Sunday, May 24, 2009

In defense of deficit spending

Richard Lipsey (and James W Dean) defend in simple terms (easily understood by IB students of Higher and Standard Level Economics) the fiscal stimulus packages put together in the US and elsewhere and try to explain why conservative critics who claim that private spending will be crowded out or that these packages will prove inflationary may be wrong.

'The first is that spending will either be hurried and wasteful, or that it won’t come on stream until employment has recovered, and will therefore be inflationary.

The second is that deficit-financed government spending merely replaces spending by consumers and firms dollar for dollar; so-called 100 per cent ‘crowding out’. Critics often fail to point out that these two arguments cannot both be true. If government spending merely replaces private spending dollar for dollar, it does not affect total demand. As a result, it cannot be inflationary.

If “crowding out” is significantly less than 100 per cent, new spending will employ labour and capital that is now idle, and the earnings of workers and investors will re-ignite both consumer and investment spending. To be sure, stimulus programmes should target projects with productive potential. Economies from the US to China are in dire need of new physical and social infrastructure. But even “unproductive” projects are better than none at all if the alternative is to leave labour and capital unemployed.

And if stimulus spending for infrastructure comes into effect after the end of recession, when real resources and financial markets are re-employed, there are adequate monetary tools to contain such pressures. In other words, long-term plans for infrastructure planning can stand on their own merit.

So the key question is whether government spending that comes into action during recession is likely to crowd out new private spending, dollar for dollar. The answer depends on the extent to which real and financial resources are currently under-utilised.

“Real” crowding out occurs when labour and capital are already fully employed so that further spending exceeds capacity and leads to inflation. The logic of the harm done by inflation is well understood. But the logic of “financial” crowding out is less intuitive and more complex.

Simply put, financial crowding out results from rising interest rates when government deficits put pressure on bond markets. This kind of crowding out is most plausible in the US, which began the recession with the biggest deficit in world history. However, relative to national income, it is not nearly as large as that which Britain ran after the Napoleonic wars. And currently, the biggest as a percentage of national income is Japan’s: almost 200 per cent of its gross domestic product. It doesn’t seem to be crowding out private spending as the Japanese long-term interest rate is still only 1.5 per cent.

Nevertheless, skeptics argue that dramatic doubling of US deficits this year and beyond could leave little room for private sector borrowing. If the US deficit stifles rather than stimulates recovery of its private sector, prolonged worldwide recession is inevitable.'

The rest is here. BTW, Lipsey has written one of the all time best intro econ textbooks. A newer version is here.

The Crisis and How to Deal with It

This is great stuff to read for IB1 Economics students (higher and even standard level) who have just finished their macro. You'll see how different perspectives arise and I think you will be able to understand what makes sense and what pretty much is driven by ideology and wishful thinking.

'...excerpts from a symposium on the economic crisis presented by The New York Review of Books and PEN World Voices at the Metropolitan Museum of Art on April 30. The participants were former senator Bill Bradley, Niall Ferguson, Paul Krugman, Nouriel Roubini, George Soros, and Robin Wells, with Jeff Madrick as moderator'

Here is the link.

Saturday, May 16, 2009

Krugman on China and pollution

The article is titled 'Empire of Carbon'. What I realize is that the Stiglitz idea which I had mentioned in class (and which I even think is written in that little purple book) that the rest of the world imposes a tariff on the US to force it to do something for the climate is picked up by Krugman. He proposes 'shoppers who buy Chinese products should pay a “carbon tariff” that reflects the emissions associated with those goods’ production'.

The article is here.

PS: Just checked that little book and here is what is written in one of those 'tips' boxes':
An interesting solution proposed by Nobel laureate Joseph Stiglitz is to consider the firms of such nations (as the US) as recipients of state subsidies. Not paying the full costs of production is equivalent to receiving a state subsidy. Since subsidies within the WTO trade system are illegal, other nations would have the right to impose trade sanctions on these nations, forcing them to cooperate and reduce emissions.

Friday, May 15, 2009

Lunch or dinner anyone?

Hi dorks! (I'm addressing my Econ Higher level Candidates 2009 of 0346...)

Our Chicago boy had a very good idea: lunch or dinner together soon!

I'm in. Anyone else?



Monday, May 11, 2009

0 Days, 0 Hours, 0 Minutes

Now, that looks weird!

You were a great class, my little dorks!

I hope I helped you a little bit to understand some basic Econ.

I hope I helped you understand the importance of trust.

I hope we stay in touch.

My best,


Sunday, May 10, 2009

OMG, 15 hours left!

Show time, guys!

Wish you all the best!

Stay calm and focused, make the right choices, and do what you got to do as best as you can. Make sure you read your work before putting down your pen....

This guy did it - so can you!


Wednesday, May 6, 2009

Stand by me!

Hope all you May kids are doing alright!

This was sent to me by my friend Yiannis A. and it's well worth a 5 minutes break.

Saturday, May 2, 2009

Can People Distinguish Pâté from Dog Food?

Couldn't resist posting this one!

It's the title of an AMERICAN ASSOCIATION OF WINE ECONOMISTS working paper......

Considering the similarity of its ingredients, canned dog food could be a suitable and inexpensive substitute for pâté or processed blended meat products such as Spam or liverwurst. However, the social stigma associated with the human consumption of pet food makes an unbiased comparison challenging. To prevent bias, Newman's Own dog food was prepared with a food processor to have the texture and appearance of a liver mousse. In a double-blind test, subjects were presented with five unlabeled blended meat products, one of which was the prepared dog food. After ranking the samples on the basis of taste, subjects were challenged to identify which of the five was dog food. Although 72% of subjects ranked the dog food as the worst of the five samples in terms of taste (Newell and MacFarlane multiple comparison, P<0.05), subjects were not better than random at correctly identifying the dog food.
You can find the paper here.

A big thanks to Tyler Cowen and the Marginal Revolution.

On the demand and supply side effects of increasing personal income taxes

Pointers on another interesting short: discussing possible effects on the demand and the supply side of an economy of increasing personal income taxes.

(caveat: not a model answer; just some thoughts)

This is the question:
A government decides to raise personal income tax rates. Using diagrams, explain one possible demand side consequence and one possible supply side consequence of this decision.

Taxes are divided into direct and indirect where indirect are taxes on goods and on expenditures while direct are taxes on income. Personal income taxes are thus a type of direct taxation which may affect consumption decisions as well as the incentive to work. (serves as a short intro that sets the framework of the answer and helps keep you focused)

Consumption is defined as spending by households on durable and non-durable goods and services per period of time. It depends on the level of disposable income which refers to income minus direct taxes plus transfer payments (i.e. pensions and unemployment benefits; Yd = Y – T + Tr).

If personal taxes increase then disposable income will decrease and thus consumption expenditures will also decrease. Aggregate demand (total spending on domestic goods & services per period of time; AD C + I + G + NX) will decrease and in the diagram below shift from AD1 to AD2. This will decrease the level of national income from Y1 to Y2 (or, slow down growth) and also may lower any inflationary pressures in the economy.

In this sense, this increase in personal income taxes may be part of a con-tractionary fiscal policy that aims at decreasing inflationary pressures.
(this wraps up the demand side consequence)

The rest can be found at our wiki here.

Elasticities: an oldie but goodie

May 11 and 12 are approaching pretty fast! I hope you are calm and and cool. I haven't seen you for a while but I've had several emails (Alex, Fro, M-N and others) which clearly suggest what I already know. That you are a bright and able bunch and that you know what to do to defend your interests, academic and broader.

I'm adding on our wiki some ideas on an 'easy' long essay.

Long essays on price/ income and cross price elasticities are not that common but they are usually a piece of cake. So easy, that many candidates get confused or do not remember the issues as they never paid much attention to the topic while revising.

I decided to jot down some pointers on this old Higher Level long essay that has also been asked in Standard Level exams. These pointers can be found here at our wiki.

This is the essay:
a) Carefully explain what is it that price, income and cross elasticities of demand are meant to measure. (10)
(b) Discuss the practical importance of the concept of price elasticity of demand for
(i) business organizations
(ii) the government (15)

Hope these pointers help...

Keep on walking...