Showing posts from January, 2009

Martin Wolf in Davos

Robert Peston interviewed Martin Wolf in Davos (along with Roger Carr and Richard Lambert, but they needn't concern us at the moment; Lambert did display a useful clarity, requesting nothing but opening of the credit markets). Martin, as always, had some exciting things to say and said them in his unique way. My paraphrasing:
The UK is the most vulnerable economy in the G7 because the financial sector is so important, because the housing boom was so large and because household debt is sensationally high, and we are also highly dependent on the rest of the world which is suffering a recession too. And our underlying fiscal position related to these vulnerabilities is much worse than anyone thought 2 years ago.It's interesting that the fact of a recession is the problem - that is, a reduction in GDP, rather than the actual level of output or consumption. If the UK has benefited (as it undoubtedly has) from huge growth in the financial sector and housing-related investment over th…

Government stakes in private companies (again)

An update on my proposal (and Roger Farmer's) from the beginning of this month:
The Japanese government has proposed buying equity stakes in small to medium sized companies. Not via the central bank, but the (state-owned) Development Bank of Japan. The plan will be considered by the cabinet next month.

Iceland and Woolies

The most unusual juxtaposition of 'Iceland' and 'Woolies' in the news in recent months:
People in Iceland - a country currently in desperate economic trouble - have shipped jumpers and blankets to pensioners in England this week, to keep them warm in the winter.
A container of woolies arrived in the north-east of England after an appeal on an Icelandic radio station. They were handed to local charities in Hull on Thursday.
Definitely up there with Kerry Katona as amusing coincidences go.

Comparative growth and shrinkage

The IMF thinks that the UK economy will shrink by 2.8% in 2009 - the worst performance among "advanced nations". Quite an amusing locution, that. But, bad as it sounds, what does this performance actually mean?
We could look at it in one of two ways: A reversal of most of 2007's growth. Real growth in 2007 was approximately 3%, so this contraction would cancel most of it out. Not good, but if we had had just 0.1% growth for a couple of years rather than +3 and -2.8, would we feel differently about it?Cancelling out a quarter of the 'excess growth' of the last eight years. Long-run estimates of UK productivity growth are around 2%. GDP growth has averaged 2.7% between 1992 and 2008. Thus, we have benefited from an economy about 12% larger than it would have been under long-run conditions. If the price of this is to lose a quarter of this growth while the economy retrenches, then it was worth it.Naturally there are plenty of variables. Is long-run productivity growth…

The state of economic debate

A good writeup from Sloped Curve of some of the flaws in the debates taking place among leading economics bloggers.
It's followed by some suggestions about how to structure the US mortgage market which are not so compelling, but worth a read anyway. Maybe this is a good structure for an article - lead in with something that's interesting, even gossipy, to get the attention of the reader. Discussion of other bloggers always gets a few points. Then subtly insert your policy recommendation at the end. Bait and switch, I think it's called.

Address to a Haggis

Many people find it difficult to understand the more obscure words of Rabbie Burns's poems; leading scholars of Scots literature are still convinced that he made half of them up. His odes to the haggis and to the mouse are famously mellifluous but quite hard to translate.
So, in time for Burns night, I offer you this annotated guide to one of his classics, Address To A Haggis. It's not a literal interpretation, but Burns never intended this poem to be read literally. It's more than a metaphor - it is in fact, as will become clear, a prophesy.
Fair fa' your honest, sonsie face, Great chieftain o' the puddin-race! Aboon them a' ye tak your place, Painch, tripe, or thairm: Weel are ye wordy o' a grace As lang's my arm. What few people know of Burns is that, as a contemporary of Adam Smith, he was a keen amateur economist. And in this verse, the haggis represents not the meaty goodness of leftover pieces of sheep, but the British economy.
In the last line, Burns eve…

The endowment effect, willingness to trade and the scale of the US economy

Driving through the US it is slightly hard to believe that a place with such a vast and humming industrial economy could have a recession. But it's all relative, and it is entirely possible that the $60-70,000/head GDP of this region could decline by $2,000/head in a year or so.
I was provoked to wonder about how the US economy can sustain what appears to be a much higher level of consumption and infrastructure than the UK. On the surface there are no great insights or mysteries here - the US has more natural resources and space, therefore needs to spend fewer resources on working around those shortages; it spends proportionally less on public goods, and (arguably) its infrastructure is of lower quality - built quicker but also decaying faster. People work more hours and therefore create more resources (which are included in GDP), but spend less time on leisure (which isn't).
But I wonder to what extent this is not to do with explicitly differing preference, but with multiple eq…

Economics of UK-US trade

I would like to come up with a justification in economic theory for mentioning this, but so far I haven't. In reality I just want to complain that, on the week of my first visit to the US in seven years, the pound has fallen to its lowest level against the dollar since 1985.
Aside from the possibility that all 2 million of Tuesday's visitors to Washington came from Britain, exchanging billions of pounds into US currency on the same day, I don't think I can manufacture a connection. Just bad luck. Is there a macroeconomic theory for that?

Models of bounded rationality and the credit environment

I've had an article published today in VoxEU:Models of bounded rationality and the credit environment: Responses to the recession should not be based on unrealistic expectations of rational behaviour. We now know enough about real, flawed human psychology to be able to take some account of it in policy setting. Mark Thoma has linked to it and there are some interesting responses in the comments to his posting.

A beautiful day in Washington

Not so many posts this week as I am in Washington, DC.

Today was both a very moving and a spectacular day. Watching the inauguration from beside the Washington Monument, there were undoubtedly a few moments in the speech that the people around us found very special. My own favourites:

"Now, there are some who question the scale of our ambitions — who suggest that our system cannot tolerate too many big plans. Their memories are short. For they have forgotten what this country has already done; what free men and women can achieve when imagination is joined to common purpose, and necessity to courage."
"And so to all other peoples and governments who are watching today, from the grandest capitals to the small village where my father was born: know that America is a friend of each nation and every man, woman, and child who seeks a future of peace and dignity, and we are ready to lead once more."
"...because we have tasted the bitter swill of civil war and segregation…

Borrow, borrow, borrow

Just as we have been discussing levels of debt, Robert Peston informs us that the UK government will be guaranteeing billions of pounds more of corporate and consumer lending, starting tomorrow. This is somewhere between the US government's guarantees of Citigroup and Bank of America's debts, and a giant credit default swap (CDS). Quite clever, in that respect.
CDSs were a good business for lots of insurance companies for a long time, and now that the worst of the losses have probably been written off by banks already, they could be a good business again. CDSs do, I believe, increase economic efficiency by aggregating a portfolio of risks and allowing capital to flow to the most productive destination without being hampered by the "one bottle of poison" problem.
The state is by far the best provider of these services, because there is no counterparty risk, and because control is correlated with a positive return. That is, because the government has the ability to direc…

More debt please

While the amount of net debt across the world is always zero, the amount of gross debt is not. And gross debt has reduced substantially in the last year as firms and consumers are deleveraging.
An interesting post from Steve Waldman at Interfluidity praises this trend. I'm not convinced by his conclusion but he does contribute something rarely visible in economics commentary - a good philosophical understanding of what debt is.
"Credit, also known as debt, is one of several arrangements by which a party with the power to command resources but lacking aptitude or interest in managing a productive enterprise delegates wealth to another party who is capable of creating value but unable to command sufficient resources."
I would put it slightly more generally: Debt is a promise to give resources to another party in the future. On this view, the gross amount of debt in the world is a representation of the number of promises we have made to each other.
A promise is a restriction on…

Stimulus that employs the unemployed

On this blog, as well as on several others, there's a strand of opinion supporting fiscal stimulus aimed at investment rather than consumption. Of course investment, depending on the multiplier, leads to a certain amount of consumption anyway. But the argument is that direct government spending should be weighted towards investment, either because there is a deficiency of investment in this phase of most recessions; because there has been underinvestment in the last few years which needs to be made up; or because it's a more "responsible" way to spend public money.
A typical goal in designing an investment program is to create demand for things that can be provided by currently-unemployed people. This encourages unused resources (people) to be brought into use, so the stimulus gets an economic free lunch instead of diverting resources that are already economically productive.
The challenge is that people are unemployed typically because their skills are less useful in …

Mystery quotation

If art and associated attitudes are not to become pleasing-appearance ready-made goods, but a living, albeit perhaps fleeting, organism, art should be able to improve exactness of its message in the time allotted to it and thus, paradoxically, define itself in history. This improvement of exactness means that its individual, selectivesieve can cover the so-called objective sieve. Where their nodes do not coincide, ‘free space‘ opens. Energy of the free space is proportional to the power of sharing, or, more precisely, it is the sum of the freely pulsating words which, in this context and in each specific time, is able to define (tangle up) different meanings naturally through spontaneous intuition. These screen points are spatial holograms of historical memory, experience, and therefore each such new overlap becomes another non-linear tangle to the naked eye.

A prize to the first person who can guess where this comes from (or what it means) without Google.

Credit insurance trap for UK retailers

Robert Peston discusses the difficulties that retailers (or their suppliers) are having getting trade credit insurance.

Fundamentally, information asymmetry combined with efficient use of capital causes this problem. The reason suppliers want insurance is because the economy is shrinking and a (small but significant) percentage of retailers and wholesalers are going to go under. Even though the number is small (I'd estimate 3 to 5 per cent), the problem is that nobody knows which ones. Therefore unless suppliers stop trading altogether, they want to be covered for the risk.

I read a nice analogy recently: if someone gave you ten bottles of water and you knew one was poisoned, you probably wouldn't drink any of them. Even if you were really thirsty.

This combines with the (quite correct) desire of retailers to minimise the amount of working capital tied up in their supply chain in order to be price competitive and profitable. Therefore they extend payment terms to the degree that …

List of UK economics blogs

I haven't found a list of UK-based economics blogs out there, so I thought I'd make one. Alphabetical order by name of blog:
2UBH: low-volume blog on economics among other things. By Tim ChapmanAdam Smith Institute: highly free-market, not especially UK-focused subject matter but based in LondonAdam Smith's Lost Legacy: Free-market oriented economics blog written in Edinburgh, at the moment mainly providing commentary on other blogsAlex Singleton: Politics and economics within the Telegraph blogs stableBluematter: Interesting links to economic and political news, and occasionally some analysis tooBusiness Angel Blog: by charter, it's not about economics - but like many business blogs, it has crept recently into the more exciting territory of discussing the economic crisisCapital Chronicle: This isn't UK-based, but the author has some UK history and writes about British news frequently. The phrase "mustn't grumble" tips the balanceCautious Bull: though…

Rigour? In a blog?

Brad DeLong has an impressively clear (although, or perhaps because, a bit technical) piece on risk appetite and fundamental values of assets. I feel I should respond to it, but it's such a tour de force of clear and explicit assumptions, rigorous logic and thunderous conclusions that I feel I barely can.
I particularly loved this statement for pure bloody-minded literalism (that's a good thing, by the way): The fundamental values of asset prices are the money-metric values that the costate variables associated with the commodities would have in some reasonable utilitarian central-planning social-welfare-maximization exercise under reasonable utilitarian preferences. However, here is what comes to mind:
Given that asset prices rarely approach the values Brad ascribes to them, could this be because there is competition for the limited amount of savings capital available in the world? If I, as a productively investing business, want to get access to some of it, I probably need to pa…

Arbitrage by piracy

When the Sirius Star oil tanker was captured by pirates on 15 November, the crude oil price was around $55 a barrel.
It contains about 2 million barrels of oil, now worth $40 each, so its value has fallen from $110 million to $80 million in the intervening period. Thus, aside from the rumoured $3 million ransom payment, the owners have lost $30 million in value of the commodity - plus whatever it costs to borrow $80 million for two months (not much these days).
Yesterday, with oil getting close to its lowest point in a couple of years, the tanker was released.
What possible economic explanations are there for this behaviour? And what does it tell us about oil prices? The owners may expect that prices are going to fall further, and decided that now is the time to get their oil back and sell it. Therefore they were motivated to deal now rather than putting it off.The pirates may expect that prices are going to fall further, and decided that their likely ransom would diminish. Therefore they…

Behavioural causes

Just discovered a site I wasn't aware of before: Baseline Scenario. They have a nice summary of Daron Acemoglu's paper which has a focus on behavioural (mental/perceptual) reasons for the financial crisis.
I have written on this subject recently and will post a link to the paper here if and when it is published.

The solution to recession

The Professor brightened up again. 'The Emperor started the thing,' he said. 'He wanted to make everybody in Outland twice as rich as he was before — just to make the new Government popular. Only there wasn't nearly enough money in the Treasury to do it. So I suggested that he might do it by doubling the value of every coin and bank-note in Outland. It's the simplest thing possible. I wonder nobody ever thought of it before! And you never saw such universal joy. The shops are full from morning to night. Everybody's buying everything!'
– Lewis Carroll, "Sylvie and Bruno"
(from Futility Closet via TYWKIWDBI)

The stimulus - spend, invest or incentivise?

Hal Varian in the WSJ (via Mark Thoma and Marginal Revolution) has touched on a topic I have been thinking about for a while: how is the fiscal stimulus best spent? On consumption or investment?
There are essentially two tools available for the stimulus: tax cuts and government spending. And there are five main sources of demand in the economy: private consumption, private investment [optionally divided into business and residential investment], government consumption, government investment and exports. I am not going to address all ten combinations, but focus on private investment - should we promote it, and if so, which are the best tools to do so? I am a priori neutral between tax cuts and spending; tax cuts are good because they let people allocate spending by efficient private choice; spending can be good if it achieves public goods that are not best purchased in the marketplace.
My intuition, like Hal's, is that private investment is important. But is there a clear argument fo…

Lottery rollover - fewer players, bigger prizes? Bad maths

I was sceptical of a claim on Free Exchange today:"...if there is no winner the prize is carried over to the following week. A smaller participant pool can then result in infrequent, higher jackpots." This struck me intuitively as unlikely. So I thought I would work it out.
Probability theory has been unpopular among economists this year - everyone quotes Nicholas Taleb and slowly, loudly explains to us how the financial markets don't behave like a normal distribution after all, and we don't have enough historical data to give us a predictable distribution for the future. Insufferable.
Fortunately lottery draws do obey standard probabilities and we do have enough data (and enough theory) to predict how they will behave. So we can use some standard results.
Assume that a lottery has 10 million participants each paying $1, with a 50% payback. The prize fund in a typical week is $5 million. Let's say the odds of getting the right numbers are 1 in 14 million; then the ch…


Comment from "AAPrescott" on Justin Webb's blog:
"From a political point of view I like many of Tom Daschle's policies, but he does talk about 'evidence based medicine'.... As a practitioner of Chinese Medicine I have some unease about this"
I hope this says more about the commenter than it does about Chinese medicine.

More wrong science

The Telegraph thinks America produces enough electricity to power one lightbulb for every 30 citizens. Huh?
This article (about a powerful laser) says it produces " equivalent to 1,000 times the amount produced by America's national grid, or more than 10 billion times more than an ordinary household lightbulb."
A bit of simple arithmetic indicates that the national grid can power 10 million light bulbs. Which, with 300 million people, means it must be pretty dark most nights.
Actually, the laser has a power of 500 trillion watts - which means nearly 10 trillion 60-watt lightbulbs. But if you let loose on science stories journalists with no instinct for arithmetic...
The crucial question that goes unanswered by the article is, of course: will it create a black hole that could destroy the Earth? I say we should shut down all scientific research until we are sure.
As Brad DeLong might say: "Why, oh why, oh why..."

The "Buy American" clause

Greg Mankiw is not in favour of a "Buy American" clause in the expected US fiscal stimulus package.
I don't like protectionist rules myself, and normally you wouldn't find many economists arguing for them. But I have a feeling now that we might see support among some economists for variations of this "Buy American" rule. For example, a condition that spending can go only to countries that have also passed a major fiscal stimulus package.
This might just come from people feeling peeved at Germany. It might come from instinctive protectionists finding a respectable way to get their point across. It might come from strong Keynesians who are worried about the damage to the fiscal multiplier from propensity-to-import.
It may be unfair to him, but I predict that Paul Krugman may be a flagbearer for this argument. He has just won a Nobel Prize for his New Trade Theory work, which argued (among other things) that some protectionist policies might be justified if they …

Innovation, investment and patents

One of my long-term themes on this blog is knowledge work - how we measure the productivity or capital value of knowledge, and how it is converted into valuable outputs. And a recurring recent point has been investment, what it is and how we encourage it.
Combining these two is a posting from VoxEU from a few months ago: "Efficiency in the 'market for innovation'" by Alberto Galasso and Mark Schankerman. They claim that
"The 'market for innovation' - the licensing and sale of patents - is, for example, one of the principal incentives for firms to invest in R&D."
My instinct is that this is not true at all. Lots of companies that I work with invest in R&D, and virtually none have any patents. Admittedly I do not work with any large biotech or electronics manufacturers, so my anecdotal evidence is not necessarily representative. But I do believe that a lot of innovation goes on in the marketplace which is not captured in patent statistics.

Nick Rowe's response

Nick Rowe responds with some feedback on my posting:
Three thoughts on your variant of the proposal:
Remember the classical dichotomy, between nominal (measured in $) and real (measured in physical, or inflation-adjusted units), and the (long-run) neutrality of money. Monetary policy cannot determine any real variable in the long run. The attempt to do so would cause accelerating inflation or deflation. (The attempt to peg employment with a vertical LR Phillips Curve was one example of this). So REAL investment won't work as a target, but NOMINAL investment might.
It is VERY hard to measure investment (even gross investment, let alone net investment). Where do you draw the line between consumption and investment; current expenses and business investment? Human capital? Home improvements? Cars? It's also noisy, on a monthly basis. Somebody buys a big order of airplanes, and up it goes. (Depends on size of country, but a guy at the bank of Canada once told me that US is a big enoug…

Robert Solow's Nobel speech

It's hardly news - he got the prize in 1987 - but I was searching for something recently and came across this. It makes a pleasant read, and those interested in the economics of growth may enjoy reminding themselves of some of Solow's work in a lucid, nicely-written piece.

Private investment by central banks

Roger Farmer has taken up my suggestion that central banks should make equity investments. OK, chances are he didn't get it from me - but his proposal is somewhat similar to mine. I explain my suggestion in more detail below.

Farmer's article has provoked much comment on economics blogs – as befits an unorthodox proposal. Although there are understandable objections to it, it is at heart a sound idea.

Most of the responses which argue against the idea use one of two grounds. First, that equity price targeting is not the government’s job. Second, that market indices are not a good way to pick the equities to be purchased (Farmer’s suggestion of the S&P 500 index would privilege those 500 companies at the expense of smaller firms outside the index). For these reasons I would also argue against the proposal in the form that Farmer makes it, but recognise the fundamental reasoning behind it. With a slightly different emphasis, the logic becomes much more compelling.

The reason fo…