You and I in a little toy shopNo real connection to IB Economics...
Buy a bag of balloons with the money we've got
Set them free at the break of dawn
'Til one by one they were gone
Back at base, bugs in the software
Flash the message, something's out there
Floating in the summer sky
Ninety-nine red balloons go by
But there’s at least one more form of damnification that has me really worried: the paradox of deflation. An individual company or worker can preserve a business or a job by accepting a lower price; but when everyone does it, we get debt deflation — a rising real burden of debt, which weighs on the economy — and also start to have deflationary expectations built into lending and investment decisions, which further depresses the economy. And once you’re in a deflationary trap, it’s very hard to get out.and:
This really should be the key point in the stimulus debate. Yes, the effects of fiscal policy are uncertain; yes, running up large debts is risky; but doing nothing is even riskier, because there’s a high probability that if we don’t act strongly deflation will get embedded in the economy. We may be damned if we do, but we’ll almost surely be damnified if we don’t.
In an excellent series of guest posts to this blog earlier this year, economist Robert Jensen described his personal quest to prove that rice is a Giffen good for peasants in China.In it there also reference to the Jensen paper that I had mentioned in class on noodles in the North and rice in the South of China. He is referred to as the Indiana Jones of Economics. Read the stuff here and here.
On The Economist magazine’s Free Exchange blog, the same claim is made about prostitutes:
Less attractive and even cheaper prostitutes may still be available, but for a variety of very good reasons, the customer will not desire the cheapest option, suggesting prostitution services can be classified as a Giffen good.
Are prostitutes Giffen goods? Absolutely not. And understanding why provides a useful economic lesson.
Next, write off anyone who asserts that it’s always better to cut taxes than to increase government spending because taxpayers, not bureaucrats, are the best judges of how to spend their money.Lots will be written against it I'm sure but the analogy does have a point!
Here’s how to think about this argument: it implies that we should shut down the air traffic control system. After all, that system is paid for with fees on air tickets — and surely it would be better to let the flying public keep its money rather than hand it over to government bureaucrats. If that would mean lots of midair collisions, hey, stuff happens.
The point is that nobody really believes that a dollar of tax cuts is always better than a dollar of public spending. Meanwhile, it’s clear that when it comes to economic stimulus, public spending provides much more bang for the buck than tax cuts — and therefore costs less per job created (see the previous fraudulent argument) — because a large fraction of any tax cut will simply be saved.
This suggests that public spending rather than tax cuts should be the core of any stimulus plan. But rather than accept that implication, conservatives take refuge in a nonsensical argument against public spending in general.
Finally, ignore anyone who tries to make something of the fact that the new administration’s chief economic adviser has in the past favored monetary policy over fiscal policy as a response to recessions.
It’s true that the normal response to recessions is interest-rate cuts from the Fed, not government spending. And that might be the best option right now, if it were available. But it isn’t, because we’re in a situation not seen since the 1930s: the interest rates the Fed controls are already effectively at zero.
That’s why we’re talking about large-scale fiscal stimulus: it’s what’s left in the policy arsenal now that the Fed has shot its bolt. Anyone who cites old arguments against fiscal stimulus without mentioning that either doesn’t know much about the subject — and therefore has no business weighing in on the debate — or is being deliberately obtuse.
But Greece’s problems are probably the worst. The country has been an easy target for the vigilantes of the European bond market, and recently it has been shaken by a wave of violent protests.This NYT article is not going to make you happy (if you are Greek, or for that matter, a Spaniard, Portuguese, Irish or an Italian).
The omnipotent hand of the Greek state produced a public debt of more than 90 percent of Greece’s total economic output. The relentlessly rising demand of its consumers, who were able to put off the day of reckoning because they enjoyed the shelter of the low-inflation euro, has created a current-account deficit of 14 percent of its gross domestic product — estimated to be the highest in Europe.
… isn’t hard to explain. Spain was basically Florida, with a housing bubble inflated by both resident and holiday purchases, and now the bubble has burst.
But Spain is in worse shape than Florida, for two reasons — reasons familiar to anyone who was involved in the great debate about whether the euro was a good idea.
First, Europe doesn’t have a central government; Spain, unlike Florida, can’t draw on Social Security and Medicare checks from Washington. So the burden of recession falls entirely on the local budget — hence the country’s declining credit rating.
Second, the United States has a more or less geographically integrated labor market: workers move from distressed regions to those with better prospects. (The housing bust has, however, reduced mobility because people can’t sell their houses.) Europe does not: yes, there’s a fair bit of mobility both among the elite and among low-wage workers at the bottom, but nothing like the US level.
So what can Spain do? It needs to become more competitive — but it can’t have a devaluation, because it’s a euro country. So the only alternative is wage cuts, which are desperately hard to achieve (and create big problems for debtors.)
Contrary to what everyone seemed to be saying even a few weeks ago, being a member of the eurozone doesn’t immunize countries against crisis. In Spain’s case (and Italy’s, and Ireland’s, and Greece’s) the euro may well be making things worse.
And Britain’s plunging pound, unpopular though it is, may turn out to have been a very good thing.“We’re on the verge of some big advances,” Mr. Gates said. In particular, a promising malaria vaccine will enter its final phase of human trials this year, with others behind it. Mr. Gates said he is “absolutely confident” that a successful malaria vaccine will be achieved, probably within a half dozen years, and an AIDS vaccine 10 or more years from now.
“It is amazing how big a difference a great teacher makes versus an ineffective one,” Mr. Gates writes in his letter. “Research shows that there is only half as much variation in student achievement between schools as there is among classrooms in the same school. If you want your child to get the best education possible, it is actually more important to get him assigned to a great teacher than to a great school.”I firmly believe in this (and there is research to support it...)
We believed that through astute policy or new technologies, including better methods of communication and inventory control, the business cycles were conqueredBut, he continues, 'greater interconnections that are an inevitable precipitate of the greater diversification create potential domino effects among financial institutions, companies and households'. Also, much of the Schumpeterian 'creative destruction' that takes place at the micro level may (now) have aggregate implications as replacement of core businesses by new forms and new products takes place (now) in companies that are large in size.
Forgetting the institutional foundations of markets, we mistakenly equated free markets with unregulated markets. Although we understand that even unfettered competitive markets are based on a set of laws and institutions that secure property rights, ensure enforcement of contracts, and regulate firm behavior and product and service quality, we increasingly abstracted from the role of institutions and regulations supporting market transactions in our conceptualization of markets.The last notion is that the discipline considered that 'even if we could not trust individuals, particularly when information was imperfect and regulation lackluster, we could trust the long-lived large firms'. These large companies would 'monitor themselves and their own because they had accumulated sufficient reputation capital'. We had called this 'reputation capital' in class 'brand name'. We had mentioned (I think) that Burger King, for example, would not serve lower quality burgers anywhere, even on a highway, because it would risk losing millions it had invested in its brand name image.
Few among us will argue today that market monitoring is sufficient against opportunistic behavior. Many inside and outside academia may view this as a failure of economic theory. I strongly disagree with this conclusion. On the contrary, the recognition that markets live on foundations laid by institutions -that free markets are not the same as unregulated markets- enriches both theory and its practice. We must now start building a theory of market transactions that is more in tune with their institutional and regulatory foundations. We must also turn to the theory of regulation -of both firms and financial institutions- with renewed vigor and hopefully additional insights gained from current experience. A deep and important contribution of the discipline of economics is the insight
that greed is neither good nor bad in the abstract. When channeled into profit-maximizing, competitive and innovative behavior under the auspices of sound laws and regulations, greed can act as the engine of innovation and economic growth. But when unchecked by the appropriate institutions and regulations, it will degenerate into rent-seeking, corruption and crime. It is our collective choice to manage the greed that many in our society inevitably possess. Economic theory provides guidance in how to create the right incentive systems and reward structures to contain it and turn it into a force towards progress.
Our trust in the self-monitoring capabilities of organizations ignored two critical difficulties. The first is that even within firms, monitoring must be done by individuals -the chief executives, the managers, the accountants. And in the same way as we should not have blindly trusted the incentives of stockbrokers willing to take astronomical risks for which they were not the residual claimants, we should not have put our faith in individuals monitoring others simply because they were part of larger organizations. The second is even more troubling for our way of thinking about the world: reputational monitoring requires that failure should be punished severely. But the scarcity of specific capital and know-how means that such punishments are often non-credible. The intellectual argument for the financial bailout of the Fall 2008 has been that the organizations that are clearly responsible for the problems we are in today should nonetheless be saved and propped up because they are the only ones that have the 'specific capital' to get us out of our current predicament. This is not an invalid argument. Neither is it unique to the current situation. Whenever the incentives to compromise integrity, to sacrifice the quality, and to take unnecessary risks are there, most companies will do so in tandem. And because the ex post vacuum of specific skills, capital and knowledge that their punishment will create make such a course of action too costly for the society, all kinds of punishments lose their effectiveness and credibility.(but, even if it makes sense to 'save' the organizations, what is it that prevents punishment of (some) of the individuals? I must admit that I lost his argument here)
It is one thing for the population at large to think that markets do not work as well as the pundits promised. It is an entirely different level of disillusionment for them to think that markets are just an excuse for the rich and powerful to fill their pockets at the expense of the rest.The article is useful for IB economics candidates as it exposes them to higher level arguments (beyond referring to the subprime crisis) in discussions regarding the possible origins of the current mess(for exams, commentaries, presentations etc).
Kristof, in a time when the rich are richer than ever and the U.S. government can find trillions of dollars to bail out the big banks, wants us to believe that the best the world's poor can expect is a chance for a sweatshop to open up in the neighborhood. In his sick version of reality, the labor movement, those who seek better wages, benefits and working conditions for the people who produce this wealth, is portrayed not as a champion of the poor but as an obstacle in their way.I don't think the solution proposed in this article has any merit whatsoever (try to think why) and in my opinion NK does not want us to believe anything - he just exposes a (sad) reality. Also, the labor movement the critic is referring to is that in the US and one could easily find instances where the true -unstated- goal is only to prevent imports from developing countries to protect the interests (jobs) of US workers, something NK explicitly mentions in his post. Even if we disagree it's still interesting to read!
PA: On that point specifically, what would you say is the biggest wrong belief currently present in development circles?
ED: The biggest wrong belief is that there is a magic bullet and I can find it.
I do not think the tax cuts are a good idea. Most of the increase in after-tax income is likely to be saved, rather than spent on buying goods and services. One of the reasons why the recession has turned into a depression is that Americans have meager savings, most of them in overpriced houses and overpriced stocks, and so they are sensibly reallocating income from consumption to saving. And there is much evidence that even in normal times, people spend less out of temporary income spurts than they do when they receive what they think will be a permanent increase in in-come. There is no such thing as a permanent tax cut, because the Congress that enacts a tax cut cannot bind subsequent Congresses (there is a new one every two years) not to rescind it.
I also think the transfer payments are a bad idea. The goal of a Keynesian deficit-spending program is to restore demand to X, not to increase it. If instead of demand rising as a consequence of the program from X - Y to X, it rises from X - Y to X + Z, there will be inflation because demand will exceed supply. Programs to transfer wealth are very difficult to abolish, because interest groups form about them. The problem is somewhat less serious with public-works programs, especially road-building and other infrastructure projects, and especially those infrastructure projects that were planned or begun by states or municipalities and interrupted or deferred because of the fall in tax revenues resulting from the depression. The federal government can finance these projects until the depression is over, and then the states can continue them with its own tax money.
There is a legitimate concern that many of the projects undertaken by the federal government will yield costs in excess of benefits. But the concern is exaggerated, because it ignores the benefits that such projects confer on fighting the depression as distinct from simply improving the nation's transportation system or reducing carbon emissions or buying military equipment to replace what has been lost in the Iraqi and Afghan wars. To the extent that the projects by increasing demand reduce unemployment, and reduce fear of unemployment by those who are not laid off (yet), they not only increase people's spendable income (unemployment benefits are lower than the wages they replace) but by reducing job insecurity reduce the fraction of wages that people save rather than spend. The saving rate has soared in recent months and is one of the major factors in reducing consumption and pushing us to the edge of a deflation.
In addition, public-works spending has a multiplier effect. The government's expenditure on buying goods and services (a road, a bridge, or whatever) increases output directly, but it also does so indirectly because the company that builds the project with government funds pays its employees and suppliers, and they in turn spend part of the money they receive, further stimulating output.
Properly structured, a Keynesian program can help to check a downward economic spiral. With monetary policy apparently inadequate to avert a downward spiral big enough to trigger deflation, there may be no good alternative to such a program.
As Posner and others have indicated, there appears to have been a huge conversion of economists toward Keynesian deficit spenders, but the evidence that produced such a "conversion" is not apparent (although maybe most economists were closet Keynesians all along). This is a serious recession, but Romer and Bernstein project a peak unemployment rate without the stimulus of about 9%. The 1981-82 recession had a peak unemployment rate of about 10.5%, but there was no apparent major "conversion" of economists at that time. What is so different about the present recession compared to that one, and to other recessions since then, that would greatly raise the estimated stimulating effects of government spending on various types of goods and services?
It is relevant in answering this question that the origins of this recession were in the financial sector, and especially in the excessive mortgage credit to sub prime and other borrowers. The widespread collapse of the financial sector, and the wholesale retreat from risky assets, clearly has called for a highly pro-active Fed. But it is not obvious why this should lead to greater confidence in the power of government spending stimulus packages. Of course, perhaps the prior emphasis on crowding out, and skepticism toward the stimulating effects of government spending, were wrong, or that recessions were too short and mild after the 1981-82 recession to call for Keynesian-type stimulus packages.
Time will tell whether I am right that a spending and tax package of the type analyzed by Romer and Bernstein may stimulate the economy as measured by GDP and employment, but that the stimulus will be smaller then they estimate, and its value to consumers and taxpayers could be even smaller.
Elizabeth LinosWay to go Elizabeth! I hope her work inspires some of you to work on such issues later on in your career!
B.A. in Government and Economics, Harvard University
Research Assistant, Paris
Elizabeth holds a Bachelors Degree in Government and Economics from Harvard University. Before joining J-PAL, Elizabeth worked in Boston on health care provision to immigrants, in Peru, conducting field research on the quality of teachers and in Honduras, studying a government social transfer for poor households. She joined J-PAL in 2007, as a field-based research assistant in Bangladesh where she worked on a female empowerment project. She is currently working on evaluations of microfinance in Morocco, student sponsoring in France, and an ultra poor program in Pakistan.
According to research published earlier this month, many may have chosen the wrong ones, and damaged their chances of getting into a highly regarded university. Policy Exchange, a centre-right think-tank, looked at the A-levels offered by successful applicants to a group of 27 very selective universities—some ancient, some modern—and concluded that, despite the fact that all subjects are notionally equal, in reality admissions tutors think more of some than of others.I'm sure that roughly the same applies for IB higher level choices. The title of the article is Getting in: Strategic thinking for the aspiring student
