Do people know what the Taylor Rule is?

The current doctrine in monetary policy is that central bank need to be very clear about their policy rule so that economic agents can form good expectations about the future path of interest rates and inflation. Whether this communication policy can be questioned, at least from anecdotal evidence, as many people are currently convinced that inflation is currently close to double digits and we are heading towards hyperinflation. But that is only anecdotal. There is better evidence, from the Michigan Survey on Consumers, which ask questions about expectations of future economic conditions.

Carlos Carvalho and Fernanda Nechio ask whether those expectations are consistent with the Taylor Rule that underlies much of monetary policy (at least when the nominal interest is not bound by zero). It turns out that by and large, they are, expect for those with lower education. Surprisingly, the Survey of Professional Forecasters yields less consistent predictions of interest rates and inflation, as if those professional were not believing in the Taylor Rule. It is rather puzzling that the public knows better the monetary policy than the professionals, or is it that the Fed manages to fool the general public, but not the forecasters?

On the advantages of hiring undocumented workers

There is a long standing debate in the United States about undocumented workers, and a more recent one in Europe as well. The debate is on two fronts: the public services they receive without paying taxes (in most cases), and the jobs they take away from local and the resulting pressure on local wages. In the second case, an easy solution would be for firms to stop hiring undocumented workers. But the incentives are not aligned for that, unless one puts prohibitive fines on firms doing illegal hiring.

Indeed, David Brown, Julie Hotchkiss and Myriam Quispe-Agnoli find, using administrative data from Georgia, that such firms have a competitive advantage over those the do not hire undocumented workers, or fewer. This advantage translates into a much higher survival rate, especially for little diversified firms requiring low-skilled workers. This looks like a prisoner's dilemma: if your competitor hires illegals, you have to as well, and vice-versa. But you would both be better off without, as there are legal ramifications.

Maybe those legal ramifications need to be trumped up. Indeed, the advantage of hiring illegals is often that they are willing to undercut minimum wages or various benefits legal workers have rights to. One way to avoid this this is to give illegal workers the same rights as legal workers, as I have argued before. This is actually in the interest of documented workers, as there is then less demand for undocumented workers.

Increasing public debt is a consequence of financial liberalization and inequality

The current debt crisis is the culmination of a long process of public debt accumulation over the last three decades in developed economies. Why this trend? I do not think it has suddenly become fashionable for governments to go deeper in debt, or that suddenly we came up with policy prescription leading that way more than before.

Marina Azzimonti, Eva de Francisco and Vincenzo Quadrini think it has to do with financial liberalization and globalization. The fact that more financial instruments and opportunities are now available certainly must contribute. There is already considerable evidence that the emergence of new borrowing instruments has increased household borrowing in the US, in particular for unsecured debt (credit cards). What these authors show is that a key component in the endogenous increase in public debt is a concurrent increase in income inequality in a political equilibrium. Public debt is beneficial because allows intertemporal smoothing. But at some point, higher debt leads to interest rates too high for the good of a majority. Interestingly, the model shows that it is not necessary for inequality to increase in all countries for this to happen. Globalization leads to a world-wide market, and local interest rates are largely determined on that market.

Why do people let life insurance policies lapse?

Life insurance is complex matters, and some say this is why you need the visit of an insurance salesman to understand the policy option (and other say this is to trick you into paying too much). But it is true that people sometimes make pretty stupid choices with their life insurance. One of them is to lapse their policy: stop paying their premium. The reason this is stupid is that policies are front-loaded: as risk of death increases with age but premiums are constant, a policy holder pays more than an actuarially fair rate during the first years and is rewarded in the later years. A lapsing policy is thus pure profit for the insurance industry, and it is factored in in premium calculations.

Hanming Fang and Edward Kung report that all this is now subject to upheaval due to the emergence of the life settlement industry, which takes policies about to lapse over, pay cash to the holder and continue paying premiums to the end of the policy. Because of the lack of lapsing profits, life insurance companies thus do have to increase premiums or leave the market. The latter would probably mean a loss of welfare for households. But the cash payment may be a welfare improvement, depending on the circumstances of lapsing. If it is because a policy holder lost interest in leaving a bequest, welfare is lower because he does not really need the cash plus faces insurance reclassification risk. If it is because of an income shock, then a cash payout is of course welfare improving.

Fang and Kung study how the life settlement industry should be regulated to maximize household welfare, under the constraint that one cannot observe why a policy holder is lapsing the life insurance policy. They try to find whether one or the other shock dominates and thus which way welfare would go. For the old policy holders, who are the huge majority, it appears the no shocks emerges as more important, thus they do not really have an answer.

The perpetual lag of macroeconomics teaching

When it comes to teaching, nobody likes revamping lecture notes and reforming a curriculum. This is especially true when one is oneself not really conversant in the new material. While I think a Economics PhD should be able to teach almost any undergraduate Economics class, one is still drawn to the path of least resistance and teach only what one knows, even when this is outdated. One consequence of this is that undergraduates get to learn what the profession discredited sometimes decades ago. Nowhere is that more true than in Macroeconomics, which went through a transformation in 1970's and 1980's that to a large extend shelved IS/LM, yet the latter is still the core of undergraduate teaching. The fact that those teaching this today were taught IS/LM is the prime reason, and the textbook writers accommodate this.

Some have called current macroeconomic theory wrong with the current crisis and thus there would be the need to a change in research paradigm and thus also teaching. I am not sure about this claim, I would rather call macroeconomic research before the crisis incomplete rather than wrong. As to the teaching reform, that will take ages. One way to the someway fix the broken IS/LM model to make it more amenable to current events, like Peter Bofinger tries by introducing involuntary unemployment that does not necessarily come from wage rigidity. There have been other such attempts, but frankly, they just make the model even less believable and impossible to teach. The true reform should be to drop IS/LM entirely from the undergraduate classroom, except for History of Economics classes.

Religion and the quality of public institutions

It is now well established that good institutions are crucial for a healthy economy. But you do not create good institutions with a magic wand, and they do not export well from one country to the next. So what makes good institutions? For one, former colonial masters matters, in particular former English colonies tend to have better institutions than other former colonies. At least for those countries, the origin of the legal system matters. For more developed economies, this is less obvious.

Niclas Berggren and Christian Bjørnskov find that religiosity, as measured by how important religion is in daily life, has an impact on institutional quality, especially in democracies. A negative impact. This seems to indicate that religion has some devious implications on the democratic process. How still needs to be established, though, but seeing how churches try to influence the political process, especially by getting poor people to vote against their interests, that does not surprise me too much.

About the strange response of consumers to gas tax increases

When we think of price elasticity of demand, there is no reason to think that it would be different depending on the reason the price has changed. The quantity of apples you demand will be lower by the same amount whether the price has increased due a tax increase, a lack of supply or a typo by the grocer. To a large extend it is so because you generally do not know why the price has increased. But even if you knew, would that make a difference?

Shanjun Li, Joshua Linn and Erich Muehlegger
find it does for gas prices in the US. A five cent increase in gasoline taxes reduces consumption by 1.3% in the short-run. The same increase in the after-tax price reduces it by 0.16%. How can the difference be so large? First, you have to wonder whether the tax change covaries with something that has an impact on consumption, and that was not taken into account. To be honest, I cannot think about a good reason. Second, could these estimates be very imprecisely estimated and thus not significantly different from each other? The coefficients seem rather tightly estimated. Third, tax increases are widely announced and anticipated, and consumers thus can prepare themselves by filling the tank just before the change takes effects. That is not the case with market fluctuations. Yet, some of the difference persists in the long run. Do tax changes have a signaling effect that prompts households to change habits? The paper seems to allude to that in the sense that there is a change in fuel efficiency after tax changes that is largely absent after other price changes.

Currency unions and trade

One of the supposed benefits of monetary union is that it leads to an increase in trade. The basic mechanism is that the exchange risk disappears and thus also the (implicit) insurance cost of that risk. How large the impact of this particular trading cost is, or its disappearance, is not well established in the empirical trade literature.

Douglas Campbell tacks a new tack at this question using a dynamic gravity model. He uses historical instances of countries breaking away from a currency union, thus the question is somewhat different from what I indicated in the leading paragraph, especially as the dynamics may be quite different. Also, the circumstances leading to a breaking up (think of the current possibility of Greece leaving the Euro) can lead by themselves to fluctuations in trade, especially in the short term. It appears, the earlier literature largely ignored these circumstances. Taking them into account reduces the impact to a measly 1% of trade volume, although quite imprecisely estimated. The consequences of Greece leaving the Euro may thus not be of much significance, especially on the trade front.

We all have self-centered beliefs about others

It should be no surprise that people tend to think they are better than average, or at least that they think they are better than they truly are. The only possible exception I can think to this optimism are Southern European who seem to constantly self-deprecate themselves. In some ways this is disturbing news, for example when we think about rational expectations: our theories say people should not be making systematic mistakes.

Eugenio Proto and Daniel Sgroi go even further. They find that people perceive the distribution of the others to depend on their own place in the true distribution. In probably better words: If you are in the tails of the true distribution, you perceive to be closer to the center than reality. I think the most likely explanation for this has to do with the fact that we do not interact with the complete distribution of people, but most likely those that are most like oneself. I tend to interact mostly with highly educated people, because of my profession, and thus I tend to think most people are well educated, notwithstanding my disappointments when teaching undergraduates.

With respect to rational expectations, the next questions is whether these personal biases cancel out in the aggregate. Possibly, but this misses the true concern. While most aggregates may not be affected by this kind of bias, the distribution of outcomes may, and this could even affect some aggregates (say, savings, human capital). How much? I really do not know.

Inter-provincial risk sharing in China

Despite widespread claims, China is still far from a capitalist economy. There is still a considerable amount of command-and-control, and the state-owned enterprises still comprise a large and heavily subsidized sector of the economy. One aspect of a command economy with a (still) poor finance and insurance sector is that it can enforce some sharing mechanism to alleviate the consequences of local business cycle shocks or offer some redistribution across geographical regions. Such mechanisms are also in place in Western economies, mostly implicitly (for example, a national unemployment insurance) and when it is explicit, it leads to tensions as some always pay and some always receive (examples: Canada, Bolivia). Anyway, back to China.

Julan Du, Qing He and Oliver Rui find that the state-imposed fiscal channel of redistribution during the business cycle has a relatively minor impact: it dampens business cycle fluctuations by only 9%. A much larger impact comes from movements in labor, which is actually surprising as the state actively impedes such movement with an internal passport system and undocumented workers face major hurdles for public services. Still an in all, there is very little inter-provincial smoothing going on. I would have expected the central government to do a much better job in this case.

Bruno Frey: the epilogue?

A little less than a year ago, a controversy erupted about the publishing practices of Bruno Frey and his students. Indeed, they tend to repackage their research and submit it to multiple journals simultaneously (or sometimes successively), without cross-references and without alerting editors to this. This is in clear violation of the submission conditions of most academic journals and even goes against principles Bruno Frey has himself advocated in multiple (of course) publications: there is not enough space for everyone to publish on the one hand, and the pressure to publish leads people to (self-)plagiarize on the other hand. On his homepage, Bruno Frey crows about over 500 or 600 publications, depending on where you look, numbers that are completely surreal for any self-respecting academic economist.

The scheme blew in his face when some editors and some blogs started raising questions when very similar articles about the Titanic, with Benno Torgler and David Savage, appeared in four journals (some say there is even a fifth one in German, but I cannot verify). And the article was not even original, as a similar analysis was done and published 25 years prior and is now standard reading and exercise in statistics courses. Newspapers picked up the story, Frey went into denial but finally confessed to the editor of the Journal of Economic Perspectives, who published correspondence about the case and publicly admonished him for multiple submissions (he do not yet know about the prior literature). But that is only for this case, there are all the other ones. The University of Zurich, from where Bruno Frey recently retired, promised an investigation. That was sometime in the Summer. Since then, nothing.

One could suspect the University would do nothing, as Bruno Frey is the best ranked economist in German-speaking universities. And the prolonged silence clearly seemed to corroborate this. But rumors started circulating in the hallways, rumors that were not encouraging at all. But no evidence from Zurich.

Finally, I got good evidence from a reliable source. And it is indeed not encouraging. The University of Zurich mandated three prominent academics to look into the case. But the mandate was formulated in such a way that only the articles about the Titanic could be analyzed. The experts came to the obvious conclusion that unethical behavior was at play for this case. They could not mention the others and thus the University concluded that this was a one off miss-step. The University gave Frey a verbal admonishment, which does not go on his record, and did not release the report.

But this was not an one-off miss-step. Frey has been banned from the editorial board of Public Choice for a similar case of re-publication. He is by now banned from publishing in at least a half-dozen journals. To make matters worse, he has himself advocated to go against plagiarizers and others that unnecessarily take up valuable publication space. The investigation should have looked at his whole career, like when a scientist is suspected of fabricating data and all his publications are subject to scrutiny. And it is not like the information would be difficult to obtain, it is readily available and people have even compiled it, as documented in the FreyPlag Wiki.

For more about the case, you can read my past blog posts: 30 April 2011, 3 September 2011, 27 September 2011. Also, Olaf Storbeck's Economics Intelligence blog was the one that convinced the University of Zurich to finally (pretend to) act: 4 July 2011, 4 July 2011, 5 July 2011, 6 July 2011, 7 July 2011, 9 July 2011, 20 August 2011, 29 August 2011, 12 September 2011

Why Scandinavian social policies work

Scandinavia is a mystery: marginal tax rates on labor income are astronomical, yet labor force participation is high, even higher than in the United States where tax rates are much lower. In addition, they is an impressive social safety net, which should also depress the labor supply, yet it is high. No standard economic model would be able to predict anything close to this, and the question is thus what is so special about Scandinavia.

Torben Andersen (the one living in Denmark) has an answer. He claims that this has to do with how the social safety net is designed. First, it is build in a way to never exclude anyone, thus there is much less marginalization and fewer people who have abandoned the labor market. Second, the social safety net provides services in a large part only conditionally on participating in the labor force. But this is not like workfare in the United States. The level of support is much higher, and thus there is a stronger incentive to try to work. But high support acts like an implicitly high minimum wage, which has consequences for labor demand. To overcome this, a strong emphasis is put on education to keep the proportion of working poor small. Education is basically free and retraining for adults is also offered (and used).

All this points towards an implicit social contract where the state provides education and insurance, and in return is getting paid through taxes when income is available. Whether this works out better than a model where the state does not intervene and people have stronger incentives to improve their well-being, but not necessarily the ability, is ultimately an empirical question. And it is not clear their is a middle ground. Considering the corner-solutions (US and Scandinavia), it is not obvious one Pareto-dominates the other.

Unemployment insurance only for the rich

Designing an unemployment insurance system is tricky, because you want to discourage shirkers (cheaters who refuse job offers or search too little, yet get benefits) while still providing well-being enhancing insurance. There is a big literature on this, with now a new paper with a rather odd result.

Sebastian Koehne and Moritz Kuhn look at an economy where households cannot borrow, but can accumulate assets. People who save well ahead do not need to be that much insured, so the moral hazard of shirking should not be that important. Also, you want more savings to generate more capital in the economy. The results is that unemployment insurance benefits should rise with wealth, as they implicitly increase the return on assets. But this also increases the unemployment rate. I suspect it is the rich who are now shirking in larger numbers, and as they are rich, the results loss in consumption does not matter much for welfare, as the have a lower marginal utility of consumption. I am still surprised, though, that a one percentage point increase in the average unemployment rate can increase welfare. Maybe it has to do with the assumption that UI benefits in the US average at 50%, which may be true for those who are eligible, but is much lower when you factor in those not eligible.

Women do not patent

A frighteningly low proportion of patents are granted to women, 7.5% in the United States, while only 5.5% of those that are commercialized are from women. Maybe they are of a more generous nature and realize how progress-crippling patenting can be these days. But I doubt this effect can be that strong. The elephant in the room is of course the low proportion of females in sciences and engineering professions. It cannot be the only explanation, because females have a higher share than 7.5%, but it is a start.

Jennifer Hunt, Jean-Philippe Garant, Hannah Herman and David Munroe claim the missing women has little to do with their proportion in the science and engineering fields. Rather, the culprit is the lack of women in science and engineering jobs that involve development and design, in particular electrical and mechanical engineering. What pushes women out? Lack of interest, abilities or discrimination? The paper is silent on this (except for hurdles in the promotion process) but ventures to say that correcting this would increase GDP by 2.7%. This number is based on the idea that if more women were working in those fields, there would be proportionally more patents, and GDP would be proportionally higher. I do not think this is that simple.

Stock market trader inattention and major sports events

Whenever some important sports event looms, the popular press inevitably comes up with articles about the loss of productivity during said event. The quoted numbers have always been a mystery to me, as I have yet to see any serious study about this. Well, now there is one, sort of.

Michael Ehrmann and David-Jan Jansen analyze stock market activity during the 2010 FIFA World Cup in South Africa. Using minute by minute activity from 15 stock markets, they find that there are markedly fewer trades when games are on, especially when the home side plays, roughly half of normal trades. That may be because traders are less attentive to markets, but also because domestic investor are less on the ball, so to say. The effect is amplified by goals.

There are other times when attention is decreasing, such as lunchtime. The decrease in trades may have some welfare implications, as some arbitrage opportunities are not taken. However, it appears to be more serious that there is a change in patterns for prices during those football matches, unlike lunch time. Indeed, the cross-section of returns across firms is lower, and the correlation of domestic prices with world prices drops by 20% when a game is on. I cannot quite quantify how much of a welfare consequence this is, I would need a model for that, but I guess this is not negligible. NB: these effects are also present on US stock markets, despite the marginal interest in soccer.

The cost of US fiscal imbalance

It is obvious that the US government is currently spend more than normal. It is also obvious that the current level of deficits is not sustainable. But just how bad would it be if the current fiscal imbalance would be maintained? We have models that can calculate welfare costs of such policies, but because the current policy is not sustainable, it is impossible to solve them and get a number. The only solution we can have is to look at what it would cost to delay going back to a sustainable path.

Bertrand Gruss and José Torres do with a heterogeneous agent DSGE model. According to their results, postponing the return to a sustainable path (defined by a pre-crisis debt/GDP ratio) by two decades leads to a permanent loss of output of 17% and a consumption equivalence loss of 7%. That is gigantic. The losses come mostly from the long run, thus it is all about whether the short-term gain is worth the long-term cost. To understand this result, it is thus important to understand the model.

This is a model of occupational choice (entrepreneur/worker), with idiosyncratic employment risk, no borrowing at the individual level, distortionary taxation and lump sum government transfers. There is another public good, wasteful government spending. A major role of the government is thus to insure agents against shocks, which they can also self-insure with accumulating Treasury bonds. Everybody knows exactly the path of policy. There is no aggregate shock except for fiscal policy. To summarize, the only beneficial thing the government does is insure people against shocks, to some extend. Otherwise, the government is harmful: it takes away goods to destroy them and distorts household choices in adverse ways to finance this. It is then no surprise that almost any government spending is harmful, no matter what the circumstances. In particular, the fact that there could be, for example, a temporarily very high unemployment rate that justifies larger public expenses is ignored here.

In other words, the model ignores the potential benefits of current deficits. Not very useful.

Are poor American voters disenfranchised to improve long term growth?

Now that the election process is in full gear in the United States, it is of interest to reflect on its peculiarities. Of course, the process is convoluted, money and marketing are the dominating factors, and catering to outrageous viewpoints brings points. But one aspect that distinguish US politics from other countries is the surprisingly low voter participation, especially among the poor.

Ranjan Sreedharan sees this as an advantage that the United States has over other countries. As the rich can rule, they put forward policies that can enrich them and then rein in welfare. The outcome are policies that favor long term development. And why do so few poor people vote? For one, many are outright excluded from voting: no fixed address, past felon. Also, voting days are not holidays and the poor, who typically hold jobs with hourly pay, find it difficult or costly to vote.

While I may not like the rhetoric of the paper, the author has a point. The Unites States has a long history of disenfranchising the poor, right from its first days where only white male land holders could vote. Slavery and segregation and gerrymandering have provided additional opportunities for rigging the relevance of votes. Corporations have always had a strong influence in the nation's capitols, with courts increasingly allowing legal bribing of elected officials. Republicans have been the leaders in disenfranchising (previous post on this), yet Democrats have not done much to prevent it. In the end, the poor voter does not matter anymore.

About the cult of statistical significance

A large part of economic research is devoted to empirical studies, and the name of the game there is statistical significance. Once you get an interesting effect being significant, it becomes a study worth writing, and possibly publishing. If you cannot find an effect, then try another specification until it is statistically significant. Nobody will know how much you tried, the one that is significant is all that counts. If one cannot find a statistically significant result, a null result, publishing it becomes really difficult. This game of finding statistical significance is unfortunately misleading, as this hunt dominates theory or even common sense when choosing specifications, and often completely neglects economic significance. What if a statistically significant results is tiny even though it is precise? And what about a large effect that is statistically weak?

I am certainly guilty as well of confusing statistical and economic significance, including on this blog. Indeed, it is often difficult even understanding what the size of the effect is, because the specification does not allow one to relate the effect to something tangible.

The reason I am mentioning all this is that I came across a recent paper by Walter Krämer, who tries to revise the argument made by Stephen Ziliak and Deirdre McCloskey that any statistical significance is useless. While he seems to concur on the general abuse of statistical significance, he claims it can still be useful under some circumstances. And these are when you do exploratory testing, as it allows to discard unviable hypotheses or specifications. But one has to remember, even though this is elementary statistics yet so often ignored, one can only reject or not reject, but never accept a hypothesis. So even the exploratory testing has its limitations.

Why encourage more students to choose scientific careers?

Everyone is calling for more students to go for diplomas in the sciences, with the idea that why need research and development to promote growth. Everyone is also lamenting that today's students are not prepared for such careers because they are lacking in mathematics skills. So it becomes a real struggle to get students interested in those fields, especially women. It is one thing to get students to take one such studies, it is a different struggle to keep them there. For one, it is a tough field to study and many abandon and go for easier topics. Those who end up graduating in sciences must be seriously dedicated to become scientists.

Not quite. Surveying British graduates, Arnaud Chevalier finds that half works outside of scientific fields within three years. Worse, having a science degree bring no wage advantage outside of sciences. In other words, they endured and persevered through science studies for no visible advantage over those who when through business, political sciences or psychology. This raises the question why everyone is pushing so hard to channel students to the science fields. There does not seem to be a market for them after graduation and/or many to do want to work in the scientific field anyway, as satisfaction studies seem to be revealing, including this one.

How to regulate prostitution

While being the oldest profession, prostitution has always been a thorn in the eyes of authorities. The market clearly says it satisfies a demand, but it goes against some moral code. Banning it has never been an efficient solution, in particular because it leads to crime and adverse health outcomes. A better way may be to regulate it in some fashion, but how?

Giovanni Immordino and Francesco Flaviano Russo may have found how, and it involves the prohibition of buying sex, but no limit on selling it. Legalizing selling sex is interesting because it allows taxing it and makes it possible to reduce STD infection rates by applying health policies. What is striking it that the policy for prostitution is the exact opposite of the policy applies in some countries for illegal drugs: decriminalizing consumption and sometimes buying but criminalizing the sale. From what I could see, this seemed to work relatively well. While the tax aspect is the same as for prostitution, the health one is different. By making drug consumption legal, one has better access to consumer to apply health policies, while sellers are of little use in this respect (except when they cut the drug with more harmful material).

How thieving elites can prevent rebellions

The Arab Spring and to a lesser extend the Occupy movement have renewed the interest in political or economic elites and how they manage to stay in power (or not). An extensive literature has already highlighted that elites need to give just enough to the plebs to prevent a rebellion, which can be quite low especially if you have a strong policy or military that is widely represented in the general population yet enjoys significant privileges. But the literature has always concentrated on a model of the elite against the people. What if there could be a potential elite that could try to overthrow the incumbent one?

Bernardo Guimaraes and Kevin Sheedy look at such an eventuality. It should not surprise anyone that an incumbent elite will design institutions that share power to some degree. More interesting is the result that institutions need to guarantee property, and elites need to show restraint in their expropriations. And that is especially good, as plenty of empirical evidence shows that better property rights lead to better aggregate outcomes. Yet, the existence of the elite still leads to too little power sharing and property rights, but more than if others could not overthrow it. According to this theory, Arab leaders went to far in their kleptomania and thereby encouraged rebellions. Let us hope their successors do better.