Sunday, March 1, 2015

Trade-Related (?)

Economic theory provides a number of useful tools for thinking about tariffs, and these tend to frame economists' instincts when it comes to discussions about "free trade agreements."  However, in many cases, tariffs are already quite low (perhaps this is a rare success for economists' powers of persuasion...) and the main ingredients of trade agreements concern other things which are trickier to analyze.

One aspect of contemporary trade agreements that is coming under scrutiny in the discussions over the Transatlantic Trade and Investment Partnership (TTIP) and the Trans-Pacific Partnership (TPP) are provisions to protect foreign investors by allowing them to take disputes with governments to arbitration.  This Vox piece by Danielle Kurtzleben is a nice summary of the debate concerning these investor-state dispute settlement (ISDS) rules.

Another issue getting considerable attention in the TPP discussions is the fact that trade agreements typically do not deal with currencies.  As the Times reported, many in Congress are pushing for incorporating a provision to deal with "currency manipulation" into the TPP.

This is a tricky issue which cuts across economics' division between international trade - which uses microeconomic theory to analyze long-run equilibria - and open-economy macroeconomics, which is concerned with monetary and balance of payments issues (which are "short-run" but can have meaningfully persistent effects).  At an institutional level, trade policy is usually the purview of trade ministers (e.g., the US Trade Representative), while currency policy falls to central banks and finance ministers (i.e., the Treasury in the US).  Globally, trade has the WTO, while currencies have the IMF (which, unlike the WTO, does not have any enforcement mechanisms).

Simon Johnson and Jared Bernstein have written in favor of inserting a currency clause, while Edwin Truman argues the contraryJanet Yellen expressed concern about the potential for trade agreements to encroach on monetary policy, and Jeffrey Frankel noted that some of the loudest concerns about currency manipulation aimed at China (not currently a party to the TPP) are out of date.

Thursday, February 5, 2015

Just the Varoufakis, Ma'am

An interesting BBC interview with Yanis Varoufakis, the finance minister of the new Greek government (interview begins at about 3:30):

If the eurozone breaks apart - and it seems we're back to worrying about that yet again - I don't think it will be because the Greeks are being unreasonable (or uncool). 

Varoufakis also spoke with Ambrose Evans-Pritchard:
Mr Varoufakis is braced for an arid meeting on Thursday with his German counterpart and long-time nemesis Wolfgang Schäuble, a man he once accused – borrowing from Tacitus - of reducing Europe to a desert and calling it peace.

“I will try to be as charming as I can in Berlin. I will tell Mr Schäuble that we may be a Left-wing riff-raff but he can count on our Syriza movement to clear away Greece’s cartels and oligarchies, and push through the deep reforms of the Greek state that governments before us refused to do,” he said.

“But I will also tell him that we are going to end the debt-deflation spiral and do what should have been done five years ago. That is not negotiable. We have a democratic mandate to challenge the whole philosophy of austerity,” he said.
In a recent blog post, Paul Krugman clarified how we should think if the conflict between Greece and the EU-ECB-IMF "troika" -
[A]t this point Greek debt, measured as a stock, is not a very meaningful number. After all, the great bulk of the debt is now officially held, the interest rate bears little relationship to market prices, and the interest payments come in part out of funds lent by the creditors. In a sense the debt is an accounting fiction; it’s whatever the governments trying to dictate terms to Greece decide to say it is.

OK, I know it’s not quite that simple — debt as a number has political and psychological importance. But I think it helps clear things up to put all of that aside for a bit and focus on the aspect of the situation that isn’t a matter of definitions: Greece’s primary surplus, the difference between what it takes in via taxes and what it spends on things other than interest. This surplus — which is a flow, not a stock — represents the amount Greece is actually paying, in the form of real resources, to its creditors, as opposed to borrowing funds to pay interest.

Greece has been running a primary surplus since 2013, and according to its agreements with the troika it’s supposed to run a surplus of 4.5 percent of GDP for many years to come. What would it mean to relax that target?

It would not mean demanding that creditors throw good money after bad; everyone has already implicitly acknowledged that the debt will never be fully paid at market rates, but Greece is making a transfer to its creditors by running a primary surplus, and we’re just arguing now about how big that transfer will be.
At Project Syndicate, Joe Stiglitz writes:
So it is not debt restructuring, but its absence, that is “immoral.” There is nothing particularly special about the dilemmas that Greece faces today; many countries have been in the same position. What makes Greece’s problems more difficult to address is the structure of the eurozone: monetary union implies that member states cannot devalue their way out of trouble, yet the modicum of European solidarity that must accompany this loss of policy flexibility simply is not there....

When companies go bankrupt, a debt-equity swap is a fair and efficient solution. The analogous approach for Greece is to convert its current bonds into GDP-linked bonds. If Greece does well, its creditors will receive more of their money; if it does not, they will get less. Both sides would then have a powerful incentive to pursue pro-growth policies.

The Greek government's proposals are along the same lines, according to Ambrose Evans-Pritchard's article:
The proposals offer a bond swap to ease the debt burden – 177pc of GDP - without demanding an explicit writedown of Greece’s foreign loans. This allows both sides to save face. The aim is to slash Greece’s primary budget surplus from the troika target of 4.5pc of GDP to around 1.5pc to pay for welfare pledges and boost investment. “This gives us a reasonable buffer. The old target is ludicrous,” Mr Varoufakis said.

Loans from the EU bailout machinery would be replaced by GDP-linked bonds, akin to Keynes’s "Bisque Bonds" in the 1930s. Money owed to the ECB would convert into “perpetual bonds”.
The Times' Eduardo Porter reminds us that economists foresaw that the euro might not work out so well:
The euro had been enshrined in a treaty but not yet come to life in the autumn of 1997, when Martin Feldstein, the influential president of the National Bureau of Economic Research, published an essay arguing that European leaders’ hopes that a monetary union would foster greater harmony and peace in a Continent repeatedly ravaged by wars were misplaced.

It “would be more likely to lead to increased conflicts,” wrote Mr. Feldstein, a former chief economic adviser to President Ronald Reagan.

War within Europe, “would be abhorrent but not impossible,” he added. “The conflicts over economic policies and interference with national sovereignty could reinforce longstanding animosities based on history, nationality and religion.”
The real difficulty is politics, not economics; as Porter writes:
Fixing this is not impossible. The most direct way would be for the creditors in Europe’s north to relax the tight conditions on debtor countries, provide them with debt relief and allow them to spend more to kick-start growth. Alternatively, they might just invest more themselves, which would lead to higher wages and prices at home, encouraging more output in their poorer neighbors.

This path presents some political complications, however. Voters in Germany and other rich northern countries have no appetite for transfering resources to the vulnerable neighbors around Europe’s edge. And, comfortably insulated by their own prosperity and conditioned by memories of hyperinflation after World War I, they still fear higher inflation. Even the direst warnings of impending doom seem unlikely to shift the public mood.

And that sets the political constraint on the other end of the field. “The right policies would defuse the political crisis in the peripheral countries at the expense of intensifying it in Germany,” Mr. De Grauwe said. “It would prevent communists taking over in the south but would fuel the extreme right in the north.”
As we've seen in the US, the right policies to deal with financial crises and depressions do not appeal to most people's moral intuition, and are thus very difficult politically.  If the euro - and the project of European unity - is to be saved, it will take some courage on the part of the leaders in Germany and other "northern" countries.

Update: the embedded video was taken down, but a shorter version is available at the link.

Wednesday, February 4, 2015

Economics, Grade Inflation, and Gender

The NSF updates us on the share of economics degrees earned by women:
while the share of female PhD is now up to about one-third, the fraction of undergraduate economics majors has slipped back under 30%.

In a Washington Post column last year, Catherine Rampell argued that the obsession with grades can partially account for the relatively low percentage of women majoring in economics as well as in science, engineering and math fields.  The women don't do worse then the men, but apparently they're more likely to avoid areas where grades are, generally, lower.  She writes:
Claudia Goldin, an economics professor at Harvard, has been examining why so few women major in her field. The majority of new college grads are female, yet women receive only 29 percent of bachelor’s degrees in economics each year.

Goldin looked at how grades awarded in an introductory economics class affected the chance that a student would ultimately major in the subject. She found that the likelihood a woman would major in economics dropped steadily as her grade fell: Women who received a B in Econ 101, for example, were about half as likely as women who received A’s to stick with the discipline. The same discouragement gradient didn’t exist for men. Of Econ 101 students, men who received A’s were about equally as likely as men who received B’s to concentrate in the dismal science. 
One of my ongoing, and largely futile, battles as a college professor is to convince my students that their grades don't matter - or at least, they don't matter nearly as much as the students often think they do.  Alas, obsession with grades is pretty deeply entrenched in young people who've been coached for years to compete to get into college.  This may have gotten worse over time with perceived increases in the competitiveness of admissions (the perception isn't fully accurate: declining acceptance rates are partly due to colleges soliciting more applications to make their numbers look better, as well as the growing ease of applying to large numbers of colleges), as well as increasing anxiety about financial outcomes after college.

Not only does the obsession with grades distract us from the real purpose of learning, the apparent difference between how men and women respond to them contributes a gender gap in fields like economics, which appear less prone to grade inflation (this study from Wellesley provides further evidence on how grade inflation distorts students' choices, though it doesn't consider gender differences).  One could make the case that grade inflation is thus an equity issue.

The better news from the NSF's report is the continued increase in the share of women earning PhDs (though the discipline still faces "leaky pipeline" issues).  I'm not too worried that the decrease in the share of women earning US undergraduate economics degrees will impact graduate education, since US graduate programs draw from a global pool (only about 30% of US PhDs go to Americans).  However, I don't think we should be hopeful that a greater share of female professors will bring more women into undergraduate economics: while a "role model" effect sounds plausible, the empirical evidence does not seem to support it.

Saturday, January 31, 2015

A Note from Irving Fisher

via twitter: from "The Debt-Deflation Theory of Great Depressions" (Econometrica, 1933). Note: the tweet was cropped a bit when I embedded it, but if you click on it you can see the entire quote.

Saturday, January 24, 2015


So, I guess we're sorta implicated, then...

Wednesday, January 21, 2015

Reminder: Your Major is Not Your Career

On twitter, Diana Farrell (Wes '87) points us to a fantastic interactive graphic from Williams math Professor Satyan Davadoss.
The varied paths from all the different majors is an excellent corrective to the widespread misperception that one's major determines one's career.

Franc Notes

Switzerland abruptly ended its ceiling on the euro-franc exchange rate last week, resulting in a 20% appreciation of the franc.

This highlights one fact of fixed exchange rates: no peg is forever.  This fact lends some drama to foreign exchange markets.  Normally pegs collapse in the other direction - a country which is trying to keep its currency over-valued spends down its reserves of foreign currency and faces speculative attacks from traders who believe it cannot sustain the policy, and the attacks make the policy even harder to sustain (e.g., Britain's 1992 ejection from the european exchange rate mechanism).  Since Switzerland's intervention involved keeping its currency under-valued relative to its market price, it was selling Swiss francs for euros.  In doing so, it accumulated reserves, so the possibility of running out which could have forced a crisis did not exist.

Normally, I'm not a fan of fixed exchange rates, but Switzerland's motivation for implementing the ceiling was understandable, as it faced huge financial inflows seeking a "safe haven" during some of the worst parts of the euro crisis.
On the graph, the exchange rate is the euro price of the franc, so an increase is a franc appreciation.  One can see the rapid appreciation in 2010-11 before the intervention, as well as the spike at the very end when the Swiss National Bank lifted the ceiling.

One of the problems of a fixed exchange rate is that it forces monetary policy to follow an external objective, rather than focusing on the state of the domestic economy.  In this case, Switzerland's policy had been forcing it to expand the supply of francs.  While this can be inflationary, in a world where deflation is the main worry, expansionary policy is appropriate (and Switzerland was not seeing any problems with inflation).  However, Switzerland does have low unemployment and a huge current account surplus.  Allowing its currency to appreciate will help its current account adjust.  It also means that the franc will not be locked into following the euro on its downward trend relative to the dollar and other currencies (the SNB's move also makes it easier for the ECB to exploit the exchange rate channel to stimulate the european economy).  Floating the franc does mean that the SNB once again faces the prospect of inflows seeking a safe haven - its trying to combat this with negative interest rates (the costs associated with holding large amounts of cash create a bit of space for negative returns on financial assets).

There has been quite a bit of commentary on this, which Brad DeLong nicely rounded up in one of his "socratic dialogues."  This guest post at The Economist's Free Exchange by Simon Cox of BNY Mellon seems to me like a sensible take.

An Interview

I did a short interview with Wesleyan student Jake Orlin for a class project of his.  He turned it into a nice video:
I definitely benefit quite a lot from editing.  A nice touch on his part working in Lee Iaccoca, my childhood hero.

Saturday, December 20, 2014

The Birth of Inflation Targeting

Inflation targeting, where monetary policy is directed to aim for a specific level or range for the inflation rate, has become a widespread practice.  The Times' Neil Irwin looks back at its first implementation by New Zealand; he writes:
Sometimes, decisions that shape the world’s economic future are made with great pomp and gain widespread attention. Other times, they are made through a quick, unanimous vote by members of the New Zealand Parliament who were eager to get home for Christmas.

That is what happened 25 years ago this Sunday, when New Zealand became the first country to set a formal target for how much prices should rise each year — zero to 2 percent in its initial action. The practice was so successful in making the high inflation of the 1970s and ’80s a thing of the past that all of the world’s most advanced nations have emulated it in one form or another. A 2 percent inflation target is now the norm across much of the world, having become virtually an economic religion.
Irwin goes on to provide a nice description of how and why New Zealand adopted this policy. Although it initially seemed quite successful in achieving the goal of avoiding a repeat of the high inflation if the 1970s (which continued well into the 80s in some countries) while maintaining reasonable growth rates, it has been tested by the experience of the past seven years.  One question is whether the level of 2 percent is the right one.  Irwin describes how Janet Yellen successfully argued against those at the Fed who wanted to go for zero inflation in the mid-1990s, but even 2 percent may be too low:
Starting in the late 1990s, Japan found itself stuck in a pattern of falling prices, or deflation, even after it cut interest rates all the way to zero. The United States suffered a mild recession in 2001, and the Fed cut interest rates to 1 percent to help spur a recovery. Then came the global financial crisis of 2007 to 2009, spurring a steep downturn across the planet and causing central banks to slash interest rates.

All of this has quite a few smart economists wondering whether the central bankers got the target number wrong. If they had set it a bit higher, perhaps at 3 or 4 percent, they might have been better able to combat the Great Recession because they could cut inflation-adjusted interest rates by more.
The apparent initial success as well the reasons for recent doubts can be seen in the UK's experience, which adopted inflation targeting in 1998:

(the chart data is from the OECD, via FRED.  The UK's target was initially 2.5%, but expressed in terms of a different price index measure, when it switched to using the CPI, it moved the target to 2% based on differences in the measures.)

While the UK generally has had low and (relatively) stable inflation since the early 1990s, it did miss its target considerably in 2007-2012, and it may be in danger of undershooting its target (as the Fed is) - inflation in November was 1% (this is not evident in the chart because it plots the percentage change in the price index from the year before).

Although I think the Bank of England deserves credit for not tightening in the face of inflation which ultimately proved transitory, this does call the inflation targeting framework into question.  Arguably, it may have helped keep inflation expectations "anchored" even as inflation deviated from target.  However, at some point, one would expect such deviations to undermine the credibility of the regime, and it was the idea of establishing credibility that made it attractive to academic economists in the first place (the underlying intuition for this was nicely described in this speech by Philadelphia Fed President Charles Plosser).

The other question, of whether a higher target, or a different one - such as a target price level (inflation is the rate of change of the price level) or nominal GDP - would be better is an interesting and important one.  The difficulty now is that, having established a monetary policy rule, the credibility of any new rule could be diminished by a change in rules.

Economics Navel-Gazing, Curricular Edition

A group of economics students in the UK have undertaken a movement to reform the economics curriculum.  I'm a little surprised that I haven't run into similar sentiments at Wesleyan - I can't decide if I'm disappointed or relieved by this.

The criticisms seem to me to be based on a somewhat unfair caricature of economics and economists, that we're head-in-the-sand apologists for "neoliberalism" who use mathematics as a form of obscurantism and have little useful to say about the "real world," particularly in the wake of the financial crisis.

Some of this may be rooted in the fact that the "economics" articulated by politicians, government officials and the press - what Simon Wren-Lewis has called "mediamacro" - does not reflect the views of most of mainstream academic economics.  In particular the obsession with government budget deficits is not based on textbook economics (I discussed an example of this misconception in a European context a couple of years ago).

Markets are at the heart of economics - this may be where the view that economists are "free market fundamentalists" comes from.  In introducing markets, though, there are really two main points to make:
  1. The gains from exchange and specialization possible from voluntary trade (i.e., Adam Smith's "Invisible Hand"), and the ability of markets make to adjustments based to dispersed information about what Hayek called "the particular circumstances of time and place" which would be un-knowable to any central planner.
  2. While economists need to make our students aware of the hidden and under-appreciated role markets play in organizing society and in lifting humanity out of subsistence-level poverty, we also devote a considerable amount of attention to how they fail.  In particular, problems of monopoly power, externalities, public goods and asymmetric information are standard subjects for introductory economics courses.  (2a., There are also reasons to be skeptical in practice of the ability of our political system to effectively correct market failures).
We do suffer from an excess of libertarians who mistakenly believe that economic theory validates their views - I usually think of these people as students who stopped listening after they learned about point #1 in first several weeks of their principles courses (or put too much weight on #2a).  But these folks are a minority in economics, though perhaps a vocal enough one that students and other outsiders might believe they are more representative than they really are.

We typically introduce markets with the model of "supply and demand," and the exercise of thinking in terms of models provides much of the lasting value of studying economics.  Working with economic models can sharpen students' logical and critical thinking skills immensely.  As John Cochrane nicely put it recently, "economic models are quantitative parables, not explicit and complete descriptions of reality." The criticism that models are "simplifications" is a cheap one - writing down a set of assumptions in mathematical form and working out the implications (and then testing them against data), is where the insight comes from.  The discipline of doing this cultivates an ability to think intelligently about tradeoffs and hidden costs, and to trace conclusions back to underlying assumptions and consider how changing assumptions lead to different conclusions.  Since models are, by necessity, very stylized descriptions of the world, students of economics must not only learn how to work with them, but also how to judge which simplifications are appropriate for a given circumstance or question.  As Keynes said, "Economics is the science of thinking in terms of models joined to the art of choosing models which are relevant to the contemporary world."

So I think the core of what we try to do in our introductory economics courses - introducing markets (both their successes and failures), and teaching students how to think in terms of models - is extremely worthwhile.  Of course, this does not cover everything that we possibly would like to do in a course (or in small set of courses).  Much of economics is concerned with the allocation of scarce resources, and the time that our students can spend on a course in a semester (both in and out of the classroom) is very limited, forcing some difficult choices on instructors.  Some of the criticisms made by the UK students seem to be about what we're leaving out, though I think what we're doing in our introductory courses is pretty important, and laying some groundwork in the economic way of thinking will help the students tackle issues like understanding the financial crisis, either in later classes or independently.  While many of the debates in the news are about macroeconomic policy (and as a macroeconomist, I'm happy to see the revival of interest in the topic, even if arises from unfortunate sources), the core microeconomic concepts are very important and not to be skipped.  While it can be exciting to be teaching a subject that is relevant to contemporary events, we should not be seduced into bringing "news" into the classroom in a way that interferes with developing an understanding of the fundamentals.

There is sometimes a bit of a muddle in these navel-gazing discussions, too, between what should be in our undergraduate curriculum and the separate, but not wholly unrelated, issue of our research agenda and graduate curriculum.  I'm not entirely unsympathetic to the calls for "methodological pluralism" though I wouldn't go as far as the UK students would like.  I have argued for graduate study of the history of economic thought, and I have emphasized it in my undergraduate teaching, using it as an organizing principle for my intermediate macroeconomics class (and also making my intro students read some Smith, Hayek, Friedman and Keynes).  As a field, I do think macroeconomics is at a point where we should be open to reconsiderations of some of the standard tools (though I don't think that is ever not the case), and I worry that the "publish or perish" incentives we all face mean that we do too little of that.

Karl Whelan of University College, Dublin has a written nice essay "Teaching Economics 'After the Crash'" with a more detailed response to the UK students' criticisms which is well worth reading.