Wednesday, December 28, 2011

The game's up

John Quiggin at Crooked Timber declares a neat little victory over Stephen Williamson, who had trashed his Zombie Economic books on his blog, and later for the Journal of Economic Literature. Quiggin points out that one of Williamson's rhetorical tools - the claim that some of the theories Quiggin critiques are actually tautological - implies that those theories are entirely pointless, and scientifically worthless.

While this was just a petty aside in a blog post, it could be safely ignored. But now the same points have been made in the august JEL, a house journal of the American Economic Association, they acquire a cachet which means they can't be so easily dismissed as Aunt Sallies.

I'm pleased to see this problem get a bit more attention because I've always been frustrated at how economists and rational choice theorists in general play bait-and-switch with the rationality assumption. Obviously if anything can be rational, then rational choice cannot make substantive predictions. But at the same time, the claims that are usually made in the name of rationality are far tougher - ie that people are self-interested, rational and capable of complex calculations about their material interests. The tautological rationality assumption is only wheeled out when the latter claims run into trouble (which they generally do when we try to explain non-trivial problems).

So, as Quiggin says, whenever we want to make this kind of point, we can just cite Williamson 2011 in the JEL.

As a footnote, I love Williamson's introductory paragraph, which states that 'in economics, the 2008-9 financial crisis has resulted in renewed appreciation of advances made in information economics, the theory of financial intermediation and monetary economics'. Which is like saying that collapse of the Berlin Wall brought renewed appreciation of advances in our understanding of Soviet communism through the 1980s, or that 9/11 alerted us to our most cutting-edge findings in the study of international terrorism.

Saturday, December 24, 2011

Thursday, December 22, 2011

Gis' a job!

Nice one. Via Brad DeLong, Jim Henley explains the otherwise inexplicable: the Lib Dems remaining in this Conservative government.

It all makes sense if you start to think about what Nick Clegg plans to do when his political career is over (circa 2015) - get a well paid job in the corporate sector. And how do you get offered a well paid job in the corporate sector? Well, not by reforming the banks, penal tax rates on bonuses, and help for the poor, that's for sure.

This raises a broader question: How much is the general shift towards pro-rich policy over the past decades explained by the failure to generate a political elite that actually responds in any serious way to popular demands? This angle certainly sounds more plausible than the alternative - that somehow median voters became convinced of the need to line the pockets of the 1%.

Martin Wolf on inequality

Martin Wolf takes on inequality in today's FT. He points out that a lot of the increase in inequality in the UK is down to an increase in the dispersion of male earnings, and that

some – perhaps a great deal – of the ultra-high incomes at the top are almost certainly the fruit of rent extraction facilitated by a breakdown in the control exercised by principals – outside investors – over their agents – corporate executives and financiers. Huge rewards then are both unjust and inefficient.

This is the key point - any pretence that inequality might be the price to be paid for economic dynamism cannot survive the events of the past three years. Hopefully this realization can spread beyond the pages of the FT fast.

Print and be damned

It looks that the ECB is finally, by a circuitous route, doing what needs to be done. It remains to be seen whether it will do enough, but the combination of nearly half a trillion euros - in one day - in cheap loans to banks, with the acceptance of troubled sovereign debt as collateral, is a step in the right direction. The direction, that is, of acting as a lender of last resort, despite German protestations.

This is a smart move by Mario Draghi, who talked tough on bail-outs, then effectively ate his words, but did so in such a way as to leave most German voters unsure as to what has really happened.

Anyway, this is just a start. The austerity medicine will still depress Southern European economies, and monetizing slices of their debt just as we approach the abyss is not exactly going to resolve the problem.

Wednesday, December 21, 2011

Is there such a thing as moral hazard for nations?

Just in case you needed any more reasons to oppose austerity, here's another, outlined in this neat and evocative Guardian piece ('Europeans migrate south as continent drifts deeper into crisis): emigration.

Yes, in a development that has probably never occurred to Europe's blinkered political leaders but is blindingly obvious to anyone residing in the real world, young, ambitious and dynamic European citizens are escaping from the misery of austerity and seeking a new life elsewhere, often outside the EU. It is hardly worth pointing out the obvious implication - that austerity is even less likely to work if the most productive sections of society are bailing out and leaving the pain behind.

This is neat in all sorts of ways, but what I find intriguing about it is the stark distinction it draws between the collective responsibility of debtor nations and the individual responsibilities of their citizens. So Greece must suffer for its mistakes, otherwise moral hazard will encourage it to behave badly in the future; but of course there is nothing stopping individual Greeks leaving the sinking ship and evading the punishment.

This reminds me of a neat piece of prose on the crisis by John Lanchester, who has made more sense out of this mess than many economists. In a piece published in the London Review of Books last summer, he noted the following:

From the worm’s-eye perspective which most of us inhabit, the general feeling about this new turn in the economic crisis is one of bewilderment. I’ve encountered this in Iceland and in Ireland and in the UK: a sense of alienation and incomprehension and done-unto-ness. People feel they have very little economic or political agency, very little control over their own lives; during the boom times, nobody told them this was an unsustainable bubble until it was already too late.

In consequence, people don't feel that the crisis was in any real sense caused by them:

The austerity is supposed to be a consequence of us all having had it a little bit too easy (this is an attitude which is only very gently implied in public, but it’s there, and in private it is sometimes spelled out). But the thing is, most of us don’t feel we did have it particularly easy. When you combine that with the fact that we have so little real agency in our economic lives, we tend to feel we don’t deserve much of the blame. 

It's difficult to argue with this. But irrespective of whatever moral responsibility an individual Greek may bear, there is no law whatsoever against him or her leaving the country and starting afresh, washing their hands of the whole mess.

A kind of citizen's default. So much for moral hazard.

Sunday, December 18, 2011

It's all covered by Road Tax

Stat of the week from the blog Man's Greatest Mistake: the total cost of all motor vehicle accidents in the UK for a year is: (drum roll) £18 billion. That's about 1% of GDP, or, put another way, about 15% of the government deficit.

So not a trivial amount of money.

I've been thinking for a while that actually, reducing car use is one of the best ways of increasing living standards. After all, many families on middle to low incomes have one or sometimes two cars, and the associated costs are enormous. Providing people with alternatives, through more public transport investment and traffic calming to make cycling more attractive, would basically make people richer. And that's before we start to consider the environmental benefits.

It's a no-brainer, but of course a very radical change to get people used to. But on the other hand we're going to have to do it one day, so why not start now when we have a bunch of other good reasons to do it, like avoiding a second great depression?

Friday, December 16, 2011

Joseph Stiglitz explains the depressions

Fascinating piece in Vanity Fair by Stiglitz. He argues that the implosion of financial sector was a symptom of broader structural dysfunctions in the economy, involving the transformation from an industrial to service-based economy. He develops the argument but comparing with the 1930s, where the collapse of the financial system was in large part an effect of the difficult structural change from an agriculture-based to an industrial economy.

This is important stuff. It carries two broad implications. First, fixing finance alone won't solve the problem. It is an essential pre-requisite of exiting the crisis, but there also needs to be a fundamental shift towards a services-based economy, achieved through state intervention to retrain workers and make the investments needed to hasten the transformation. The private sector won't do it alone, and currently policy, by depressing demand, simply locks us into a downward spiral.

Wednesday, December 14, 2011

How to increase your debts by saving more

When it comes to understanding the crisis, it's still hard to beat Krugman. By explaining IS-LM to a popular audience (including me) he's doing a great service, and I read today's blog post after seeing this chart (courtesy of Richard Koo), which shows that the UK government deficit is paralleled by a big increase in private saving.

According to IS-LM deficit reduction, unless it is counteracted by a dramatic increase in private borrowing (in a credit crunch?) will simply shrink GDP, because this is the way that desired savings get to match desired investment.

So if we really save hard enough, our incomes will shrink enough to make our savings as small as the paltry levels of investment we're currently suffering.

Look at the IS-LM graph long enough and a smaller deficit looks less appealing.

Saturday, December 10, 2011

Britain's loss, Europe's gain?

Fascinating piece in The Economist about the Euro summit and Cameron's 'walk out'. The interesting thing is that the article discusses the whole issue from the point of view of the kind of pro-free market Anglo-focused angle typical of the Economist.

It finds, with impeccable logic, that Cameron, and the British right, have been roundly defeated. After all, what does a 'walk out' mean? Either that we stay in the single market but with no real influence on how it's regulated, or we leave the single market and see investors take a detour around us as they seek access to a market of over 400 million people. Even the City, which Cameron purports to defend, could well ditch us and head to Frankfurt (after all, the City is basically an offshore arena for American banks, and stopped representing indigenous capital sometime in the 1960s).

Doesn't look good. Unless of course you want to take Britain back to the 1950s, which is precisely what most Conservatives really aspire to.

One step from disaster

A pretty good assessment of yesterday's summit outcome from Tim Duy's Fed Watch (via Mark Thoma).

In the end, this mess is entirely a political one. Not that economists aren't in large part to blame, but the key point is that some economists have figured out what the answer is, but too many politicians find it convenient to stick to the line that made some kind of sense until 3 years ago, but makes no sense at all now.

So what we need is a theory of economic policy lunacy.

Thursday, December 8, 2011

Weber's revenge

Markets have faith in Protestants (% of Protestants in population, by logged 5 year CDS price today).
The Rsq without Greece is .45, meaning that Protestantism predicts almost half the variation in the log of CDS prices.

Quite why Protestantism is related to the perception of fiscal responsibility is one for another post.

Tuesday, December 6, 2011

Monday, December 5, 2011

When will Germany start living beyond its means?

In most of my posts on the southern Europe debt crisis I've focused on the contractionary nature of fiscal retrenchment, and the 'paradox of thrift' it engenders - that by retrenching, Southern Europe risks shrinking its GDP, thus cancelling out any putative gains from austerity.

Paul Krugman, in response to Ezra Klein, reminds us that there is another big obstacle to this strategy: that Southern Europe cannot recover without unwinding its trade deficit, and its trade deficit is the counterparty to the German trade surplus.

In other words, are the Germans willing to run a trade deficit to make this happen? Because if they are not, it's not going to work. And nothing I've heard out of Berlin recently sounds like coming close to recognizing this.

Elementary, Signor Monti

Fascinating stuff - yields on Italian debt dropped sharply today (FT Alphaville » Signor Monti, sensazionale). Monti's €27 billion of contractionary budget cuts and tax rises really did the trick...

The fact that Spain's yields did much the same suggests a momentum behind the Euro crisis management strategy of Merkel and Sarkozy. It also suggests that should this week's summit fail, we could pretty quickly be back to where we started last week.

All of this goes to show that policy's real effects seem to matter less than their effects on expectations, and that countries like Italy and Spain are only at risk of default if markets think they are at risk of default. There is nothing remotely rational about our current financial arrangements.

'via Blog this'

Munchau is depressed

Reading Wolfgang Munchau is not a lot of fun at the moment. His doom-laden pronouncements are all the more depressing for the fact that he is almost certainly right to predict that France and Germany look set to fudge it yet again.

In any case, at least the scenario is becoming clearer. The ECB will probably act if given the political backing, as Draghi suggested the other day. But Merkel only seems to want ECB action if the Southern Europeans commit to open-ended austerity. This is politically implausible, as well as being almost certainly economically counter-productive.

So here we are. If we were a game theorist, I could probably write a nice paper about this. It's basically a Prisoner's Dilemma game, but I fear it's an unbalanced one, because I'm not sure the Germans even understand what the cooperative outcome would be. So they dig in their heels.

Let's just hope they blink, because they're going to be dragged down by this as much as anyone else. What price those years of 'sacrifice' for competitiveness if they end up with a Swiss exchange rate and an insolvent banking system?

Sunday, December 4, 2011

George Osborne's U-turn

George Osborne has turned Keynesian:

"We need to put to work the many billions of pounds that British people save in British pension funds, and get those savings invested in British projects. You could call it British savings for British jobs," he said in the autumn statement, adding that the government was exploring guarantees and ways of letting city mayors borrow against future tax receipts in an echo of the vast municipally funded works that built Britain's water, sewerage and road network in the Victorian era, as well as hospitals and schools"

Exactly how is that different to the deficit spending that the government refuses to contemplate?

The Monti treatment

Contractionary measures for contractionary times (Monti outlines tough measures for Italy). €27 billion taken out of a stressed economy, which is also suffering financial uncertainty on a colossal scale.

Can any of this work? Yes, but only as an offer to the Gods of austerity, giving them the political offer to authorize a monetary bailout through the ECB.

Peculiar how entirely irrational policies can become rational, if they are designed to encourage irrational leaders to do rational things.