the making of an economist

Remembering Milton Friedman

2012-02-19T13:33:00.001-05:00

The Free to Choose Network is commemorating the 100th birthday of Milton Friedman by releasing an update of his groundbreaking series Free to Choose. The series titled Testing Milton Friedman will be a three part series of roundtable discussions on three major topics: "The Power of the Market," "Tyranny of Control," and "Created Equal." The participants include original Free to Choose participant Walter Williams (George Mason University) and other famous economists such as J. Bradford DeLong (University of California - Berkeley), Kevin Murphy (University of Chicago), Bryan Caplan (George Mason University), Austan Goolsbee (University of Chicago), Dani Rodrik (Harvard University), Raghuram Rajan (University of Chicago), and others.

It is scheduled to begin airing May 1, 2012. Check your local listings for exact date and time. For those of you who would like to brush up, here is the original Free to Choose series from 1980.

My Professor, Thomas Rustici, was taught by James Buchanan who was taught by Milton Friedman so I think that makes me Friedman's Great-Grandstudent. One of the stories that Rustici told me about Buchanan's tenure at the University of Chicago is that Friedman arrived while he was in the middle of his doctorate. He had already taken his graduate level microeconomics class with Frank Knight, who was chairman of the department. Knight was apparently so impressed by Friedman's approach to micro that he forced every graduate student to retake their micro course with Friedman. According to Rustici, Buchanan said that he never really understood Microeconomics until that class.

I recently found a copy of Friedman's Price Theory, which is actually the lecture notes of David Fand and Warren Gustus which were reviewed and enhanced by Friedman. Friedman characterizes the notes as being part of his course on Price Theory, so I'm not sure if that is the same course that Buchanan told Rustici about (these are the perils of second-hand knowledge) but when I was reading through the book, it was basically what Rustici was teaching on the subject. In any case, it is a terrific book and even though it is far from famous it is as good or better than anything I've ever read by Friedman or on the subject.

In one of the last conversations I had with my grandfather, Dr. Philip Raup, he mentioned that he once shared a two hour drive with Milton Friedman in the early 1950's. Friedman was lecturing at Saint John's University in Collegeville, Minnesota. My Grandfather rode with him from the airport in the Twin Cities to Collegeville. I asked him what they talked about, or what he could recall of the conversation, and he only said that "He was very opinionated." I think that is a gentleman's way of saying that they didn't agree very much.

Color Me Impressed: Supreet Kaur

2012-02-14T07:30:00.002-05:00

As a student, being blown away by new information is a more common experience than for most individuals. This is the purpose of my series "Color Me Impressed." An economist who just amazes me so much with their writing that I can't help but share.

One of the problems with the recent contraction is that economists are constantly comparing it to a small number of other severe contractions. Television personalities and economists alike try to fit this recession into the U.S. recession of the early 1980's or the Great Depression, often it ends up being a square peg in a round hole. With such a small number of severe economic contractions, we're constantly reminded that crises are actually very idiosynchratic.

The truth is that despite GDP numbers bearing certain similarities, this most recent recession was not very much like the Great Depression or the recessions of the early 1980's. Comparing them might not be very helpful, because of the large number of differences. At the same time, we are using a lot of economic logic, based on these previous experiences, without really having a robust sample to see whether or not these theories work very well at all or whether they just worked that time. The study of economics largely being based on the study of non-repeatable observations is a true thorn in the side of macroeconomists.

One of the issues that we have a great deal of theory about, but not very robust studies of is nominal price rigidity. Many economists have pursuasively written about how price stickiness interplays with falling asset prices with regard to current and new contracts. Supreet Kaur wrote a job market paper on that subject using more often repeated observations, disastrous rainfall in India.

In her paper, "Nominal Wage Rigidity in Village Labor Markets," Miss Kaur somewhat confirms our understanding and fills in significant details, especially with regard to the situation at hand, Indian land usage and its labor markets. "In the presence of wage rigidity, volatility has an additional implication: production may often not be at the frontier because labor markets do not adjust to optimize fully in each period. As implied by the employment results, this means rigidities may lower the levels and increase volatility of income and output - they may compound the adverse consequences of production volatility." She goes on to suggest that "fairness norms" might be a good way to maintain stable real wages.

I enjoy the fact that she's found a larger sample size for unusual events. General economic contractions might not be completely similar to regional weather events, but this is still a pretty good test, with worthwhile observations. Overall, this is one of the better papers I've read all year, and I just can't help but be impressed. She will be an economist to watch in the future.

Have I Mentioned How Much I Love Books?

2012-02-13T23:52:00.003-05:00

On Facebook, they have this new timeline feature which gives users an opportunity to put a banner sized picture up to sort of visually sum up your personality or whatever you want. I chose to take a picture of my bookshelf, but I wanted to cherry pick the books on the shelf. So I totally tore out a whole shelf and grabbed all the ones that I wanted away from my normal organisational method. Yes, I am this nerdy.

Listed:

Second Treatise on Government, John Locke
The Theory of Moral Sentiments, Adam Smith
On the Nature and Causes of the Wealth of Nations, Adam Smith
The Mathematical Principles of the Theory of Wealth, Augustin Cournot
The Open Society and Its Enemies (volume 1 & 2), Karl Popper
The Principles of Political Economy and Taxation, David Ricardo
Theory of Value, Gerard Debreu
The Theory of Econometrics, Harold Davis
Linear Programming and Economic Analysis, Robert Dorfman, Paul Samuelson & Robert Solow
Principles of Economics, Alfred Marshall
The General Theory of Employment, Interest and Money, John Maynard Keynes
Value and Capital, J.R. Hicks
A Theory of the Consumption Function, Milton Friedman
Capitalism and Freedom, Milton Friedman
Price Theory, Milton Friedman
Rational Expectations (volume 1 & 2), Ed.: Robert Lucas & Thomas Sargent
Rational Expectations and Inflation, Thomas Sargent
The Calculas of Consent, James Buchanan & Gordon Tullock
Private Wants Public Means, Gordon Tullock
Selected Papers of Economic Theory, Knut Wicksell
Economics and the Art of Controversy, John Kenneth Galbraith
The Road Ahead for the Fed, Ed.: John B. Taylor
The Costs and Benefits of Price Stability, Martin Feldstein
Lessons from the Great Depression, Thomas Rustici
Social Economics, Friedrich von Wieser
Decision Order & Time, G.L.S. Shackle
A Theory of Economic History, J.R. Hicks
Mathematical Tables & Formulas, Richard Burington
American Economic Review (October 2012)

Andrei Shleifer Speaks at George Mason University!

2012-02-06T07:30:00.002-05:00

Andrei Shleifer, the world's top economist by citation, spoke at George Mason University. He presented the paper, "Education and the Quality of Institutions." It was attended by many economists and graduate students from the University and the Mercatus Center.

Here is the abstract:

"Generally speaking, better educated countries have better institutions, an empirical regularity that holds in both dictatorships and democracies. We suggest that a possible reason for this fact is that educated people are more likely to complain about misconduct by government officials, so that, even when each complaint is unlikely to succeed, more frequent complaints encourage better behavior from officials. Newly assembled individual-level survey data from the World Justice Project show that, within countries, better educated people are more likely to report official misconduct. The results are confirmed using other survey data on reporting crime and corruption. Citizen complaints might thus be an operative mechanism of institutional improvement, one that explains the link between human capital and the quality of government."

It was the first time that I've ever seen a single paper formally presented, and this was a very good one to see first. It was very interesting and the model was simple enough for me to follow. I think that I understand the way that models fit into economic papers much bettter now after seeing one presented. For more economic events, at George Mason University or at other regional institutions, visit the Speakers Calendar.

How to Make Chai

2012-02-04T07:00:00.002-05:00

Economists cannot survive on models and working papers alone, so here is a simple recipe that will help our studies because it is caffeinated. Chai is a beverage that originated on the Indian subcontinent. It is a hot spiced tea that is enjoyed as a delicious break any time of the day. It is simple to make, if a bit more complicated than coffee. One important thing to note is that there is some variety in spices for making chai, but this is one, somewhat standard way of making it.

This recipe is for two cups. First grab a pot for boiling the water, tea and spices in. Then add:

1.5 cups of water

8 cloves (optional)

1/2 stick of cinnamon (optional)

8 crushed cardamom pods

6 thin slices of ginger

Once it has boiled for a minute, turn the burner down and allow it to stop boiling for a moment while you add the tea.

3 heaping spoons of black tea (3 or 4 bags may substitute)

2-3 spoons of sugar (as sweet as you would like it)

Let it boil for about three minutes to allow the flavors to soak into the chai. One good way to tell when they are done is that the tea will fall to the bottom of the pot. Then add a cup of milk and allow it to boil for thirty seconds or a minute more to allow the flavors to fully mix with the milk. Then place a strainer over a tea cup or mug, pour the chai into the cup and enjoy the chai!

As you probably noticed the cardamom, ginger, tea, sugar, and milk are the only truly universal ingredients. Other spices such as cloves, cinnamon, anise, and others can be used. Different sweeteners such as honey are also often substituted for the sugar.

Chai is probably the most popular beverage in India. Many Indians drink it all day and all night. The picture above is at a village in rural India, where I purchased a cup of chai. Here is a video showing you how to do it, if my directions weren't clear enough.

Inflation Targeting Formally Begins in the U.S.

2012-01-30T07:30:00.004-05:00

The Federal Reserve just announced its first formal inflation target. They set a target of 2% interest as a long term target for inflation. This is in step with Bernanke's academic work on monetary policy and with the recent Fed moves towards transparency and their attempts to create expectations rather than simply respond to them. Many central banks have already practiced this for some time.

Brief Case Study: Sweden

Sweden Consumer Price Index

Sweden has been targeting inflation since recovering from a currency crisis in 1993. This gives us a long period of time to examine inflation targeting's effectiveness. The first graph (above) shows the monthly inflation rate of Sweden since their online data begins in 1980. Their maximum inflation rate during the period has been 5.2%, and the minimum -1.9% with the average being 1.56%. The standard deviation has been 1.42%, but while it has had a lot of variation, it has been pretty centered around 1.5% as shown by the histogram below.

The histogram shows the number of times that Sweden has hit a given percentage of inflation since they introduced inflation targeting in 1993. I added a box from 1% to 3%, with a line down the middle at 2% showing the target and the acceptable range. This shows that Sweden has been conservative in their approach to their intention, which has been a static 2% inflation target ±1%. It looks more like that they've targeted 0-3% inflation rather than 1-3%, which ended up with a median 1.5%. This policy has been largely successful in creating relatively stable growth for their economy, as shown in the graph below which begins in 1993.

Target Too Low?

Almost immediately after releasing the target, it was criticized. This is probably to be expected, but not in the way that I expected it to be. One of the first critics of the policy was Paul Krugman, who argued that 2% is too low. Two percent is a pretty standard number in inflation targeting central bank circles. It would be more shocking if they chose to formally inflation target and didn't choose 2%.

Olivier Blanchard was an early major economist to write of raising the inflation target in his paper (along with Giovanni Dell'Ariccia and Paolo Mauro) "Rethinking Macroeconomic Policy" which considered more than monetary policy, but also fiscal and tax policies as well. Blanchard mainly asks if there would be substantially higher costs and benefits to targeting 4% compared to 2% inflation.

Stephanie Schmitt-Grohe and Martin Uribe wrote an interesting paper in 2010 titled, "The Optimal Rate of Inflation" where they attempt to formalize some aspects of the debate on inflation targeting. "For a realistic model of the monetary transmission mechanism must incorporate both major sources of monetary nonneutrality, price stickiness and a transactional demand for fiat money. Indeed, in such a model the optimal rate of inflation falls in between the one called for by the money demand friction—deflation at the real rate of interest—and the one called for by the sticky price friction—zero inflation. The intuition behind this result is straightforward. The benevolent government faces a tradeoff between minimizing price adjustment costs and minimizing the opportunity cost of holding money. Quantitative analysis of this tradeoff, however, suggests that under plausible model parameterizations, this tradeoff is resolved in favor of price stability."

They bring up an incredible amount of ideas that I hadn't considered. They examine ways in which the Friedman rule, or the optimal monetary policy that focuses on zero opportunity cost to holding money, could break down. All three of these ways are related to taxation, whose relation to monetary policy I had not considered.

While I'm not sure if I agree with them, all of these are important concepts to consider, especially when current monetary policy is constrained by the Zero Lower Bound due to our current liquidity trap. Formally announcing a target seems to be a way of creating expectations both for better and for worse. The better is that it signals to the market that the central bank is taking steps to create inflation, and the market can often help by making the claim a self-fulfilling prophecy. Similarly for worse, inflation hawks can be cooled by the setting of a reasonable level of inflation target.

The latter of the two is important as the Federal Reserve will eventually have to perform a tricky dismount of these current monetary policies. They have undoubtedly increased the monetary base in shocking amounts. Much of this has been done with relatively normal operations using Treasury security repo's, but much of it has been done with alternative monetary policies. This has been done to combat liquidity trap conditions, but as those conditions ease, longer term inflation problems will start. The Fed has a large amount of sub-prime mortgages and it is unclear whether, even now, that there is a market for those assets. The point being that many of the assets that the Fed purchased might not be incredibly easy to sell.

John B. Taylor has talked about crisis policies of the Fed being unprecedented and that there is a need for a clear exit strategy. This is due to the fact that if or when inflation does creep above the target, all of the old devilish aspects of relatively high inflation will creep back into society. The chief of those being: increases in the cost of capital to the user. I recently wrote an article in praise of Chairman Bernanke, and I stand by that post, but to be clear... the most tricky part for Bernanke's Fed is still to come.

References:

Blanchard, Olivier and Giovanni Dell'Ariccia and Paolo Mauro. "Rethinking Macroeconomic Policy." Washington DC: IMF. 2010.

Working Paper.

Cohen, Darrel, Kevin Hassett, and R. Glenn Hubbard. ED: Martin Feldstein. The Costs and Benefits of Price Stability. "Inflation

and the User Cost of Capital: Does Inflation Still Matter?" Chicago: University of Chicago Press. NBER Conference Report.

1999. Print.

Krugman, Paul. "Two Percent is Not Enough." The New York Times. New York: New York Times Publishing. 1/26/12. Web.

http://krugman.blogs.nytimes.com/2012/01/26/two-percent-is-not-enough/

McCallum, Bennett. "Should Central Banks Raise Their Inflation Targets? Some Relevant Issues." Economic Quarterly.

Richmond: Federal Reserve Bank of Richmond. Vol. 97, No. 2. 2011. Journal.

Schmitt-Grohe, Stephanie and Martin Uribe. "The Optimal Rate of Inflation." 2010. Working Paper.

Taylor, John B. ED: John B. Taylor. The Road Ahead for the Fed. "The Need for a Clear and Credible Exit Strategy." Stanford:

Hoover Institution Press. 2009. Print.

Federal Open Market Committee. "Press Release." Washington DC: Federal Reserve System. 1/25/12. Web.

http://www.federalreserve.gov/newsevents/press/monetary/20120125c.htm

New Semester, New Speakers!

2012-01-29T19:40:00.005-05:00

The new semester means that there are a new round of speakers in the Washington D.C. metropolitan area. Highlights include Andrei Shleifer of Harvard University, Tyler Cowen of George Mason University, Nassim Taleb of New York University Polytechnic Institute, and David Card of the University of California - Berkeley. Jonathan Levin of Stanford University and Ben Bernanke of the Federal Reserve Board will also be giving lectures, but those might be tricky to get into as Bernanke's is part of a class at George Washington University and Jonathan Levin's is part of the Caroll Round at Georgetown University.

Here is the full list. If you would like to add an event, please send me an email here.

Hero Worship: Simon Kuznets

2012-01-27T22:39:00.002-05:00

Economics is a bit like a religion. It is often centered around cult of personalities. The individual is often promoted as much as the idea that is actually useful, and that individual becomes a bit of a demi god. I am as guilty (or more) of this as anyone, and this is my forum for presenting my heroes.

Simon Kuznets is one of the giants of economics. He was given one of the first Nobel Prizes in economics, and is best regarded as the economist who helped the U.S. Department of Commerce develop the measure of national income, the Gross National Product. Unlike other giants of twentieth century economics, Kuznets is not even close to a household name. He did not write books to attract a popular following, but rather technical books to be read by fellow economists and interested lay people.

I own two books by Simon Kuznets, and they are important parts of my collection. In Population, Capital, and Growth, He adds another nail in the coffin of Thomas Malthus's Essay on Population by pointing out that "the assumption of the inability of human knowledge and technology to cope with the constraints imposed by the scarcity of natural resources" has been proven wrong. He also takes on Marxist and Classical thinkers viewed scarcity of land, diminishing returns created the iron law of wages. In this sense, he has something in common with Julian Simon, who later became famous for predicting that human knowledge would be the variable that would solve population and resource issues, although I'm not certain that Kuznets would agree with Simon line for line.

To Kuznets, population growth and the limited availability of resources are central topics in economics despite these false starts based on the labor theory of value. He places great importance on capital being available for individuals to use in order for their productivity to rise to levels where they are not wasteful of natural resources. This suggests that efficiency has capital requirements, or that it is not an accident. To this, he points to the work of Theodore Schultz and Gary Becker on the subject of human capital. The idea that education is a critical element that fosters technology, innovation and greater efficiency. The higher the level of education, the more efficient a society is, and then the less resources they need to satisfy the same number of wants (and greater).

Much of Kuznets work have become truisms in economic literature, but at the time they were written they were groundbreaking and somewhat controversial. Perhaps his most seminal paper, "Economic Growth and Income Inequality" is when he introduced the Kuznets curve. Kuznets is an important figure for all economists, but especially for anyone studying development economics. Both, Population, Capital, and Growth and Economic Change are available inexpensively on the used book market.

What to do When You're in a Liquidity Trap?

2012-01-23T07:32:00.005-05:00

These are trying times in macroeconomy. There have been several ways of dealing with severe drops in output. The first is to lower interest rates, which creates the potential for a liquidity trap after they're lowered to zero. At that point, we enter the liquidity trap and our knowledge of monetary economics becomes wholly incomplete. There have been several ways that have been proposed to deal with this problem, and all of them deserve review.

A liquidity trap is defined specifically as the point when bonds and cash become perfect substitutes and traditional monetary policy is no longer effective. The metaphor that economists use for this situation is that central bankers are "pushing on a string." These are the situations that cause catastrophic recessions.

The chart above shows the liquidity trap situation in an IS-LM chart. Important things to note are that at the point of equilibrium, the LM's slope is flat (indicating the issues surrounding the lower boundary) and equilibrium is to the left of 'full employment' level GDP.

The liquidity trap is a phenomenon of monetary policy. While the liquidity trap is a somewhat rare situation, it has become a major problem in the past few years for several major economies including the United States. There has been quite a bit written about this phenomenom in the past ten years starting with essays confronting Japan's economic malaise.

Japan was one of the countries that people described as an 'economic miracle' much like Germany in the same era or China and India in the 2000's. In the early 1990's, they began having a prolonged economic downturn that never returned to robust growth (yet). The chart above includes Japan's annual growth rate. It mostly describes growth around 0-1% with several downturns in 1994, 1998, 2002, and a particularly severe one in 2009.

This chart shows the base borrowing rate that the Bank of Japan uses to affect the economy. It has been very low for a very long time. During 2002 and 2009, we can observe liquidity trap, or near liquidity trap conditions. In 2001, the Bank of Japan pursued a novel alternative monetary policy called Quantitative Easing." The purpose of this program was to quickly inject more money into the economy under the zero limit boundary conditions. Current Governor of the Bank of Japan, Masaaki Shirakawa writes about the experience in a working paper, "One Year Under Quantitative Easing." Some issues that he brings up in the paper are that hoisting up asset prices becomes an act of fiscal policy rather than monetary policy, and that this lends itself to the debate on whether fiscal policy is helpful at all in stimulating an economy.

In the 2008 financial crisis and 2009 global recession, many countries were confronted with a similar situation. Pronounced contractions while central bank interest rates are already low. Many countries quickly found themselves in liquidity trap situations. The ways that they addressed these issues varied. Lars Svennson was deputy governor of the Riksbank in Sweden, and had already written extensively on such a scenario. He was most famous for being a proponent of inflation targeting, but also for "The Zero Bound in an Open Economy: A Foolproof Way of Escaping from a Liquidity Trap."

Svennson advocated announcing upward sloping short term price levels coupled with small long term inflation targets. Then announcing that the currency would be devalued and that the exchange rate would be pegged. The Central Bank would make a commitment to buy and sell as much currency as they need to maintain the peg. Once that short term price level target is reached, then the peg is abandoned.

When Sweden found itself in a liquidity trap, Svennson did something that most monetary economists said was impossible. The Sveriges Riksbank became the first central bank to announce negative interest rates.

There have not been any academic papers about the Swedish experience yet, but it can be said that Sweden had the most growth (nearing 8% one quarter) of any European country coming out of the recession in 2010. At first glance, it is was successful policy.

The chart above shows that the United States has had several episodes of near zero interest rates. During the "Great Depression" of the 1930's, interest rates were very low. These were also the times that John Maynard Keynes originally advocated for activist monetary policies, and even fiscal policies when those were ineffective. He did not use the term liquidity trap, but The General Theory of Employment, Interest, and Money is basically written from that perspective.

In 1961, the Federal Reserve adopted "Operation Twist" during a period of low interest rates (not zero), as an alternative monetary policy to stimulate the economy. Now, we have been confronted with near zero interest rates since 2009. The general economy has recovered to modest growth, but unemployment has remained high due to structural changes in our economy.

This high rate of unemployment has led to a general sentiment that even though we are technically not in a recession, it still feels like recession-like conditions. It harks back to the old expression that a recession is when your neighbor loses his job and a depression is when you lose yours. Jobs play a critical part in any economy, and the current jobless recovery has left many Americans dissatisfied with economic policymakers' results. Above shows that drastic uptick in unemployment, accompanied with relative price stability. It shows that we did have a period of pronounced deflation despite the fact that the Federal Reserve cut rates, and pursued several rounds of Quantitative Easing. The United States also engaged in fiscal stimulus.

CONCLUSION

We still do not have a great idea of how to tackle the liquidity trap. The typical policies of fiscal stimulus, and alternative monetary policies have (for the most part) been lackluster. The liquidity trap is one of the most difficult and vexing situations in economics and deserves much more study. Another issue that confronts policy makers is a large part of economics blames monetary policy for the problem in the first place and are wholly dissatisfied with the remedies. One fact that they point to is the enormous growth in the monetary base and central bank assets. They point to this as a sign of coming hyperinflation. This makes it difficult for policy makers to pursuade the public that the inflation that they are pursuing is managable and desirable, rather than a prelude to hyperinflation. There is also the problem of the lower boundary. Bennett McCallum predicts that this might not be zero, but it likely still does exist, so there are still issues there even if it is not quite zero.

It is very possible that Europe may be facing this situation very soon, and perhaps other countries such as the United States would follow in that case. For that reason, this will remain a critical issue to study in 2012.

REFERENCES:

Krugman, Paul. "IS-LMentary" The New York Times. 10-9-11. Web.

Krugman, Paul, Kenneth Rogoff, and Kathryn Dominquez. "It's Baaack: Japan's Slump and the return of the Liquidity Trap."
     Washington DC: Brookings Papers on Economic Activity. Vol. ? No. 2. 1998. Journal.
McCallum, Bennett. "Theoretical Analysis Regarding a Zero Lower Bound on Nominal Interest Rates." Boston: NBER. 2000.
     Working Paper.
Shirakawa, Masaaki. "One Year Under 'Quantitative Easing'." Tokyo: Bank of Japan. No. E3. 2002. Working Paper.
Svennson, Lars E. "Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others." The Journal of Economic
     Perspectives. Vol. 17, No. 4. Journal.
The Federal Reserve System Purposes and Functions. Washington D.C.: Board of Governors of the Federal Reserve. 2002.
     Print.

This article is based on a presentation by Joseph Ward, Hares Fakoor, and Olivia Gonzalez for an intermediate macroeconomics course.

Too Late for Greece?

2012-01-17T05:00:00.002-05:00

S&P downgraded a number of the Euro-zone nations last Friday, including France, Austria, Italy, Spain, Portugal, and others. They did this writing, "The outcomes from the E.U. summit on Dec. 9, 2011, and subsequent statements from policymakers, lead us to believe that the agreement reached has not produced a breakthrough of sufficient size and scope to fully address the Euro-zone's financial problems." They go on to assess the recent European Central Bank monetary policy actions as "instrumental in averting a collapse of market confidence."

Athens (photo: Steve Swayne)

Additionally, S&P's managing director Moritz Kraemer told Bloomberg, "Greece will default very shortly. Whether there will be a solution at the end of the current rocky negotiations I cannot say." Adding, "There is a lot of brinkmanship on and a disorderly default will have ramifications on other countries but I believe policymakers will want to avoid that ... The game is still on."

Kraemer is calling the Greek default based on European Union (E.U.) plans to force current Greek debt holders to "roll over" Greek debt into new debt instruments such as EFSF bonds (which was also downgraded from AAA to AA+). "Even the debt exchange, by our definition, is a default. It's a distressed exchange." The ratings agency, Fitch has also indicated that it believes that would be a default as well. The Wall Street Journal is setting a date on the potential default as March 20, 2012. Apparently Greece has an especially large amount of debt to repay that day, and they do not currently have the money, so they will either need another large bail out or a rollover program in place.

There seems to be an enormous decoupling of Greek debt from the primary market, which has had small interest rate increases and the secondary market, which has seen interest rates rise quickly. The secondary market is seeing Greek government one year bond spike to as high as 415%. Greece has stopped offering one year debt, but their 26 week debt interest rates went for significantly less, 4.9% at their last auction last Tuesday. This decoupling suggests the large extent to which the E.U. is bailing out Greece, and that few other institutions are joining them in loaning to Greece.

(chart via Bloomberg)

The run up in the secondary market also happened after this rollover plan was announced. Details of this plan have not been finalized, and this is what S&P and Fitch are saying will constitute a default when it occurs. The ECB is saying that it will still accept Greek debt as collateral if even only one of the three major ratings agencies does not declare Greece in default.

This comes on the heels of success for the E.C.B.'s fine tuning program, which drove down yields last week on Greek debt (slightly), and Italian debt. I have to worry if this program, as fine suited as it is for putting out the flames of this crisis, is too little too late for Greece (and then perhaps for the rest of Greece if contagion overwhelms). If contagion and crisis does spread from either a Greek default or a Greek exit from the Euro... one has to place a large amount of blame on the ECB (under Jean-Claude Trichet) for not starting their fine tuning earlier, and attempting to target it towards Greece which has seen a significant shrinking of their M2 all year.

Greece is auctioning off more 13 week debt today.

Crisis Averted?

2012-01-12T16:58:00.002-05:00

It would be premature to say that Europe is out of this mess, but they are certainly heading in the right direction. Italy and Spain had successful debt auctions this week. Spain issued €10 billion, twice what was expected, and Italy issued €8.5 billion. Both countries saw yields decrease significantly which will lower the borrowing costs of these distressed governments. At the moment it appears that the European Central Bank (ECB) has provided adequate liquidity both for European banks, and the sovereign debt market through their fine tuning operations.

Rome (photo: Russell Yarwood)

Last month, I speculated whether the ECB would avert a crisis through their fine tuning program. This is why I and many other economists and financial analysts have been paying close attention to the Italian debt auctions this week. The early indications look as though the ECB's fine tuning has (at least) been somewhat effective. Italian 1 year securities fell to 2.735%, down 53% from their auction yields last month. This provides much needed breathing space for Europe.

I had called this crisis an "avoidable catastrophe" because there really was not any real reason that Europe had to endure a catastrophic break up of the currency or bankruptcy of some of their major states. The main problem in Europe has been political, and the barriers to solving the problem have been exacerbated by the complexity of Europe's current governing structure. European member states have significant structural issues relating to my of their governments' size relative to their economy's size. Germany, France and others have demanded that governments such as Greece and Italy undergo austerity, a step that is likely necessary in the long run, but crushing these fragile economies now. Europe has also entertained the idea of creating Euro-bonds and other elements of fiscal unity, but steps this important are difficult to do in the middle of a crisis. If the European Union is to be continued, fiscal unity is likely necessary, but those decisions should be made without the threat of a depression hanging over politicians' and voters' heads.

Today, the ECB also decided to keep its main rate at 1%. I would lower them further as much of Europe is now in a recession, but they've been doing this longer than I have. Reserve requirements for European banks will be lowered from 2% to 1% starting on January 18th in accordance with last month's ECB measures to support bank lending and there will be another equally strong dose of fine tuning still to come in March.

This is not over, but these are crucial positive steps from the brink of a serious and long term economic depression. Let's hope that Europe continues along this path!

2012 Italian Debt Watch Begins

2012-01-10T15:39:00.000-05:00

Italy's Dipartimento del Tesoro will be making the first debt offering of 2012 on Thursday, January 12, 2012. They will offer 3 month and 12 month securities to replace ones that become mature on January 16th. This will be another test of the European Central Bank's latest 'fine tuning,' which I wrote about last month. Hopefully their lending will allow banks to strengthen themselves through arbitrage and hold down Italian, Greek, and other yields so that their governments can function.

Here is a link to their 2012 auction calendar. The general public cannot participate in the auctions, but it might give you a better idea about some key dates for Italy's financial future.

Economists are Used to Arguments... but Protests?

2012-01-08T08:34:00.006-05:00

aThe 2012 American Economic Association Meeting is happening this weekend in Chicago. For those of you that went, I'm very jealous. I've tried to console myself with writing an essay (on Atlas Shrugged, of all things) and all the accompanying reading that goes with that. But really, I'd much rather be listening to Peter Diamond and Daron Acemoglu. One of my professors, Mark Klee, was a discussant at one of the meetings on "Analyzing Occupational Licensing Across Institution Settings."

So, I'm happy that he got that opportunity. I can't imagine what an honor or how daunting it would be to speak at one of those events. Normally you would simply have to worry about another economist asking some ridiculously difficult question about an aspect of your subject that you hadn't thought of... but this year there was also a call to Occupy the AEA! It looks as though that protest has mostly boiled down to a counter conference called the People's Economic Conference.

Rather than protesting these proceedings, I would recommend some of the papers being discussed at the conference simply based on their titles and what I know about the goals of the "Occupy" movement.

"Fiscal Policy, Growth and Income Distrobution in the UK"
"The Keys to Financial Success Curriculum: Impact on Personal Finance Behaviors"
"Seeking Alpha: Excess Risk Taking and Competition for Managerial Talent"
"Trust and Investment Management: The Effects of Manager Trustworthiness on Hedge Fund Investments
"The Influence of Exotic Mortgages in the Housing Price Bubble"
"The Role of Home Equity Lending in the Recent Mortgage Crisis"
"Do We Want to Subsidize the Losers' Mortgages? Stabilization Policy in an Age of Righteous Outrage"
"Utilizing Rawls' Theory of Justice and Law of the Peoples to Oppose Friedman's Doctrine of the Social Responsibility of the Firm"
"How People Work Together: Precis of a New Introduction to Economics, with Implications for the Social Responsibility of Business"
"The Effects of Early Intervention on Human Development and Social Outcomes"

and many more!!!

The Increasingly Transparent Federal Reserve

2012-01-04T10:33:00.003-05:00

The Federal Reserve has become significantly more transparent in the past few years. Amid appeals from Congress and the public to "audit the Fed," they posted to their homepage, that they get audited by the Government Accountability Office. Chairman Bernanke has even recently started giving press conferences and this week they announced that they would release their Federal Funds Rate forecasts. They announced it from the minutes from the December F.O.M.C. meeting. This has been a pet project of Chairman Bernanke for some time, he gave a speech in 2010 on the subject. To many, this might come as an obvious positive step, but I'm left scratching my head a bit. I'm thinking... how is this going to help and how might it harm the pursuit of monetary policy?

(photo: MeDill News Service)

There are two issues in monetary policy that relate to this, and they are (as most things in monetary policy) opposing relationship to one another. The first issue is central bank credibility. It could be said that the Federal Reserve's reputation as a Central Bank has suffered in the past few years (rightly or wrongly) in the eyes of the general public. In this sense their credibility has gone down. Most monetary economists, not the Austrian school (of course), give high marks for the job that they have done.

The second issue is information asymmetry. Not many people write about it (perhaps because it is elementary Keynesian economics, but perhaps not), but nominal price changes waxing over real price changes is a product of not much more than an enormous information asymmetry problem with regard to fiduciary media (money). Robert Barro was (maybe) the first to write about it in his article "Rational Expectations and the Role of Monetary Policy." (gated) I'm writing about the issue as a potential moral dilemma in "The Morality of Monetary Policy" (forthcoming). The root of this idea is a purely Keynesian one, "Whilst workers will usually resist a reduction of money-wages, it is not their practice to withdraw their labor whenever there is a rise in the price of wage-goods. It is sometimes said that it would be illogical for labor to resist a reduction of money-wages, but not to resist a reduction of real wages." (Keynes, The General Theory of Employment, Interest and Money, 9) This demonstrates what has come to be known as wage rigidity, an example of sticky prices.

So, if information asymmetry is essential for nominal changes in prices to affect positive changes in output, then why is Bernanke's Fed reducing it? I think that is because of rational expectations. Rational expectations involve what the public thinks the future value of money will be. Typically, expectations are formed from the average of the past few quarters price movements (inflationary or deflationary). This is why monetary economists are interested in trend inflation, because we think that we are measuring expectations. There can be deviations from this when the consumer has information that runs strongly counter to this. Also, inflation can deviate from this when it begins to escalate take on a momentum of its own.

Keeping expectations within trend inflation is easy for a central bank with a good reputation, but not easy for one that does not. Bernanke's moves towards transparency likely show that he is interested in promoting the Central Bank as credible, and promoting the effects of shrinking the money supply as soon as he can or sooner.

This is likely a good move, as long as he understands that when or if the Fed needs to expand the money supply again... they likely will need to increase information asymmetry rather than decrease it. So if Bernanke is using this as a tool to promote Fed actions to curb inflation when inflation becomes more of a problem, I'm all for it. If he's planning to be more transparent generally... we'll have to see how it impacts the implementation of monetary policy.

One last thing to note is the stark comparison for how the Bernanke Fed uses information to transmit monetary policy and affect behavior versus the way that every other Fed administration has. Obviously they've been much more vocal and transparent. One could compare if the public has been more sensitive and responsive to changes in the money supply when they are expecting it and understand the reasoning better or when it just occurs without comment. I think this would be an good research project.

Top Economists of 2011

2012-01-01T08:00:00.040-05:00

Comparing economists is a bit like comparing apples and oranges. There is so much diversity in the topics that they approach, and different approaches that they take. Still, it can be quite fun even if ultimately meaningless.

I started entering all the living economists names that I could think of into Google Trends to see who is the most searched for name at Google in 2011. I think it's an interesting addition to the ways of ranking economists because it shows searches and general awareness. Here are the results:

Paul Krugman (photo: Cory Doctorow)

rank. name, affiliation (relative percent to top score, ranking last year)

1.   Paul Krugman, Princeton University (100%, 1)
2.   Manmohan Singh, India (85%, 2)
3.   Mario Draghi, European Central Bank (60%, NR)
4.   Ben Bernanke, Federal Reserve Board (46%, 3)
5.   Amartya Sen, Harvard University (34%, 4)

6. Gloria Arroyo (30%, 16)
7. Alan Greenspan (26%, 5)

7.   Nouriel Roubini, New York University (26%, 7)
9.   Robert Reich, University of California - Berkeley (24%, NR)
9.   Thomas Sowell, Hoover Institute (24%, 6)
9.   Joseph Stiglitz, Columbia University (24%, 8)
9.   Walter Williams, George Mason University (24%, 9)
13. Mario Monti, Italy (20%, NR)
14. Justin Lin, World Bank (18%, 10)
14. Lawrence Summers, Harvard University (18%, 30)
16. Simon Johnson, M.I.T. (16%, 12)
16. Jeffrey Sachs, Columbia University (16%, 12)
18. Robert Lucas, University of Chicago (14%, 30)
19. Peter Diamond, M.I.T. (12%, 20)
19. David Friedman, Santa Clara University (12%, NR)
19. Mervyn King, Bank of England (12%, 12)
19. Robert Merton, M.I.T. (12%, 16)

23. Brad DeLong, University of California, Berkeley (10%, 12)

23. Robert Shiller, Yale University (10%, 16)
25. Gary Becker, University of Chicago (8%, 20)

25. Tyler Cowen, George Mason University (8%, 20)
25. Steven Levitt, University of Chicago (8%, 26)
25. Greg Mankiw, Harvard University (8%, 16)
29. Elinor Ostrom, Indiana University / Arizona State University (6%, 20)
29. Michael Spence, Hoover Institute (6%, 30)

A number of economists were withdrawn because they were not their top Google search. The best example of this is John B. Taylor of Stanford University who also shares the same name with a former NFL player and a member of rock group Duran Duran. Others include, Robert Hall, Robert Lawrence, Peter Phillips, James Hamilton, Kevin Murphy, and James Robinson.

EDIT: As a commenter noticed, Robert Merton is now at M.I.T. and I switched that. I appreciate everyone adding new economists that I did not think of, this can be considered my selection bias. I'll leave them in the comments this year, but I will make sure to include them in my calculations next year. Please keep them coming.

Will the ECB's 'fine tuning' Avert a Crisis?

2011-12-23T12:40:00.002-05:00

The European Central Bank (ECB) just offered their first of two "fine tuning operations." These seem like the opposite of fine tuning, because the first is one of the largest loan operations in ECB history. They loaned 640 billion euros to banks at 1% for three years. The second fine tuning operation will take place March 22, 2012.

Mario Draghi (photo: Daniel Fallenstein)

This comes after ECB President Mario Draghi had announced that he wouldn't be purchasing sovereign debt to hold down the interest rates. The ECB was criticized for this stance, and comparisons to Nero playing his fiddle while Rome burned were made. Part of this might be a misunderstanding. One important thing to note is that the ECB does not work exactly like the Fed.

When the Fed wants to increase the money supply, they enter into repurchase agreements with banks involving short term Treasury securities. When they want to make longer term monetary policy decisions, they purchase the securities or bonds outright. So, the Fed doesn't buy U.S. debt directly from the U.S. government but it allows for them to have influence over the U.S. bond interest rate and prices in addition to providing liquidity to the banks and the economy at large which is the ultimate goal.

The ECB operates slightly differently. When they want to make monetary policy decisions, they loan directly to one of their member banks. That loan might be short or longer term, depending on the policy goals. So their influence on sovereign debt interest rates is much more indirect.

This action by the ECB is the first credible step that they have made to stabilize this crisis. For one thing it directly injects much needed liquidity into the economy. If banks purchase sovereign debt, it could push down yields and provide much needed breathing room for Greece, Italy, Portugal, Spain, etc. Of course, they don't have to... and in the days following these loans, the yields for Italian bonds which have really become the weather vane for Europe, have not gone down.

This might mean that one of the key differences between the ECB and the Fed, might be a critical problem for Eurozone countries suffering through this debt crisis. This "fine tuning" is a positive first step towards stabilizing the Eurozone, but if interest rates do not fall, the ECB should consider modifying their loan program in March towards a more Fed-like system.

Ask A Future Economist

2011-12-22T09:51:00.002-05:00

A lot of people love to talk about politics and economics. When people find out that I'm an economics student, they like to ask me questions about the state of the economy, where it's going, or some episode in the past. Here's one that I was asked recently (paraphrased from memory):

"Can America ever be less dependent on China for its products? Obviously, a lot of imports come from China. Can we trade less and begin businesses on our soil to be less dependent of others to create the products in the stores?"

My answer was:

"We are not dependent on China for its products. We trade with China because China is a good source of cheap labor. We also trade with many nations around the world for similar reasons. As skills, productivity, and incomes rise in China, they will progress along what many refer to as the Kuznets curve, where the vast inequality of their population will begin to even out more. The equilibrium pay for their median worker will rise and they will be less competitive. This feature will only add to the competitiveness of domestic manufacturers, or more likely, other international manufacturers. So the real answer to the question is that we are not dependent on China, but rather we want products from them and we are happy to take them as cheaply as we are getting them now."

Send any questions you have for the Future Economist here.

The KLF - "Chill Out"

Why is Regulation so Common?

2011-12-18T23:02:00.000-05:00

The United States has many regulations both on a state level and at the national level. I recently wrote that one way to give tax cuts to businesses without diminishing government tax revenues and therefore increasing the debt was to diminish regulatory taxes. Most of the groundbreaking literature (Stiglitz & Posner) on the economic effects of government regulation comes from a post-hoc point of view. Andrei Shleifer wonders, in his forthcoming (February 2012) book, The Failure of Judges and the Rise of Regulators, why do we have so many regulations?

The M.I.T. Press describes it: "Government regulation is ubiquitous today in rich and middle-income countries - present in areas that range from work-place conditions to food processing to school curricula - although standard economic theories predict that it should be rather uncommon. In this book, Andrei Schleifer argues that the ubiquity of regulation can be explained not so much by the failure of markets as by the failure of courts to solve contract and tort disputes cheaply, predictably and impartially. When courts are expensive, unpredictable, and biased, the public will seek alternatives to dispute resolution. The form this alternative has taken throughout the world is regulation."

This book is based on several papers that he has written over the years. Here is one that he wrote in 2001 with Edward Glaeser titled, "The Rise of the Regulatory State."

Andrei Shleifer is an economics professor at Harvard University. He is most known for his work on law and finance. He gained some notoriety during a scandal involving USAID, Harvard, and programs to transition Russia to capitalism during the 1990's. This recent work on the origins and reasoning behind the current regulatory situation in the U.S. and around the world seems like important additions to the study of regulatory economics.

With Central Bankers Like These...

2011-12-12T20:12:00.000-05:00

Greek Monetary Situation

The Greek money supply has dropped 13% from December of last year to last October. It begs the question: what has the European Central Bank done to help this situation?

On April 13th 2011 they raised key interest rates 25 basis points, and on July 13th they did it again. In November, and last week they lowered them 25 basis points so they are back to the same level that they started out with at this time last year, 1%. In the meantime, Greece has lost 13% of its monetary base. Greece's economy has been enormously harmed by the European Central Bank who took measures that were perhaps reasonable for the Eurozone as a whole, but terrible for Greece.

These statistics are all before news organisations began reporting bank runs in Greece last month.

New Nobel Laureates in Sweden

2011-12-10T16:09:00.002-05:00

Thomas Sargent and Christopher Sims were announced as winners of the Sveriges Riksbank Prize in Economic Sciences in the Memory of Alfred Nobel. They won for their "empirical research for cause and effect in the macroeconomy." The announcement was made last October, as usual, but they are being awarded today with the Nobel laureates in Stockholm.

Christopher Sims and Thomas Sargent at the U.S. Embassy in Sweden

Christopher Sims' main contribution is a statistical technique known as vector autoregressions, which he first outlined in his often cited essay, "Macro-economics and Reality". Thomas Sargent is known as one of the most important monetary economists of his generation and a key figure within the rational expectations movement. His most often cited article is "Some Unpleasant Monetarist Arithmatic".

They are both top notch economists and deserve to be applauded for their contributions to the field.

(note: image contains two photos of Sargent and Sims, taken by embassy staff)

The Avoidable Catastrophe

2011-12-09T17:04:00.082-05:00

European Union leaders concluded their latest summit, with their usual small solutions to enormous problems. Here is a link to their release, detailing their new agreement. They have decided to offer up more funds for member state bond market stabilization and redoubling their efforts at austerity, which has only exacerbated this problem thus far (including a ridiculous tax on countries that go over the 3% rule). They still have Italy contributing 17% and Spain 11% of the EFSF funds, which sounds ridiculous given the fact that they are currently mired in severe deficits and Italy is already paying high interest rates to service its debt. The only good thing to come out of this summit was that nobody has left the Euro (yet).

During the summit, fears and rumors led to multinational corporations reportedly moving their money from countries rumoured to be exiting the Euro to presumed safe countries. That also probably compounded the bank runs problem in Greece.

Despite markets being up Friday, these problems will likely continue as none of the them have really been solved. This means that none of the uncertainties that have created deflationary conditions in southern Europe will go away, and the economic conditions will continue to deteriorate.

European leaders signing the Treaty of Rome in 1957

Speculation of this variety does not help, but for countries that could be forced out or leave the Euro, this could amount to an economic catastrophe. Their country will likely be almost immediately bankrupt unless Eurozone countries agree to continue bailout loans, or a bailout fund through the IMF. It is hard to imagine that their currency will have any reputation as a store of value. Their central banks will have little in the way of credibility to create monetary policy. This will leave these countries in something like a liquidity trap because any monetary policy they try to employ will have little effect. Deflation will be immediate and substantial, and it will be difficult to turn that around towards inflation or GDP growth.

A liquidity trap is defined as the point that monetary policy is no longer effective because bonds and money are perfect substitutes. This situation is slightly different, because there will likely be so little demand for bonds, coupled with little central bank credibility that they will not be able to hold down interest rates to stimulate the economy in a meaningful way. This means that monetary policy will be an ineffective tool to stimulate the economy. Similarly, these countries will likely not have full sales of their bond offerings, and will have to cut government expenses even more significantly. GDP will almost assuredly nosedive. This should be classified as something worse than a liquidity trap because it will be a situation where neither monetary nor fiscal stimulus will be possible.

IS-LM in a Liquidity Trap (Krugman)

What would be left of the Eurozone will not be spared from a significant contraction. Mark Cliffe of ING speculates that the new currencies would plunge. His white paper speculates on a full break up of the Euro, but similar movements would be felt from select countries exits. Similarly, northern European countries will inevitably feel the effects of the severe economic contractions of southern European countries in the form of contractions of their own. These contractions could last a year in the case of northern Europe and years of severe contraction for southern economies.

The only possible heroes are the European leaders, but it looks as though they are still not truly believing in their own shared destiny. The main villain can easily be viewed as the European Central Bank (ECB). Their strong currency position has strained the growth of southern European countries, and even this Spring, they raised rates because of inflation fears. Thursday, they cut rates, but at a paltry .25%; when Greece, Spain and Italy were literally having capital streaming out of their banks, economy, and even geography. Much of this agreement seems to be stressing an increased ECB role, but hard to imagine them doing what is necessary to help southern economic conditions. They will be acting as the operating agent of the EFSF and ESM funds to purchase sovereign debt. Hopefully they will be more active in that pursuit, than they have in monetary policies.

Solution:

I would argue that there is still time and opportunity to avoid this recession. I think the best solution is to pool credit risk. An agency such as the European Stability Mechanism or the European Financial Stabilization Mechanism or another more robust agency could purchase all the debt of all member nations, and in turn issue Euro bonds. The Eurozone, in total, has a debt to GDP ratio of 85%, which is below the United States and within an acceptable range. The Euro as a currency has and would continue to have significant transaction demand, and the ECB would continue to have legitimacy and credibility for creating monetary policy.

Creating a true fiscal union (as opposed to the current proposal which merely acts as an enforcement agency of the 3% rule) would also be important to insure that this does not become a repeated problem, and (of course) to pay down the Eurobonds, and pool more government expenses. These two solutions (Eurobonds and fiscal union) might cause Eurozone nations to rethink whether they actually want to remain in the currency. It is hard to imagine EU members that have not adopted the Euro join this arrangement which would leave countries like the U.K. and Sweden out. For that reason, I think secondary treaties such as a greater European community (but explicitly non-EU) would be important for keeping important commercial and economic ties, while being excluded from a federal system and unified currency and bonds.

It does not look like enough European leaders are interested in this arrangement. I think we are still staring at a difficult situation in Europe that hasn't really been solved. If conditions continue to deteriorate, European leaders will be forced to hold another summit, and who knows how much longer bond markets are going to tolerate these half-steps. They're barely tolerating it now!

If countries leave the Euro, France and Germany will instead likely be somewhat forced to bail out banks that will be overexposed to southern European debt or too weak to withstand this recession (Commerzbank, which is trading at an awfully low price of € 1.37 might be the first) or face a more severe recession of their own. Southern Europe will be have negative economic growth for years. It should be considered a failure of leadership that Europe was not able to find a way towards this solution over the past year and a half.

Another Way to Cut Taxes

2011-12-05T16:41:00.006-05:00

In the current economic climate, policy makers have dual fears of raising taxes, and cutting government spending for fear of corresponding changes in GDP. At the same time, policy makers are concerned about large and growing national debt totals. Clearly, both all of these are important priorities and somewhat in conflict with one another. This is where reducing regulatory taxes can provide an important third way to promote growth even as the federal government begins reconciling deficits.

Philip Howard of Common Good recently wrote a terrific op-ed in the Wall Street Journal. “How to Overhaul Regulation” is a very interesting take on what substantive regulatory reform could look like. He identifies the key underlying problems inherent within most modern American regulations: their complexity and their universality. Regulation overhauls should be seen as an incredible opportunity for the federal government to effectively offer businesses tax breaks without affecting government income. Government income would likely increase due to increased efficiency and corresponding general reductions in price levels.

Regulations, at their best, help solve market problems. These problems might ensure that producers are not damaging shared resources, or if they are that they are, these damages do not become externalities. That is, that the producer is the one who pays for damages, and prices those damages into their products for consumers to ultimately pay.

All regulations add costs for firms. The first cost is that of information. Understanding a regulation’s impact on an individual firm must be borne out before substantial investments are made. When information costs are high (as they are when regulations become complex), they become a substantial burden on firms. Large firms are able to employ economies of scale to minimize these costs, but small firms are not. This is why small firms are dramatically more impacted by this feature. Howard’s idea of regulating small firms differently is an important idea. Laws are meant to be evenly applied throughout society, but when regulations that come from those laws are universally used, they affect firms disproportionately. Then they become unfair to small firms.

Heavily regulated industries can become dominated by large firms as smaller competitors drop out. These regulations act as barriers to entry which reduces competition and causes consumers to be harmed twice by this regulation. First the consumer is harmed by the regulatory costs, which are ultimately passed on to the consumer. Then the consumer is harmed by decreased competition and potential monopolistic market conditions.

As Howard describes, “Regulators try to imagine every possible mistake and then dictate a solution. The complexity is astounding.” Regulations should be observed from an information economics perspective. One way that the federal government could help American firms is by estimating how much time it would take a lawyer or an ordinary business person to read and implement a regulation. Departments could issue guidelines about what an appropriate range of time for agencies to target, as these should be considered costs for the businesses and as they pass these costs on, consumers. The reduction in information costs could be seen as a very real tax cut for American businesses and therefore consumers. Regulations have often been seen in economics as taxes because they incur costs and are compulsory. (Posner)

The Obama administration has made regulatory changes including simplifications, especially through the Office of Information and Regulatory Affairs. President Obama has made this a priority through Executive Order “Improving Regulations and Regulatory Review.” This is an important mandate by the President at a time when American market flexibility is needed to meet increasing strong competition from global trade.

The order stresses that agencies "facilitate the periodic review of existing significant regulations, agencies shall consider how best to promote retrospective analysis of rules that may be outmoded, ineffective, insufficient, or excessively burdensome, and to modify, streamline, expand, or repeal them in accordance with what has been learned."

As stated earlier, regulations are useful to correct market failures or behaviors in which completely free markets produce inefficient results. Many or most regulations are also more complex than they need be to resolve these inefficient results. Many regulations also inject rules that do not solve market inefficiency, but rather add to it (perhaps where it didn't exist in the first place). As President Obama pointed out in his executive order, analysing which regulations promote market efficiency, and which aspects merely add to the billable hours of compliance lawyers should be a regular activity in the federal government.

Regulatory tax cuts could be used in concert with either real tax increases or reductions in government services to moderate their impacts on GDP. The purpose of this would be to attempt deficit reconciliation during a weak economy. Hopefully 2011 will be a year of regulatory tax cuts for American firms that could become more efficient and therefore more competitive.

References

Dudley, Susan. "Prospects for Regulatory Reform in 2011." Washington D.C.: George Washington University.
April 5, 2011. Working Paper.
Howard, Philip K. “Starting Over With Regulation.” The Wall Street Journal. New York: Dow Jones &

Co. 3. December 2011. Newspaper.

Posner, Richard. “Taxation by Regulation,” The Bell Journal of Economics and Management Science.

Santa Monica: The Rand Corporation. Vol. 2, No. 1. Spring 1971. Journal.

Exec. Order No. 13563. (January 18, 2011)

The Currency of Collectable Signatures

2011-11-27T19:33:00.000-05:00

Collectable signatures are fascinating to me because they seem to have almost magical properties to them similar to government legal tender laws. By this I mean that they create value where there would be none otherwise. Dollar bills are practically worthless in terms of materials, and a one dollar bill cost as much to create as a one hundred dollar bill. What makes a dollar valuable is that it is legal tender of the United States of America, which is the largest economy in the world.

Similarly, most autographs are not on anything that is particularly valuable. They are often on slips of paper, letters, books, or sometimes memorabilia. The second that their signature is written onto the item though, the item becomes more valuable. Its value is based on natural properties of supply and demand, and in the case where a signature is especially rare (George Washington) or especially in demand (Mickey Mantle), the price can be especially high. It strikes me that we all have signatures, but celebrities have autographs. These autographs have transformative effects on the items which they adorn. This also makes the author, if still alive, a bit like a money press.

Current asking prices for famous autographs include $599.00 for President Franklin Roosevelt, $450.00 for Dr. Milton Friedman, $35,750 for President George Washington, £49.99 for former Prime Minister Tony Blair, $500.00 for athlete Michael Jordan, $400.00 for athlete Mickey Mantle, and $49.99 for musician Gene Simmons (to name a few).

These prices fluctuate with public interest, and based on how often the celebrities' signature is available in markets. Some celebrities are signing constantly, such as a popular author, politician, athlete, actor, or musician, and others can be very infrequent signers.

This makes the behavior of autograph hounding more understandable. Autograph hounding is the active pursuit of celebrities for the purposes of acquiring their signatures. Many autograph hounds use children as fronts for what is essentially a business operation. Many celebrities sign in social or public situations freely, but others are more guarded.

(warning: profane language)

The video above shows musician Ted Nugent demanding money for his autograph. Celebrities demanding money for their autograph is also very common, and many memorabilia fairs feature former athletes signing for a fee. Many celebrities also use autograph signing sessions as a method of promotion for their books, albums, and artwork.

Signature collecting used to be a common hobby in the United States. Individuals would collect signatures from famous celebrities and friends alike. Setting out guest books at ones' home was another common way of collecting signatures that was quite common in the recent past. To a certain extent, it is still practiced.

This is a film titled "The Autograph Hound" from 1939 starring Disney character Donald Duck.

Celebrities must be sensitive to the factors of supply and demand if they want to maintain a stable and relatively high price for their autograph. This is why many celebrities do not sign autographs very often, and sometimes leave relatives with caches of signed materials with instructions about how to release them into the public. A famous story relating to that practice is with the death of Joe DiMaggio. DiMaggio was an individual who was able to charge many dollars for his signature, because he limited the supply. Before he died he signed many baseball bats, and left them to his family so that they could have an income from selling them after he died.

Please let me know if there is an aspect that I've neglected about the economics of collectable signatures in the comments!

Color Me Impressed: Hyun Song Shin

2011-11-23T15:01:00.005-05:00

As a student, being blown away by new information is a more common experience than for most individuals. This is the purpose of my series "Color Me Impressed." An economist who just amazes me so much with their writing that I can't help but share.

Dr. Hyun Song Shin is a Professor at Princeton University. He has just exploded with amazing articles on financial and monetary economics. Some titles include, "Carry Trades, Monetary Policy and Speculative Dynamics," "Monetary Cycles, Financial Cycles, and the Business Cycle," and "Leveraged Losses: Lessons from the Mortgage Market Meltdown," to name a few.

Just this past month, he gave a speech at the International Monetary Fund. The speech was titled, "Global Banking Glut and Risk Premium." He seems to take the topic of the global recession, which is one that has been tackled by almost every economist, and give an entirely new spin.

I can't say that I've completely absorbed this, but I am so impressed because he seems to be observing international finance and monetary policies on a more sophisticated level than I have seen previously.

George Soros and Economics

2011-11-20T22:34:00.005-05:00

George Soros is one of the more polarizing figures in the world. He has backed pro-democracy movements throughout the world, and other politically aimed organizations primarily through his Open Society Institute. Because of his political support, he has been criticized severely and has been made the subject of many conspiracy theories. Glenn Beck and other American right wing pundits have especially made pointed remarks about George Soros.

One of the paradoxes of American right wing distaste for Soros is how much Soros' philosophy is similar to theirs. Soros has been a lifelong capitalist and promoter of free societies. He studied philosophy at the London School of Economics under Karl Popper. Popper made an enormous impact on Soros and his book, The Open Society and its Enemies. In some aspects, Soros is a classical liberal, but he clearly has different ideas about the role of government than typical Austrian economists and philosophers.

George Soros (photo: World Economic Forum)

One of George Soros ideas that has gained little, if any, traction is his Theory of Reflexivity. For economics, this is an enormous idea that if it were accepted, would be as revolutionary as marginalism. The idea for reflexivity is grounded in logic rather than mathematics, but it seeks to replace the equilibrium as central point of analysis for economics.

Soros writes that "there is a two way interaction between the participants' thinking and the situation in which they participate. One the one hand, participants seek to understand reality ( f ); on the other, they seek to bring about a desired outcome ( φ ). The two functions work in opposite directions: in the cognitive function reality is the given; in the participating function, the participants' understanding is the constant. The two functions can interfere with each other by rendering what is supposed to be given, contingent."

His set of equations looked like this:

f (x) = y ,

φ (y) = x .

Soros criticizes the concept of equilibrium as being illogical because it attempts to use a dependent variable to influence a respondent variable when the dependent variable is also a respondent variable. Soros admits that this is a bit of circular logic, an aspect which he calls a feedback loop.

Soros gives several stock and currency market examples of his theory in action in his book, The Alchemy of Finance. He criticizes the concept of economic equilibrium and attempts to shake it to its core, but he does not replace it with any robust mathematical concepts, instead merely simple logic and life experience. Surely, all of us find the concept of equilibrium to be very abstract when applied to our daily lives, because equilibriums are not always intended for real life. They are models based on assumptions to help us understand difficult but widely observed truths like the relationship between supply and demand. In real life, we often depart from these concepts on the individual scale, and it is often not until we reach populations that noticeable trends emerge.

The concept of perfect information is used to make our supply and demand lines straight rather than a blur of individual dots that trend in those lines. Similarly, on supply demand graphs with equilibriums, we generally use static time, which is not realistic either. Transactions are constant and as Soros describes, the market's actions affect the market's information about future actions. He is correct that there not actually any constant variables and that everything is actually respondent.

Soros actually borrows this idea from his mentor Karl Popper who wrote about it in, The Poverty of Historicism. Popper defines it as "the influence of the prediction upon the predicted event," which he was using to refute what he called historical prophecy. Popper is such a famous philosopher, and one that the progressive movement has not warmed to. Like the flip side of a coin, Soros is probably an even more famous currency trader and philanthropist, and one that classically liberal and conservative movements have not warmed to either. Yet the connections between Soros and Popper are very strong.

While many have accused George Soros of various conspiracies, most of these accusations are rather groundless. He would like to replace the concept of equilibrium with the theory of reflexivity, while it may not be a sinister conspiracy involving dark alley ways and secret handshakes, it is something. It seems to me that his main argument against it is that it is static, but it is measuring elements which are dependent upon one another and are never actually static. He would prefer a different, reflexive point which would be dynamic and more realistic. G.L.S. Shackle writes of this issue in economics, "We cannot, then, regard the 'present moment,' or the moment-in-being, as strictly a still platform from which the 'rest of time' can be surveyed."

Many others have written about how future events or our expectations affect our decision making and even that a certain awareness of our own impact could enter into these rational expectations. These writings do not scrap the notion of equilibrium, and nor would I. I do not think that Soros' theories have risen to level of rewriting our understanding of economics, but that does not necessarily mean that they are not worthwhile ideas either. For a more detailed, mathematical understanding of reflexivity, read the paper by C.P. Kwong, or read it in its original form in The Alchemy of Finance.

REFERENCES:

Kwong, C.P. "Mathematical Analysis of Soros' Theory of Reflexivity." Cornell University. 2008. Web.
Popper, Karl. The Poverty of Historicism. London: Routledge & Kegan Hall. 1957. Print.
Shackle, G.L.S. Time in Economics. Amsterdam: North Holland Publishing. 1957. Print.
Soros, George. The Alchemy of Finance. Hoboken, NJ: John Wiley & Sons. 2003. Print. (originally published in 1987)