Knowing and Making

Many of you will have noticed Paul Krugman's continuing demands for a bigger fiscal stimulus - he thinks it should be around double the size proposed by the administration. If nothing else, we have to give him credit for being consistent, right? Well...maybe not. You see, I came across an old article where he was, as usual, insisting that the stimulus should be doubled...but only to $600 billion! A double-take. Could it ever be true that the administration was proposing only a $300 billion stimulus? Yes it could - in fact in the early days of the election campaign Obama's proposal was for a stimulus of $60 billion . No wonder Paul originally supported Hillary. I thought it would be interesting to run a comparison of Paul Krugman's desired stimulus versus the stimulus proposed (and eventually passed) by the Obama administration. Here it is (click on the graph for a larger version). The red line is the administration's efforts and the blue is what Paul wants: The red lin...

Generally it's a fallacy to suggest that governments should act like ordinary people in managing their debts. Governments have a responsibility to consider the effects on the rest of the economy - whether in economic stimulus, or the effect on long-term interest rates of an increased debt burden, or the fact that they create a destination for excess desired savings. So does this apply to the financing of aircraft carriers which Robert Peston reports today? As Peston says, the government appears to be acting like a cash-constrained household - deferring payments now and accepting that they'll have to pay more in the future. This may be perfectly logical for households - if they need to buy a car that they can't afford, the value to them of having access to the car may exceed the extra payments, especially if it helps people get to work and earn more money. But for governments there are different ways of borrowing money. The way Peston presents this it looks like vendor fina...

I was curious to notice that the UK's aircraft carrier contracts have been allowed to overrun their budget by around 25% . This seems to be a common phenomenon in public sector contracts - but should it be? Why aren't the contracts signed at a fixed cost with the private sector allowed to take the risk? This is a common question in my own field of software development. There are traditionally two ways you can approach a contract - with a third variation now emerging which might solve some of the traditional conflicts between client and supplier. The old-fashioned approach - which I believe is still used in many military contracts - is that the supplier bills on a time and materials basis. This reduces the risk for the supplier and places it all on the client. This may well be appropriate if the client is responsible for specification and design - if that is the case, the supplier might not be able to estimate the timescale accurately enough, and many overruns are caused either ...

This is a word cloud from all economics blog postings in the last week. I generate this every Sunday so please subscribe using the links on the right if you'd like to be notified each time it is published. It has been constructed from a list of economics RSS feeds from the Palgrave Econolog and other sources, and uses Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data. You can also see the Java version in the Wordle gallery . The millionth Wordle is coming up in about a week, so look out for that. If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch. Special this week : Guest appearance from Virgilio Anderson .

The Royal Mail is caught in the middle of a collision between its past and its future. Decisions made in the past have led to a £10 billion pension fund deficit. Other decisions - whether by the board or by the Post Office's regulators - have held its business model back from evolving in a world where communications technology is changing faster than any other. I don't know about you, but I send barely any letters nowadays; the occasional Mother's Day card and VAT return is about it. I pay bills online, send invoices by email and even our direct marketing is mostly by email. On the other hand, I probably receive more than I used to: Amazon and other online stores have enabled a combination of online ordering and delivery service to compete very powerfully with retailers. And the margins on these deliveries must, I suspect, be better than on ordinary letters - though there is much more competition. So the Royal Mail has two problems. Its past has created huge obligations, i...

As promised, a more detailed to Chris Dillow's posting Is behavioural economics wrong? Analysed in comparison with Age and time discounting from the Geary behavioural blog. The key factor to note in the research Chris posts (by Laurie Pounder ) is that it is based on a very different age cohort from most behavioural experiments. The subjects were aged between 53 and 73 because the author wanted to better understand the behaviour of those who contribute the majority of savings in the US economy - which happens to be that age group. As Chris mentions, the results show that people over -save compared to the theoretical prediction of the permanent income hypothesis (PIH). This hypothesis predicts that rational people will smooth their consumption over time according to their expected lifetime income - borrowing if their income is lower than the lifetime average, or saving if it's higher. The results, however, indicate that people save more and consume less than the theory predic...

Even though this blog's Technorati authority has gone down from 52 to 44 (I assume because some of our incoming links went past the six month limit), we have improved in the rankings - now into the top 100,000 blogs for the first time. Although thoroughly anecdotal, this fact might support Charles Arthur's theory that the long tail of blogging is dying . If there are fewer active blogs, the remaining ones will inevitably rise up the list. Have any other blog-owning readers noticed less competition out there?

There's lots of Bryan Caplan I don't agree with, but I can't deny he has some interesting ideas and a good way of thinking about them. The connection between growth and ideas is not so much logical as psychological. It is not logical for people to embrace counter-productive ideas just because conditions are getting worse, but they seem to do it anyway. This is from a paper on idea traps which is the concept that a society can get stuck in a sub-optimal equilibrium where the economic ideas that it runs on are flawed, but do not self-correct. My own experience of this is a paradox based in the economic situation in the UK right now. Logically, when there is low demand in an economy companies with a fixed cost base should spend more on sales and marketing. (This might not apply to firms which can easily scale down their costs - you can argue that the marginal return on sales spending is lower and therefore the optimal spend is less. But most companies are retaining most of th...

Too many people in recent weeks have concentrated on the differences between professional economists' thoughts about the recession and recovery. Are there green shoots? Is the economy still shrinking? Is it shrinking slower than it did? Is the rate of slowing of shrinkage increasing or decreasing? What does the historical record show, in contrast with the economic models of Keynes, Lucas or Krugman? Too much information! I think it's time for a survey of non-professionals. These are people out in the real world, after all - none of your ivory tower theorising from them. I'm going to start with the comments on today's Robert Peston blog , which give some real insight into the political and economic factors behind where we are today. Why do you think this great country is in this awful mess:- 1. Labour Government 2. Gordon Brown 3. Prime minister Peter Mandleson The only way we can start to even think about recovery is by getting rid of the above. The banks are waiting, b...

The Economist's underrated Free Exchange blog asks: Can behavioural economics save newspapers ? Of course the Economist itself is famous for designing a multi-product framing approach (see the first chapter of Dan Ariely's Predictably Irrational for details) which successfully biases customers to switch to a higher priced subscription. The phenomenon they describe is either a good example of price discrimination (a commenter suggests environmental benefits), or a clear instance of cognitive bias. Perhaps it's both. While you're visiting Free Exchange, they also link to Alex Tabarrok discussing QALYs . I went to a lecture by Tony Atkinson at the RSA last week which discussed this issue. The conversation there was about how to value health outcomes as a component of GDP (and by extension, government services in general - which in the US are valued at cost, but in Europe are valued by an output measure which is meant to estimate their value). One approach is to attempt t...

Robert Peston has an interesting insight into the financial regulation debate today: In other words, what's known as micro-prudential issues dovetail with macro-prudential issues. And if that's the case, it would make sense to put the central bank, the Bank of England, in charge of both. Or so the shadow chancellor believes. Intriguing. Indeed, it's true that there is a direct causal link between micro and macro behaviour in the financial markets. There are two reasons for this. First, the trivial one that all macro outcomes are ultimately caused by individual decisions. Second and more interestingly, one of the key influences on credit and asset markets is the appetite of individuals for risk. And a key factor in the stability of markets is whether these risk appetites are governed by rational preference theory and therefore have the ability to self-correct. In the long run everything (more or less) does correct itself, but an asset bubble and a financial crisis can easil...

Greg Mankiw wonders why he was kicked off a jury by one of the lawyers in a medical malpractice lawsuit. "Why does being a professor of economics at Harvard make one an undesirable juror in such a case?" he asks. I have another theory. Perhaps it was this quote from 2005 : Greg Mankiw, the administration's chief economist, noted in early December: "The president's economic agenda involves removing obstacles to growth. One such obstacle is the considerable burden placed on everyone by excessive lawsuits." Or this one from 2004 : The President's economic policies are precisely aimed at encouraging businesses to expand and create jobs in the United States. In addition to the tax cuts, he wants to reduce the burden of frivolous lawsuits, contain the growth of health costs... Lawyers have Google too, you know.

Tyler Cowen's thought-provoking analysis of national income accounting. From Cheap Talk (also via Tyler), Is behavioural economics doomed ? Linking to Cheap Talk rather than the original David Levine paper because there are a few interesting comments on that version. A piece by Christopher Caldwell (no relation) in the FT on addiction and Gene Heyman's book Addiction: A Disorder of Choice . I don't think I fully agree with his political/moral point but he has a couple of interesting notes on intertemporal optimisation and the serial nature of choice.

The BBC has reported that the chief executive of RBS, Stephen Hester, is about to be offered a new pay deal by the board . If one thing is predictable in life, it's the howls of outrage that will accompany the headline figure: £9.6 million. But the real figure is not £9.6 million - it's £1.2 million. Still a big salary, but on nothing like the same scale. The biggest chunk of the rest will be payable only if the share price of the bank hits 70p - double its current level and 40% up from the 50p at which the government originally invested - meaning that the taxpayer will have made an £8 billion profit on its RBS investment. So why is it being presented as a £9.6 million deal? Of course this might just be the BBC's spin. Perhaps they put together all the figures themselves and picked the highest figure, a natural thing for any reporter to do. But in fact it may be the bank who has decided to lead on this figure. If so, why would they do that? Surely they have an interest in k...

From Richard Serlin: It's far better for China to increase demand and net-imports through investment spending than consumption spending : ...increased government spending on high enough return investments (and there are plenty) can be maintained indefinitely even without tax increases (in rate) because the high returns over the long run allow the payoff of the government debt and much more While I'm certainly sympathetic to this argument in principle, it isn't proven by simple assertion. Serlin links to one of his previous articles via Mark Thoma , and outlines the argument: ...high social return projects that the free market won't undertake due to market imperfections that are well established and proven in economics...like externalities, asymmetric information, impracticalities of patenting, large economies of scale and monopoly issues, the zero marginal cost of information and ideas, the inability to price discriminate well, and many more. Again, this is the basis o...

This is a word cloud from all economics blog postings in the last week. I generate this every Sunday so please subscribe using the links on the right if you'd like to be notified each time it is published. It has been constructed from a list of economics RSS feeds from the Palgrave Econolog and other sources, and uses Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data. You can also see the Java version in the Wordle gallery . The millionth Wordle is coming up in about two weeks, so look out for that. If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch. Sorry : Last week's analysis never happened. I will include a summary in this week's analysis of the moves and trends coming soon. For now, I'll simply mention the following: 139 751...

I am looking forward to Tyler Cowen's new book, Create Your Own Economy , which sounds like a thought-provoking and very unusual approach to economics. But I didn't really want to pay US shipping fees or wait several days, so I clicked over to the UK version of Amazon to see its entry there . I was surprised to see that on the UK edition, he has acquired a new editor and illustrator...with very strange names: But I guess people have all sorts of odd names nowadays. So I thought I'd scroll down and find out a bit more about what the book covers. I'm afraid, however, that it may be a little too avant-garde for me. The product description is in some rather odd style of free verse. I am sure the book will be exciting but it's going to be tough going if this is any guide:

I'm on a continuous quest to apply behavioural modelling to macroeconomics, and I have some way to go before I complete a model that is credible, tractable and predictive. But what I can do is use behavioural finance research to explain a trait that Paul Krugman discusses in his blog posting today . Put simply, people feel losses much more keenly than they imagine gains. Ask a hundred people whether they'd work an hour to earn £10 and most of them will say no. But overcharge them £10 on their mobile phone bill and watch them sit on hold, fill out forms and argue with shop assistants for as long as it takes to get their money back. And there is something about fiscal deficits that just feels like a loss. Carrying billions of pounds of debt and knowing that your income tax will go up to pay for it is a very concrete concern. But the idea that without it, you will lose 10% of potential growth in your income, is much harder to get worked up about. You could make a legitimate argume...

As I start this posting, I have no idea what I'm going to write about. But surely there must be something? The guy has been so pilloried that his real attributes must surely be better than his public image. Goodwin has just agreed to give back a chunk of his pension , helping the government achieve its political objective, RBS get rid of a distraction, and Goodwin himself look at least a little better than before. But looking further back, surely there were people who thought he was good at his job in 2007? With so many executives hagiographed in the business press, he must have had his turn. So what can we dig up? Start with a Google search for " Fred Goodwin achieved ". Amazingly, there is only one link: someone defending him on the grounds that the cost of his pension was only a small fraction of RBS's losses , and that by performance-related pay standards he does better than the Bank of England. Similarly, " Fred Goodwin succeeded " returns nothing, and ...

A very good article from Matt Grist , countering the argument that all choices arise from a priori objective preferences, pointing out that choice in itself can shape behavioural capabilities. Chris Dillow asks: Is behavioural economics wrong ? (the answer is no but that's a subject for another posting) A funny post from missmarketcrash about gambling, gold, smoking and rats . And the odd link out: Justin Fox's article summarising his new book The Myth Of The Rational Market discusses the history of the idea of market (ir)rationality without once mentioning behavioural economics. Still, the following line made me think: "Joseph Stiglitz showed that a perfectly efficient market was impossible, because in such a market, nobody would have any incentive to gather the information needed to make markets efficient" While that's true in principle, it should not be hard to incorporate the cost of information gathering into a market model: then those who have a comparative...

28th July 2009 : Happy birthday to Virgilio Anderson. We hope that your serene Facebook nature will be restored to us soon. CRITICAL UPDATE : Virgilio Anderson has disappeared from Facebook. We are urgently investigating - more news later... Fans of Robert LePage and Richard Herring (there must be one of you out there) may enjoy The Virgilio Anderson Project , in which Herring attempts to steal Virgilio Anderson's identity in return for Anderson having taken his. His name on Facebook, that is. The real Richard Herring explains all on the page linked above. Please do not get the wrong idea from the imagery of the page - the moustache thing is an experiment...well, just read it, that is all explained too. Update 1 : Thanks to Virgilio I have had a good couple of hundred thousand people come to this page this week. So I think it's worth adding a little more content. Why don't you answer some of the questions posed by Richard in his column: Is Paul Sheppard the new Virgilio A...

Stephen Carter's Digital Britain report, published this afternoon, will propose that the licence fee be shared out among other broadcasters as well as the BBC. I guess the idea is to ensure a diversity of voices and that there is some competition within the public-funded media. But the BBC is already providing that on its own. Robert Peston today : perhaps the prime minister over-egged it this morning (surely not) when he wrote in the Times that "a fast internet connection is now seen by most of the public as an essential service, as indispensable as electricity, gas and water". And yet, what did one of his colleagues at the BBC write last week but: The Communications Consumer Panel, which advises Ofcom on broadband issues, recently conducted research among 2,000 people, both on and offline. It found that 73% described broadband as essential a utility as water or electricity. Now maybe Robert Peston does think that part of his role is to conduct a robust internal debate ...

This is a word cloud from all economics blog postings in the last week. I generate this every Sunday so please subscribe using the links on the right if you'd like to be notified each time it is published. It has been constructed from a list of economics RSS feeds from the Palgrave Econolog and other sources, and uses Wordle to generate the image, the ROME RSS reader to download the RSS feeds, and Java software from Inon to process the data. You can also see the Java version in the Wordle gallery . If anyone would like a copy of the underlying data used to generate these clouds, or if you would like to see a version with consistent colour and typeface to make week-to-week comparison easier, please get in touch. Update : Analysis of this week's moves later today.

West Bromwich Building Society has raised £185m of new capital using an innovative new shareholding structure. They were previously a mutual building society but the new move makes the company into a hybrid between mutual and private company. Does it matter? Economics would say not. The Modigliani-Miller theorem states that (given some assumptions) all forms of capital are equivalent to a company. But in this case, the following questions arise: There appear to be at least some costs to the firm in raising capital in this new way - at the very least, there will be political and possibly legal costs. The management needs to be able to defend its decision against some of its mutual owners who will object to the fact they now have private shareholders who will share in some of the profits. So why do these costs arise? Because there are costs, there must therefore be benefits to the new source of capital (otherwise the firm would not pursue it). What are these benefits? The answer to bot...

A commenter on Robert Peston's latest article asks: why can't we just treat banks and building societies like normal businesses? And Mark Thoma also links to a similar question from Joseph Stiglitz: are the banks too big to restructure ? First an answer to Robert's commenter: The most obvious difference between a bank or building society and a normal business is that the government guarantees the deposits of a bank. If this didn't happen, the depositors would be creditors like any other. But the other distinction, which I'll come to in a few paragraphs, is that banks are much more closely embedded in the operation of the rest of the economy than most other companies. If they were to be treated as a normal business, then the liquidators would come in and start to sell off their mortgage book (probably at a discount) and the creditors (bondholders, depositors and suppliers) would have to queue up to get back whatever they could from the proceeds. If there was anythin...