on deregulation

These days in class we are discussing supply side policies and we initialy discussed two ways of distinguishing them. One route is to make the distinction between interventionist and pro-market policies and another way is to divide them into policies that are commonly accepted and policies that are considered more controversial which, in my opinion at least, include the 'pro-market' set and industrial policiy.

In discussing 'deregulation' I mentioned that quite a few consider the US banking and financial deregulation of the 1980s as being to a significant extent responsible for the current crisis.

Today, I was reading in Project Syndicate a short article by Hector R. Torres, a former Executive Director of the IMF.

The whole article is of nterest but these paragraphs are especially interesting for us:

Let us now consider the second question – whether the Fund suffered from a mindset that blinded it to the causes of what was happening. As early as August 2005, Raghuram Rajan, the IMF’s Economic Counselor (chief economist) at the time, was warning of weaknesses in the US financial markets. Rajan saw that something potentially dangerous was happening, warning that competition forces were pushing financial markets “to flirt continuously with the limits of illiquidity” and concealing risks from investors in order to outperform competitors.

Perhaps most revealingly, though, Rajan nonetheless optimistically argued that “[d]eregulation has removed artificial barriers preventing entry of new firms, and has encouraged competition between products, institutions, markets, and jurisdictions.” In other words, he clearly believed that regulation created “artificial barriers,” and that “competition between jurisdictions” – that is, between regulators – was to be welcomed.

Such beliefs come naturally to those committed to the view that markets perform better without regulation, and Rajan’s statement is a good illustration of the IMF’s creed at the time. And it was this boundless faith in markets’ self-regulatory capacity that appears to be at the root of the Fund’s failure to find what it was not looking for.

Read the piece here.

revenue and profit maximization

Ideas on past IB Economics HL P2 questions on profit vs. revenue maximization can be found here at the IB Freeway.

A short on trade

If you are a May 2010 candidate and you are taking higher economics you should be comfortable with the analysis of a tariff.

These are 2 past IB questions relating to tariff analysis:

* How do tariffs affect economic welfare? (Short trade 3)

* Using an appropriate diagram, explain who gains and who loses from the introduction of a tariff (Short trade 34)

An analysis that may be considered useful can be found in my wikispace here. The usual warning: make sure you listen to your own teacher before adopting what I say to my students....

On Greece and the IMF

The situation in Greece as it is unfolding doesn't look that good but one positive side effect is that you guys ('you' in a very narrow sense i.e. my year 1 students) will, by the time you graduate next year, know much more about the IMF than most other candidates from our school since 1993...!

Here is the transcript of an interesting IMF press briefing on what is going on right now between Greece and the Fund. Easy reading and you get an idea about the process.


The October 2009 World Economic Outlook can be found here. Downloading and skimming over Chapter 2 may be a good idea. Some stuff will sound familiar (and, as we move along the syllabus, you will understand more and more) but even just looking at some figures and tables and trying to 'read' them and make sense out of them is a good idea.

IB May 2010 Exams - Economics

The May exams are approaching fast...

I had prepared this for my students and I think that it may be interesting (or, perhaps, even useful) to post here. The usual caveat: listen to your teacher and what he/she has to say before adopting someone else's approach.

Candidates are often asked to evaluate fiscal policy (in HP1 / SP1 or in HP3/SP2) so here are some thoughts:

Evaluating Fiscal Policy

Possible Strengths of Expansionary Fiscal Policy
* Fiscal policy is direct: any increase in government spending will automatically increase national income (Y) by at least as much, if not more
* If the government expenditure multiplier is greater than one (Christina Romer, the Chief Economist of Obama’s Council of Economic Advisors, estimates it at 1.6) then it is also a very powerful tool
* A decrease in taxes to reflate an economy (as part of an expansionary stimulus plan) may also have beneficial supply-side effects as lower taxes may improve the incentives to work and to invest
* In an economy in deep recession (or, depression) interest rates may be at or close to zero, so monetary policy is totally ineffective; in such a case policymakers have only fiscal policy to turn to
* If the institutional framework of the economy is equipped with unemployment benefits and a progressive income tax system then policymakers have the benefits of ‘built-in stabilizers’ (automatic stabilizers)
* If the increased government expenditures of a stimulus package include spending on infrastructure (roads, bridges, harbors, telecommunications etc i.e. physical capital typically financed by governments that create very significant positive externalities decreasing transaction costs across the board), health and education then a positive supply-side effect will also result
* If the increased government expenditures of a stimulus package include spending on the development of ‘green’ technologies then an additional long run benefit will be the improvement of the environment, permitting sustainable growth.

On the other hand (Possible Weaknesses of Fiscal Policy):
* The government expenditure multiplier may even be less than one as some economists claim (Robert Barro of Harvard, is one example)
* There are significant time lags associated with fiscal policy that may even end up destabilizing instead of stabilizing an economy
* Large deficit spending may increase national debt to unsustainable levels and may force significant tax increases in the future (so, in a sense the cost of such a policy is shifted on to future generations)
* There is also the chance that if the fiscal effect continues for longer than needed then inflationary pressures may arise
* There is always the possibility that the increased funding needs of a stimulus plan (remember the Government must borrow from the ‘loanable funds’ market to finance the deficit spending) may crowd-out private investment (and consumption) through a rise in interest rates or even directly (resource crowding-out)
* Also, fiscal policy suffers from an ‘expansionary bias’ because politicians often are irresponsible and prefer to spend more and tax less rather than spending less and taxing more as the former maximizes their short term re-election chances (Greece is now suffering from the ‘fiscal irresponsibility of governments of the last 30 years’….)

Lastly, contractionary fiscal policy to fight inflationary pressures is more difficult to employ compared to increasing interest rates (i.e. tight monetary policy).

On the size of the multiplier see Barro: ; for a more general discussion of the size of the multiplier read this.


Hope this helps.

PS: the word file that you can tweak can be found here at my wikispace as entry #9

Rogoff on the IMF and Greece

An interesting to read short article by Ken Rogoff:

...Now, the eurozone countries have agreed that the Fund can come into Greece and, presumably, Portugal, Spain, Italy, and Ireland, if needed.

and:

...To be fair, the Fund’s reputation for imposing austerity is mostly an illusion. Countries usually call in the IMF only when they have been jilted by international capital markets, and are faced with desperate tightening measures no matter where they turn. Countries turn to the Fund for help because it is typically a far softer touch than private markets.

and:

The stakes for the IMF in Europe are huge. It is not going to be an easy balancing act. If the Fund attaches tough “German-style” conditions to its loans, it risks provoking immediate confrontation and default. This is the last thing that it wants to do.

Read the article here.

Not bad!

Do Values Matter? (Complete)

Do Values Matter? (Complete)

... a little bit of Bono bashing, a little bit of Harrod - Domar and ....

....lots of evaluation of foreign aid!

A great, short, article (actually, a review by Bhagwati of a new book ) that is great for IB Economics 2010 candidates to read. Highly recommended.

Banned Aid: Why International Assistance Does Not Alleviate Poverty

Krugman in the New Yorker

(in the picture, Krugman and his wife, Robin Wells, at home with their cats, Doris Lessing and Albert Einstein...(!))

....In recent years Krugman has also spent a great deal of time distilling his views into an undergraduate textbook. When he first signed the contract to write it, in 1994, he did it mostly for the money. Then he did no work on it for years. Finally, his publisher told him that he had to get moving, that he should work with a co-author who was better organized and more highly motivated than he was, and suggested his wife. It took them five years of intense work to write the first edition.

“It’s excruciatingly hard,” Wells says.

“You have to put yourself back in the mind of an eighteen-year-old,” Krugman says. “And it has to be impeccable. If you’re writing an academic paper, if you have some stuff that’s blurrily written, that won’t do too much harm. If you write a newspaper article and a third of the readers don’t get it, that’s a success. But a textbook has to be perfect.”

Even though they were doing it mostly for the money, they knew that, for the students who read it, their textbook might be the only time in their lives that they were exposed to proper economic thinking, which of course would have an influence on their political thinking.

“The books we’re competing with tend to be much more rah-rah about the market,” Wells says. “That’s partly because that reflects the views of the author, but also because it’s easy to do it that way—you just find where the lines cross and everybody’s happy. It’s more difficult to talk about how markets fail.”

“The trend when we were putting the latest edition together was to have less and less about the business cycle, and we said, ‘No, this is wrong, the business-cycle sections are still important,’ ” Krugman says. “That turns out to have been a really good bet.”

“We were the only textbook that incorporated the financial crisis, as we were chronically late. We were supposed to have the manuscript delivered in August or September, and by October we were still working, and we just said, ‘We can’t send it out like this, too much is going on.’ We were really in nail-biting territory, because you have to get it to the printers by a certain date or you miss the academic year.”

“We were right in the middle of that when the Nobel Prize committee called, and Robin’s reaction was ‘We don’t have time for this!’ The stress of the week or so after the announcement was crazy, so we actually went off to St. Croix. We were working frantically.”

Fun reading about the life of a Nobel Prize guy. Click here.

Myths and facts about Greece and the current crisis

Prof. Charles Wyplosz, co-author of the most popular text "Macroeconomics: A European Text' which many of you (my students) may use in college (mostly those bound for UK schools), wrote these 'Myths and Facts" that will definitely enlighten you:

Myth 1: Greece is bankrupt. Countries cannot be bankrupt; their governments can only default on their debts. In the absence of internationally recognised resolution mechanisms, government defaults open up a messy situation as governments negotiate with their creditors.

Fact 1: There is no reason for the Greek government to default. It is not in its interest and it can service its debt, whose size is half that of the Japanese government and the same order of magnitude as that of many other governments, including soon the UK and the US (OECD 2010). Yet, markets can force the government to default if they refuse to refinance the parts of the debt that reach maturity. This is a pure case of self-fulfilling crisis.

Fact 2: This crisis started as a panic reaction to fears of default but, as usual, some market players now also bet on a default. The market reaction is both defensive and offensive.

Myth 2: Greece is being singled out because it cheated repeatedly. Reports of Greek data manipulation have occurred long before this crisis. The latest report was issued by the government elected in October 2009 while the risk premia have been large since October 2008.

Myth 3: The Greek government is particularly vulnerable because its debt is widely held internationally, in contrast with the Japanese debt. Crisis after crisis, post-mortem examinations reveal that residents act exactly like non-residents. They panic and speculate like all financiers do, independently of where they live and work.

Fact 3: The monetary union is an agreement to take monetary policy out of national sovereignty. Very explicitly the Treaties leave budgetary matters in national hands. There is no sense in which the current crisis is a “proof” that Europe has failed. The Greek (and Portugese, and Spanish…) debt situation is a Greek (and Portugese and Spanish…) problem.

Myth 4: This is a euro crisis, which could result in a breakup of the monetary union. There is no mechanism for transforming the debt crisis into a Eurozone breakup. No country can be forced out and it is in no country’s interest to leave (Eichengreen 2007). Had Greece not been part of the eurozone, it would have long undergone a major currency depreciation, like in Hungary in November 2008. The euro protects Greece.

Fact 4: A debt default by the Greek government, on its own, would be a non-event. Greece is a relatively small country (with 11 million people, its GDP amounts to less than 3% of Eurozone’s GDP). Contagion to Portugal, which is even smaller, would also be a non-event. Moving on to Spain and Italy is another matter.

Myth 5: Contagion, already under way, would be destructive. This statement is too vague. It cannot destroy the monetary union, as argued above. But contagion can bring the value of the euro down – but this would be mostly good news for the Eurozone as it is suffering from an overvalued exchange rate at a time of anaemic domestic demand.

Fact 5: The real worry is the banking system. Some European banks hold part of the Greek debt and, if still saddled with unrecognised losses from the subprime crisis, some might become bankrupt. Many governments have simply not pushed their banks to straighten up their accounts, and they are now discovering some of the unforeseen consequences of supervisory forbearance.

Myth 6: Other Eurozone governments should support the Greek government to avoid destructive contagion. I argued that contagion need not be destructive if banks can bear it, so the need for a collective bailout is not established. There is a huge moral hazard cost, on the other hand.

Fact 6: The Treaty strictly prohibits bailouts. Art. 100(2) states: “Where a Member State is in difficulties or is seriously threatened with severe difficulties caused by exceptional occurrences beyond its control, the Council may, acting unanimously on a proposal from the Commission, grant, under certain conditions, Community financial assistance to the Member State concerned. Where the severe difficulties are caused by natural disasters, the Council shall act by qualified majority.” This article has been written precisely to ban bailouts. Interpreting continuing fiscal indiscipline as “exceptional occurrences beyond its control” runs against the spirit of the Treaty. Violating the Treaty to rescue countries whose successive governments have made no effort to achieve fiscal discipline over the last decade (or longer) is indefensible.

Fact 7: If Greece, and other countries, needs support to refinance their public debts, they can and should call the IMF. In contrast to EU countries that have no instrument to impose debt discipline (the Stability Pact has failed over and again and is completely discredited by now), the IMF operates an effective conditionality machinery.

Myth 7: The IMF cannot intervene in this case because the euro is a shared currency; an IMF intervention would reduce the sovereignty of all Eurozone countries. This is a serious misunderstanding of what IMF routinely does. It deals with any financing problem, independently of currency difficulties. The IMF would impose conditions on fiscal policy, not on monetary policy. Besides, the Eurozone is not a member of IMF – it only has observer status – but individual countries are.

Fact 8: Greece, along with Spain, Portugal and Ireland suffer from a loss of competitiveness due to continuing higher inflation. This partly explains their widening current account deficits until the crisis. Yet, the budget deficits are unrelated to this evolution.

Myth 8: The loss of competitiveness is a threat to the monetary union that warrants collective support. It is true that the competitiveness situation represents a huge policy challenge but a bailout will not help and could well make matters worse if it means that unwarranted wage and price increases are supported by the rest of the Eurozone.

The remaining three can be found here.
(found at voxeu)

On Prof. Stiglitz once again

The new IB economics syllabus will include bits fom the economics of information literature which a owes vey much to Joseph Stiglitz.

As I mentioned in one of my sections a few days ago, the latest issue of the IMF magazine 'Finance and Development' has a very interesting and readable presentation of Stiglitz and his work that you should read.

Realizing Stiglitz’s potential, his professors encouraged him to leave Amherst after his third year and start graduate work elsewhere; they were nevertheless devastated to see him go. “Frankly, seeing Stiglitz leave is like watching the disappearance of one’s right arm,” one of them wrote. The Massachusetts Institute of Technology (MIT), however, was overjoyed to get him as a student. The institution’s admissions committee sent his information to the economics department and asked what the amount of his stipend should be, listing choices ranging from no stipend to $12,000. The professor assessing Stiglitz’s application scribbled on the folder: “Offer him Department Head’s salary.”

and,

A common theme in his papers is the difficulty in getting markets to function properly when information is costly to acquire or when the parties involved in a transaction are not equally informed.

In a 1981 paper with Andrew Weiss, Stiglitz gave a powerful demonstration of how credit markets could malfunction when this was the case. In the textbook model of credit markets, interest rates work to bring about balance between supply and demand; if there is too much demand for credit relative to supply, interest rates rise to cut off the demand of some of the borrowers. But what if lenders don’t know which of their borrowers will work hard at their projects and repay the loan and which are going to shirk and simply hope that good fortune will enable them to pay off the loan? If there is excess demand for credit, raising the interest rate discourages the hard-working borrowers but not those who are intending to take a gamble with the loan. So, far from restoring balance between supply and demand as in the textbook model, the rise in the interest rate actually ends up tilting the composition of borrowers toward the undesirable type. Nalebuff says the Stiglitz-Weiss paper shows that “who you end up lending money to or what they do with that loan changes with the interest rate you charge . . . . Or, as Groucho Marx might have said: ‘I wouldn’t want to lend money to anyone who would borrow at that interest rate.’ ” The Stiglitz-Weiss paper helped develop a more realistic description of credit markets by showing why lenders might engage in credit rationing (i.e., limit the volume of loans) rather than raise the interest rate. In other papers, Stiglitz showed that such information gaps could also plague labor markets. In the textbook model, the wage rate is the lever that eliminates unemployment by moving up or down as needed to balance out the demand and supply of labor. But, just as in the credit market, there are informational deficiencies. Employers often lack accurate information about which of their workers will give the proverbial 110 percent to their job and which are inclined to shirk. They could of course monitor their employees to determine who’s been working hard and who’s been merely saying so. But such monitoring is costly in terms of the employer’s time and can lower employee morale.

Employers, Stiglitz argued, are therefore likely to use the wage rate as a tool to separate workers from shirkers. They may offer a wage higher than the going market rate as an incentive to induce hard work from those who are willing and able to supply it. Paying a wage higher than the competition means that the good workers have something to lose if their jobs are terminated; they thus have an incentive to work hard. But with wages set above a competitive level, the wage rate no longer acts a lever to eliminate unemployment. In fact, as Stiglitz demonstrated in a 1984 paper with Carl Shapiro, unemployment is necessary as a “disciplining device” to keep workers from shirking.

Stiglitz also questioned how well stock markets could work when their information was costly to acquire. A tenet of the textbook model of stock markets is that stock prices accurately reflect all publicly available information. But in a 1980 paper with Sandy Grossman, Stiglitz presented a paradox. If prices reflect all the market information perfectly, then no one should bother to collect information because they can get it for free from the prices. But if no one bothers to collect information, then prices reveal no information. “The paradox lays the basis for the argument that imperfect information is likely to be the rule, rather than the exception,” says Nalebuff.

Read the whole article here.

at a theater (very) near you.....

Read this on our debt problem and the 'between a rock and a hard place' very uncomfortable condition for the Greek government:

Crisis to take a month off

on the optimal inflation target

We're discussing this week in class the goals of macropolicy and we've just introduced the 'price stability - low inflation' goal realizing that the meaning of 'low' is pretty fluid (just as 'satisfactory' growth is pretty fuzzy).

To add to this fuzziness, skim through this (probably, better to save the link so we discuss a few of the easier issues in class):

What's the right inflation target?

Reorienting macroeconomic policy

Thanks to Free Exchange:


Check out:
IMF Explores Contours of Future Macroeconomic Policy

Perhaps the most interesting quote (NB for IB2 candidates ready to sit the May exam):

IMF survey online: Central banks have chosen low inflation targets, around 2 percent. In your paper, you argue that maybe we should revisit this target. Why?

Blanchard: The crisis has shown that interest rates can actually hit the zero level, and when this happens it is a severe constraint on monetary policy that ties your hands during times of trouble.

As a matter of logic, higher average inflation and thus higher average nominal interest rates before the crisis would have given more room for monetary policy to be eased during the crisis and would have resulted in less deterioration of fiscal positions. What we need to think about now if whether this could justify setting a higher inflation target in the future.

On road pricing

We've introduced the analytics of road pricing this week in class so do check out these:

London Congestion Pricing: Implications for Other Cities

Road pricing: Lessons from London (David Newbery Cambridge University and CEPR)

(full paper: here --> skim only, of course, to see the structure of a professional paper and only if something strikes you as interesting, make an attempt to read a bit)

In Greek: 'Σχεδιασμός, εγκατάσταση και λειτουργία συστημάτων οδικής χρέωσης σε κυκλοφοριακά κορεσμένες περιοχές'

and, read section 2: definition of tradable permits from here.

Carbon Trading (and airlines in the EU)

In today's IHT, an article on carbon trading (tradable pollution permits - we were discussing the issue in class these days) with a couple of interesting points:

Carbon trading is a system that caps the amount of carbon dioxide, the main greenhouse gas, that companies may emit each year. Companies exceeding their quota can buy extra certificates from those companies that succeeded in shrinking their carbon footprint by adopting environmentally friendly technology or modifying production in other ways.

The system is the main tool used by the European Union to meet its ambitious pollution-reduction goals.

Many economists say trading provides the most economically efficient way to reduce pollution. They point out that environmental markets elsewhere in the world, including in the United States, have succeeded in bringing down levels of sulfur dioxide emissions, which cause acid rain.

and

Last week, the European Commission emphasized that the attack would not set back its plans to include international airlines in the system beginning in 2012, and it vowed to impose “high-security standards in its legislation to prepare for the inclusion of the aviation sector” in the system.

This is relevant to a data on the 'true cost of flying' we'll be doing later on in class!

See Fraud Besets E.U. Carbon Trade System

Rapping this time about Keynes - Hayek

I found this at the Georgia Council on Economic Education and since we'll be staring soon our macro lectures I thought this video might provoke some questions:

For IB Economics students (macro short essays sorted by subtopic)

I have just completed reorganizing my file with all past (May 1988 - May 2009) HP2 macro related questions (the short essay questions).

The file has been uploaded in our wikispace. You can find it and download it by clicking here.

Hope it helps your work!

Mark Danner's 'Stripping Bare the Body: Politics Violence War'

Again back to Haiti. This time a review of Danner's new book 'Stripping Bare the Body: Politics Violence War' by Charles Simic in the New York Review of Books.

...History repeats itself in unhappy countries. The absence of respected institutions and well-established laws that a person can count on to protect him condemns these societies to reenact the same conflicts, make the same mistakes more than once, and bear the same horrific consequences of these acts...

How true.