ASSA 2014 Highlights

Despite the awful arctic cold wave, attending ASSA 2014¬†in Philadelphia was a delight as it is every year! The sheer amount of energy and enthusiasm that comes from such a large professional gathering is really unparalleled. Economists also seem to be getting better at entertaining themselves, if this year’s music and humor sessions are any indicator. But most off all, for me, the highlights were AEA/AFA luncheon with the recent Nobel Laureates Ms. Fama, Shiller and Hansen ūüôā and continuing education series on Economic Growth.

Due to illness, Fama could not actually make it to the luncheon but he was ably represented by his long time coauthor Ken French. The conversations were well facilitated by Luigi Zingales of Chicago Booth. Some interesting highlights:

On bubbles: There is nothing called as bubbles- there is only volatility in asset prices.

Take on market efficiency: Bob Shiller thinks that efficiency of markets is only half truth but nonetheless a very significant one. Hansen responded by saying that the function of financial markets is aiding resource allocation in the economy. Hence, the more important question is about its role in promoting allocative efficiency. This, according to me, is one of the clearer statements of how economists should look at the process of financial intermediation.

While elaborating on the half truth comment, Shiller, who came across as an extremely soft spoken yet a very candid speaker, said that any profession should be wary of ‘group think’. This refers to the blind spots that professionals develop to obvious gaps in understanding a phenomenon as more and more people buy into the dominant thinking framework. That was a very interesting point.

Optimal Investment Strategy: If markets cannot be predicted, what should be the optimal investment strategy? According to Shiller, people should seek advice from paid professionals and there should be more of them available.

The second interesting session I attended was ” What Macroeconomists should know about finance?”. It was a panel discussion constituted by Markus Brunnermeier,¬†Atif Mian, and Arvind Krishnamurthy. Some interesting points about macro-finance linkages that were made in this discussion were as follows:

1. Atif Mian: Debt matters for macro aggregates through:

  • Asset Price Channel: asset prices declined faster in states where foreclosure laws are laxed.
  • Aggregate Demand Channel: HH that suffer higher net wealth shocks cut back on spending. Higher level of leverage means that aggregate losses are going to be shared by levered households disproportionately. Decrease in demand leads to reduction in tradable and non tradable jobs.
  • Financial Rigidity Channel: absence of state contingent debt. Rigidity in financial contracts. Hence,¬†important question is why are private contracts not optimal from macro perspective.
  • Endogenous risk = systemic risk

2.  Arvind Krishnamurthy:

  • Multiple asset prices- Do not respond in synchronous manner.
  • Careful thought to Intermediary asset pricing is needed.
  • Market segmentation:¬†Importance looking at process of intermediation for macro.
  • Changes in risk premia are not included in standard macro.
  • Capital structure of financial firms is not irrelevant as macro assumes.

3. Markus Brunnermeier: Unfortunately I missed this presentation-I definitely blame it on cold weather ūüėČ

The best part was the continuing education series on economic growth. Oded Galor and David Weil did an extremely good job of summarizing the existing research, commenting on intricacies of research designs and giving a clear picture of what we know about economic growth till now. Further, Galor’s Unified Growth Theory is a sure winner according to me. His paper on genetic diversity and comparative economic development was supremely exciting! You can access his research from his IDEAS page. You can access David’s research on health and economic growth here.

Update (January 11, 2014): Not sure why and how I missed this- Claudia Goldin’s Presidential address tops everything-you can watch it here.

Update (January 19, 2014): Interesting presentation on Railways and Famines in India. Check it out here.


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On Cows and Central Tenets of Capitalism!

Santosh Anagol has been doing interesting research on several phenomena concerning the Indian economy. In a recent paper, he and his coauthors estimate that returns to owning a cow in India are negative and hence the continued existence of cows violates the central tenets of capitalism.

Daron Acemoglu and James Robinson discuss these findings in their extremely interesting blog¬†here.¬†They argue that social embeddedness could help us understand why cows are still a part of a typical Indian farmer’s portfolio. I think that their arguments certainly makes sense, however, one might also look at new monetarist economics for an answer to this question. For example,¬†Lagos and Rocheteau (2008)¬†analyse an economy with money and capital as competing media of exchange and their model I think could explain this puzzle that Anagol pose.

In their economy, agents over-accumulate capital in a non-monetary equilibrium because the capital asset performs the function of a productive asset as well as a liquid medium of exchange when needed. The introduction and use of money therefore allows the liquidity use to be separated from the productive use and corrects the inefficient over-accumulation of capital. Thus, fiat money plays a welfare enhancing role in this economy. However, that precisely does not seem to be happening in India and that is the puzzle that Anagol and his coauthors are referring to.

So why do Indian farmers seem to be preferring to invest in an asset that has negative returns,¬†despite the availability of a liquid medium of exchange? Here, it is important understand what constitutes return on capital. Lagos and Rocheteau propose that return to capital in such an economy can be thought of being comprised of two parts: a liquidity return referring to capital’s role in exchange process and the intrinsic return associated with the productive use of cows.¬†Anagol’s analysis seems to be capturing only the intrinsic return while cows continue to have a liquidity return (premium) in the minds of Indian farmers. Ideally, this perceived positive liquidity return for cows should not prevail if fiat money does provide the necessary insurance against uncertainty. The fact that it does implies that the insurance provided by access to fiat money is not enough.

Anagol and his coauthors do raise this point but dismiss it citing the proliferation of different forms of microfinance institutions in rural India increasing access to savings. However, research has shown that actual use of these institutions is quite uneven and tends to depend on factors that could be explained using the economics of networks. For example see Matt Jackson’s work¬†here. I think the factors mentioned above still continue to influence the basic uncertainty that farmers face in a substantial way. I am not sure if microfinance would be able to provide enough insurance in case of a crop failure for example. Because provision of funds in such case may require access to a mechanism to transfer funds from non-affected areas to affected areas to meet the demand and microfinance in its current state most likely is not in a position to handle that.

I still think that social embeddedness plays an important role. On the one hand traditional socioeconomic relationships have broken down reducing the access to mechanisms that could serve as partial insurance mechanisms and on the other hand access to modern monetary economy is still hard to come by. Lack of roads, absent storage and refrigeration facilities, ineffective or absent land reforms, inadequate irrigation facilities keeping agricultural output sensitive to rainfall shocks, all imply that the benefits from participating in the market economy only add to the existing uncertainty that these farmers face. Till these issues are addressed Indian farmers will continue continue to hold cows despite their negative intrinsic return.

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Fiscal Stimulus: Old Keynesian vs. New Keynesian

This is fascinating stuff! John Cochranne urges us to call spade a spade and be done with it in this very interesting blog post: New vs Old Keynesian stimulus. Then you have Steve Williamson commenting on Cochranne here: John Cochranne and Keynesian Economics, while Nick Rowe adds his own views on these differences here: On understanding and spinning your own New Keynesian model.

You can find John’s extremely insightful paper here:¬†New Keynesian Liquidity Trap.


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Austerity or Fiscal Stimulus?

Here is the link to my response to an article in the Economic and Political Weekly. You can also read the not so civil response¬†by the original authors to my response. ¬†I thank them for putting a layer of thick skin on me ūüėČ

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What macro do we teach at the Principles level?

Every time I take a look at the principles level texts, it turns out to be a thoroughly entertaining experience! I usually look at how the authors have dealt with business cycles and more often than not the treatment turns out to be biased. For example take a look at this passage (pp. 273) from Hall and Libermann’s principles text. It looks at changes in labor demand as a cause of business cycles:

A Change in Productivity? One possibility is that the labor demand curve shifts leftward because workers have become less productive and therefore less valuable to firms. This might happen if there were a sudden decrease in the capital stock, so that each worker had less equipment to work with. Or it might happen if workers suddenly forgot how to do things‚ÄĒ how to operate a computer or use a screwdriver or fix an oil rig. Short of a major war that destroys plant and equipment, or an epidemic of amnesia, it is highly unlikely that workers would become less productive so suddenly. Thus, a sudden change in productivity is an unlikely explanation for recessions. What about booms? Could they be explained by a sudden increase in productivity, causing the labor demand curve to shift rightward? Again, not likely. Even though it is true that the capital stock grows over time and workers continually gain new skills‚ÄĒ and that both of these movements shift the labor demand curve to the right‚ÄĒ such shifts take place at a glacial pace. Compared to the amount of machinery already in place, and to the knowledge and skills that the labor force already has, annual increments in physical capital or knowledge are simply too small to have much of an impact on labor demand.

So in making fun of the RBC school or the classical model, they totally forget to mention oil price shocks, creative destruction because of technological changes, weather shocks in developing countries, etc. According to the discussion that follows, business cycles are caused by sudden autonomous miscalculations of demand on the part of producers coupled with herd behavior or changes in spending coupled with malfunctioning credit markets or people keeping unspent money under the mattress!

Dismissing changes in labor supply as a reason for business fluctuations, they say the following:

One way the classical model might explain a recession is through a shift in the labor supply curve. Figure 3 shows how this would work. If the labor supply curve shifted to the left, the equilibrium would move up and to the left along the labor demand curve, from point E to point G. The level of employment would fall, and output would fall with it. This explanation of recessions has almost no support among economists. First, ¬≠remember that the labor supply schedule tells us, at each real wage rate, the number of people who would like to work. This number reflects millions of families‚Äô preferences about working in the market rather than pursuing other activities, such as ¬≠taking care of children, going to school, or enjoying leisure time. ¬†A leftward shift in labor sup-ply would mean that fewer people want to work at any given wage‚ÄĒ that preferences have changed toward these other, non work activities. But in reality, preferences tend to change very slowly, and certainly not rapidly enough to explain recessions.

Now here the treatment is somewhat reasonable. However, there is no mention of preferences for work and leisure over time and how they could affect the labor supply curve or the fact that every time there is a recession, graduate enrollment goes up or government policies like welfare programs could affect unemployment duration (The Redistribution Recession story!).

Now I am sure Robert E Hall knows better than that.  For example look at this paper where he talks about preference shifts as causing changes in employment.  So instead of taking sides with one model why not present alternative explanations of an economic phenomenon?  Yes, the economy could be hit by real shocks or aggregate demand shocks or a combination of both or one turning into another. It is important to emphasize this to foster critical thinking and developing a balanced perspective.  When it comes to lack of a balanced perspective, most macro-principles texts are to be blamed and not just the one mentioned above. Thankfully, though, the textbook I use fares better and I kind of feel proud for not bombarding students with only one version of the story.

PS: Came across one more Principles of Macroeconomics that has a balanced treatment: Macroeconomics: Theory through Applications by Russell Cooper and A Andrew John published by Flatworld Knowledge.


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Kalecki-Krugman Deconstructed!

Michael Kalecki is/was one of the favorite authors in Center for Economic Studies and Planning, JNU, India. But frankly speaking I did not understand what he said much while I was a student there. However, recently Steve Williamson has done a very good job of putting Kalecki’s ideas in a very accessible way. Of course, the whole thing began as usual with Krugman trudging up Kalecki’s ghost!

You can read Steve’s analysis here¬†and here.

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Dual currencies in a Bangladeshi Slum!

This link  was brought to my notice by my advisor on how a second currency emerged in a Bangladeshi slum in Mombasa. As with all the stories of how monetary arrangements emerge to solve some or other friction that holds exchange back, it yet again vindicates the basic idea behind search models of money.

The credit nature of this arrangement signifies how debt might have evolved before money as argued by anthropologist David Graeber here.

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On Pareto improving trades!

When I first came to US (suburban CT), the idea of thrift stores was totally new me. At first, I had no idea what these stores were about.The name suggested that one could possibly save money by shopping at such stores. It was only later when I actually visited one in NYC that I realized that much of what these stores sold were used clothing, books, kitchen stuff, shoes, etc. The stuff was indeed cheap and sometimes even brand new, probably chucked of someone who got bored with the purchase. As an international graduate student on a shoe string budget it was a great boon to have one right near where I lived.

As a student of economics the question that intrigues me  was why are there thrift stores? It was particularly interesting because stuff from China and other developing countries had already made sure that goods are available at dirt cheap prices. Also, if you are not picky and can be patient, then you could get all that you wanted at a price that is affordable. But I think there in lies the answer. There are consumers who are obviously poor and benefit from thrift shops. But then there are others who are not that poor but would like to have things now and thrift stores provide an opportunity for them. Later, as I finished my studies and moved to other town for a job, I became a donor to these shops. This was stuff that I had acquired over the years, brand new and used, but did not see me using it anymore. So the thrift store provided an avenue to reduce clutter and then buy stuff that I would need for the new phase in my life. I am sure mine is not a peculiar case and many people at some or the time have been on either the consumer or supplier side of thrift stores.

When I moved to south east Massachusetts, I came across another variety of stores called consignment stores. This was a version of a thrift store but only somewhat pricier. Here the stuff is actually consigned by owners to be sold for them. So the products are not donated. The quality is overall better than a thrift store and at times you just might get lucky with a latest fashion shirt or a jacket!

So what the thrift and consignment stores seem to be doing is provide an opportunity for a beneficial trade (people who want to get rid od stuff and people who do not mind using it), clear the markets( reduce the price to ensure sales) and in the process create sustained demand for new products. Given this, I think they are an integral part of a market based economy. Do we see these kind of stores in other countries? I can speak for India. Markets for used automobiles are every where. You can also buy used books and other second hand goods sometimes through stores and at other times through personal and social networks. In my home town there is also this network of people who buy junk, exchange old clothing for new sundry items like utensils, crockery, etc and then sell the junk and old clothing to people who are in need of them. So the markets may not be as organized as in the US but they are certainly there and there might be an argument for making them more visible and ubiquitous to improve economic efficiency.

I have not come across any studies on this phenomenon but then that is just a good excuse to dig deeper, is it not?

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Moving back home- Determining the household size!

I am great fan of Greg Kaplan’s paper `Moving Back home’ in which he motivates moving back with parents as an insurance mechanism against labor market risks. I think, apart from explaining consumption and savings responses of low income households, it highlights one of the most important economic determinants of household size for not only the US but also for other countries. When no other insurance mechanisms are available, people tend to huddle up economizing on costs of living and minimizing labor market risk through skill set diversification (much like portfolio diversification!). This explains, for example, why traditional societies like India had joint family systems for a very long period of time to the extent of becoming a defining feature of Indian society. The important thing to realize is that this system may not be here for long. The ¬†general increase in incomes, economic opportunities, and capacity to¬†shield¬†oneself from economic risks will reduce the need for a joint family. ¬†This is already evident in the increasing nuclearization of families across urban India. Moreover, the size of the households also might change over the business cycle!

A recent paper with José-Víctor Ríos-Rull and Sebastin Dryda,  extends the idea of moving back home with parents to build a model of household size determination that is amenable to equilibrium business cycle analysis with aggregate technology shocks. The authors then use this model to explain the discrepancy between the micro evidence on the Frisch elasticities and the ones implied by the macro models. Interesting stuff!

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Must be right- Krugman says it!

A couple of students from UMass Amherst find a fault in the results by Ken Rogoff and Carmen Reinhart weakening their claim about the proportion of debt to GDP and its deleterious effects. It seems, now that this link appears to be tenuous, the case for austerity in case of many debt ridden EU countries is significantly weakened and finally the Keynesians of the world win the intellectual battle. Certainly, Paul Krugman seems to think that in successive blogposts on the Rogoff affair!

So is the case for austerity for these debt ridden EU countries really that tenuous? Should they be allowed to continue to inflate their way out? I do not think so. A clear picture of what plagues EU can be found here. The theoretical and empirical evidence against government spending as a way out of economic problems is overwhelmingly in support of austerity. Empirical work by Barro clearly shows that even with huge government spending shocks, the expenditure multiplier tends to just a little over or equal to 1. Moreover, theory tells us that polices that alter the incentives people face will tend to work far better in stimulating the economy in the desired direction. Even if there is deficient private demand, just filling in the gap will just do that- plug the hole. It does not affect the behavior of private sector in the long run. For example we know that the 2008 tax rebate did not move current consumption at all. Savings went up and people paid down the debt that was accumulated in the past. Sometimes even seemingly well intentioned policies can have opposite effects. Casey Mulligan makes an interesting case for this in his latest book, “The Redistribution Recession”.

There might be some case for government spending or inflation tax in developing countries. The presence of a substantial informal sector and significant positive returns on investment in public infrastructure are the cases in point. But you cannot have the same prescription for every country, and hence the Keynesians or Left thinkers especially in developing¬†countries¬†should not take shortcomings in Rogoff and Reinhart’s work as their victory. ¬†Increased government expenditure on employee salaries is still unproductive and deficient private demand (if present at all) may still not be corrected with it. And that replication of results should be still taken seriously before we base policy prescriptions on them.

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