Tag Archives: narayana kocherlakota

Notes on Workshop on Financial Crisis, Montreal PQ

I was quite excited about this workshop. It had all the right speakers and almost everyone was eager to listen to what they have to say about the crisis. The workshop was didvided into two parts. In the first part, Timothy Lane from Bank of Canada, Robert Hall from Stanford and the Hoover institution and Narayana Kocherlakota from the Fed Minneapolis presented their thoughts on the crisis.

Timothy Lane’s talk was a good survey of lessons learnt so far from the crisis with a bit of central banker’s perspective. Robert Hall’s speech promised a lot. It was kind of a precursor to what he was suppose to talk the next at the SED plenary session (the plenary talk did not turn out be that interesting though!). One of the important points that he made based on the data was that the zero lower bound on the interest rate may not mean much if the rates faced by consumers are positive and sticky. The second arguement was that because consumption expenditure has been pretty resilient and productivity infact surged during the crisis the real business cycle explainations of the crisis are completely useless.

Narayana’s speech turned out to be the attraction of the evening.  Based on the idea that finanical investments by banks pose a negative externality and hence need to be internalized by taxing risk taking, in his speech he carefully laid out the arguement and some thoughts on how to approach its implentation.  When Kocherlakota was appointed as the Fed Chief, lot of people had doubts about his effectiveness as a policy maker. But he has time and again proved that clear and disciplined thinking can save the day anywhere. I am sure in the coming days this first rate theoretician will have many interesting things to say and I will be all ears!

The second half of the workshop was a round-table discussion by two Nobel prize winners- Bob Lucas and Ed Prescott and John Murray from Bank of Canada. It contained much of off hand talk by Bob Lucas and a no nonsense presentation by Ed Prescott. In spite of the argument by Bob Hall above,  Prescott continued with his RBC story of the crisis. He argued that Hall is wrong because data can be revised any time and mostly contrary to what Hall is saying. Hall argued that Prescott is wrong because his RBC story requires completely unrealistic estimates of Frisch elasticity. The most notable feature of the evening, however, was that in spite of the clash of titans, all the questions after the presentations and the round table were for Kocherlakota and his idea of risk tax. He kind of completely stole the show.

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On the Desirability of Bubbles!

I would not have thought about whether bubbles are desirable or not given the current crisis. But one of the many things I admire about economists is that they are not afraid of heretic thought experiments. Some implications of Narayana Kocherlakota’s this paper certainly fall in this category.

He uses a model similar to the Kiyotaki-Moore model (2008) to account for the dramatic fall in firms’ networth and and employment in the aftermath of the financial crisis. In his model firms lend and borrow using land as collateral. The model is then used to analyze what causes bubbles in land price and what are welfare consequences of a bubble burst.

One of the implication of the model is that agents would prefer an unstable asset price bubble to no buuble at all. This happens becasue a bubble typically relaxes borrowing constraints allowing a lot more people to borrow and consume more than otherwise. This makes bubbles desirable and so the important question then becomes can government do something to sustain a bubble?

What should be the policy initiatives to respond to a crash? The model implies that even though in the long run putting money in hands of workers or firms is equivalent, in the short run it pays to give the money to firms rather than workers. This is because firm borrowing and lending plays an essential role in allocating capital to its efficient uses.  So here we have another argument against fiscal stimulus.

PS: Narayana Kocherlakota is now the President of the Minneapolis Fed!

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