and ignorant of the larger forces around them. Therefore, Marx says, they cannot constitute a unified and purposive political force. (The photo of a battalion of Vietnam Minh troops in Indochina just a century later refutes this conception.)

                                                        From this description we can draw several positive ideas about the foundations of collective solidarity. Here are the elements that Marx takes to be crucial in the formation of collective consciousness in this passage:

                                                        1. The group needs to possess "manifold relations" to each other.
                                                        2. There needs to be effective communication and transportation across space, not just local interaction.
                                                        3. There needs to be a degree of economic interdependence.
                                                        4. There need to be shared material conditions in the system of production.
                                                        5. There needs to be an astute appreciation of the social and economic environment.
                                                        6. There needs to be organization and leadership to help articulate a shared political consciousness and agenda. 

                                                        And Marx seems to have something like a necessary and sufficient relation in mind between these conditions and the emergence of collective consciousness: these conditions are jointly sufficient and individually necessary for collective consciousness in an extended group.

                                                        There are several crucial ideas here that survive into current thinking about solidarity and mobilization. So Marx's thinking about collective consciousness was prescient. It is interesting to consider where his thoughts about collective solidarity came from. How did he come to have insightful ideas about the social psychology of mobilization and solidarity in the first place? This isn't a topic that had a history of advanced theory and thinking in 1851.

                                                        Two sources seem likely. First is the tradition of French socialist thought in which Marx was immersed in the 1840s. French socialist thinkers were in fact interested in the question of how a revolutionary spirit came to be among a group of people. And second is Marx's own experience of working people in Paris in 1843-45. He writes of his own observations of working people in the Economic and Philosophic Manuscripts in 1844:

                                                        When communist artisans associate with one another, theory, propaganda, etc., is their first end. But at the same time, as a result of this association, they acquire a new need – the need for society – and what appears as a means becomes an end. In this practical process the most splendid results are to be observed whenever French socialist workers are seen together. Such things as smoking, drinking, eating, etc., are no longer means of contact or means that bring them together. Association, society and conversation, which again has association as its end, are enough for them; the brotherhood of man is no mere phrase with them, but a fact of life, and the nobility of man shines upon us from their work-hardened bodies.

                                                        Here Marx gives as much importance to the substantive relations of friendship and everyday association as he does to shared material interests in the formation of the class consciousness of French workers.

                                                        Marx's misunderstanding of the political capacity and consciousness of peasant communities has been noted by many scholars of rural revolutions. James Scott once opened a public lecture on the revolutions of the twentieth century by saying that his lecture would only treat the peasant revolutions of the century. But he then paused and laughed, and said, this isn't much of a limitation, because they were all peasant revolutions! Marx's assumption that only urban workers were capable of revolutionary consciousness was a serious misreading of the coming century of anti-capitalist and anti-colonial struggles. (Here is an earlier post on Scott's studies of peasant politics. Scott's accounts can be found in Weapons of the Weak: Everyday Forms of Peasant Resistance and The Moral Economy of the Peasant: Rebellion and Subsistence in Southeast Asia. Eric Wolf's Peasant Wars of the Twentieth Century picks up similar themes.)

                                                        Also interesting in the Eighteenth Brumaire is Engels' statement on the law of history as class struggle in his preface to the third edition of the book:

                                                        In addition, however, there was still another circumstance. It was precisely Marx who had first discovered the great law of motion of history, the law according to which all historical struggles, whether they proceed in the political, religious, philosophical or some other ideological domain, are in fact only the more or less clear expression of struggles of social classes, and that the existence and thereby the collisions, too, between these classes are in turn conditioned by the degree of development of their economic position, by the mode of their production and of their exchange determined by it. This law, which has the same significance for history as the law of the transformation of energy has for natural science -- this law gave him here, too, the key to an understanding of the history of the Second French Republic. He put his law to the test on these historical events, and even after thirty-three years we must still say that it has stood the test brilliantly.

                                                        Engels plainly endorses the idea of laws of motion of society and the idea of class conflict as the primary motor of historical change. "History is a history of class struggle." There is not much room for contingency or conjunctural causation here! But this is a dimension of Marxist theory that is plainly incorrect. Far better is to understand history in a more multi-factoral way in which contingency, conjunction, and agency all play a role.

                                                          Posted by on Thursday, October 1, 2015 at 12:15 AM in Economics, Politics | Permalink  Comments (24) 


                                                          Links for 10-01-15

                                                            Posted by on Thursday, October 1, 2015 at 12:06 AM in Economics, Links | Permalink  Comments (158)