When restricting access to financial markets is good

In standard economic theory, any friction that inhibits the clearing of markets or efficient allocations is viewed as bad, and so it should. But there may be some situations where adding frictions leads to better outcomes. One example is the Tobin tax of financial transactions which is thought to prevent excessive speculation and volatility.

Aleksander Berentsen, Samuel Huber and Alessandro Marchesiani have come up with another potentially useful friction. Imagine a world where economic agents face individual and aggregate shocks to liquidity, and there are liquid (money) and illiquid asset markets. Of course, they will want to use these assets to insure themselves against these fluctuations. One way is to accumulate liquid assets yourself. Another is to acquire them from others when needed. But because the latter option is easily available, there is not enough aggregate liquidity as its price is too low: people do not factor in the positive externality on markets of getting more liquidity. The authors argue that this effect can be so strong that it is worthwhile curtailing financial markets so that agent accumulate more liquidity for themselves (and others).

The Fed is very good at forecasting inflation, obviously

There was a time where central banks liked to surprise markets. Macroeconomic theory dictated then that central banks should be secretive and could only be effective if they could fool the market's expectations or play on the fact they have some privileged information. After the disastrous inflation of the 1970's, central banks have completely reverse course and are now models of openness. They go as far as publishing their economic forecasts, even with various scenarios, explain in great detail their policy, in some cases even publishing the Taylor rule they follow. Is there still some asymmetric information left? If central banks still manage to forecast information better than markets, then yes.

Bedri Kamil Onur Tas uses the Fed's Green Book forecasts for inflation and the federal funds rate, which are released with a five year delay, to find that the reason the Fed has better forecasts is that its FFR forecasts, which is its own policy instrument, are used and are better than the market's forecasts of the FFR. What this long sentence means is that the Fed knows better its future policy stance, and it uses this efficiently in its inflation forecast. What this also means is that the Fed could still improve the way it communicates its policy intentions.

Leaning against publication bias: about the experiments that do not work out

It is quite obvious that journals will only publish results that are significant in the statistical sense. If it turns out that X does not influence Y, in most circumstances there is little interest from editors and referees. Yet, this could be valuable, especially when this was rather costly to do. You want to avoid having someone else waste resources trying to do the same thing. And nowhere is this more important than in the outrageously costly experimental literature. (Yes I realize results could still be published as a working paper, but few people write working papers without the initial intention to publish).

Francisco Campos, Aidan Coville, Ana Fernandes, Markus Goldstein and David McKenzie report on seven such failed experiments, where it was not simply the lack of significant results that was causing trouble, but rather that they never came to the evaluation phase. While no designer of experiments will ever cite this paper, everyone should read it. Why did these experiments fail? Delays, hindrances from politicians, and low participation. The authors think this occurred because of some idealized vision of the experiment by the designers that cannot be translated into the field. In particular, one needs to cope with the local political economy, the incentive of field staff, and be a bit pragmatic in terms of program eligibility criteria. And in the end, if the experiment is not properly randomized, one cannot draw conclusions from it.

I wonder how many millions have been wasted on failed experiments that nobody hears about and nobody can learn from. And that is without counting the millions wasted on experiments that are impossible to generalize, and thus not useful even if "successful."

The unemployed should shop less for bargains, and they would not be unemployed

It sucks being unemployed. You have a significant loss in income and your self-esteem takes a hit, for example. However, you enjoy significantly more leisure time (as mentioned earlier, job search takes on average a ridiculously small amount of time). That leaves unemployed people also with plenty of time to do bargain shopping.

Greg Kaplan and Guido Menzio remind us that this negative externality also works the other way: when a company hires someone from the pool of unemployed, this person does less bargain shopping and increases the profits of other companies. Kaplan and Menzio manage to measure these externalities and argue they are strong enough to generate strategic complementarities that can trigger self-fulfilling equilibria. And in such case, expectations become very important. Another reason why I think it was a very bad idea for Paulson and Bernanke to publicly hit the panic button in 2008 (see I, II).

About growth miracles and lost decades

What makes countries grow? That is probably the most important question in economics, especially when you think about the huge differences in economic well-being across the world's economies. Yet, we do not have good answers to date, except for explaining obvious growth disasters (North Korea and Zimbabwe come to mind). Empirical work may have identified some regularities ("institutions", "distance from equator"), but these factors are either vague, not that robust, or difficult to explain. In particular, why is it that some countries suddenly grow fast while similar ones go into prolonged stagnation?

Recent research by Nancy Stokey shows that the distance between growth miracles and "lost decades" can be surprisingly small in theory. Add to this more complexities of real economies, and I surmise they could even overlap according to observables. Her point is the following. Using a rather bare bones model with technology (which flows from abroad) and human capital (which needs to be accumulated domestically), she shows that there are multiple equilibria depending on initial conditions and policies. The key is that there are positive reinforcements in both directions between technology and human capital. More technology makes human capital more productive (and worthwhile), while more human capital makes adoption of new technology easier. Start with little human capital, and you'll never notice all the technology that is available and your economy is trapped in poverty. With a lot of human capital, you never miss a beat on what is new out there, and your economy grows.

Policy in here is represented by barriers to technology inflow and subsidies to human capital accumulation. Changing such policies can have a dramatic impact. A stagnating economy can tip over to a growing one with little change in policy, and as this economy is now catching up to the others, grow rates are impressive. Or small changes the other way can get an economy to suddenly stall. In Stokey's calibration, lowering barriers is more effective, because human capital accumulation takes away resources, but I am not convinced there is that much of a difference as human capital will end being accumulated anyway.

Can IKEA replace the BigMac or the Ipod?

When a good is exported and exchange rates fluctuate, how much of the exchange rate change is reflected in local pricing? Establishing the extend of this pass-through has been the subject of an extensive literature over the past years as international price datasets have been made available. A major difficulty is with the coding of the goods, and one is not always sure that goods in different countries are comparable.

Anthony Landry and Marianne Baxter fix this issue by looking at the IKEA catalog in six countries over seven years. Part of the IKEA catalog is marketed in several countries, and these goods are identical and produced in the same country. The prices are valid for a full year, though, so the prices also reflect how the company thinks the exchange rates will move over the next year (How does IKEA do in high inflation countries?). Pass-through is estimated to be about 14-30%, which is low but may reflect the fact that the forecasts made by IKEA end up being smoother than actual exchange rate movements.

There is one aspect that I find very exciting in this data. Could the IKEA be a replacement for the Big Mac index that the Economist has popularized? The latter measured whether currencies are over- or under-valued by looking at exchange rates and local prices of a supposedly uniform good. As I argued before (I, II), the Big Mac is, however, not uniform, and meat or other components are sometimes local and of different quality, especially because there may be some local regulations for food products. In addition, a Big Mac contains a service component that is priced in as well, and MacDonald restaurants are definitively not comparable across countries. I better indicator was the iPod index, as this is a uniform good across all countries, unfortunately it looks like the iPod is going to go the way of the dodo within a few years. Could the IKEA catalog be the a good candidate? I think so, as it contains many goods that are available in several countries, and thus we have ways to take into account when a good is dropped from distribution. The drawbacks are the limited number of countries (IKEA is present in 40) and the annual frequency. And the fact that IKEA is making bets over future exchange rates with its pricing.

Reconciling macro and micro estimate of the Frisch labor supply elasticity

If you manage to get a labor economist and a macroeconomist to talk to each other, invariably the conversation will turn to the fact that macroeconomists use a Frisch elasticity of labor supply that is much too high to what microeconomic labor studies seem to reveal. And both will absolutely stand their ground and treat the other with disdain. This mutual frustration has gone for a long time as it has been extremely difficult to reconcile micro and macro estimates. One solution to this is to accept that they are going to be different, even when estimated wit the same dataset (see previous post). But that does not seem to have settled the debate.

William Peterman points out that microeconomic estimates are usually drawn from a sample of white married male heads of household. These are probably the least flexible in the labor force, so you should not be surprised that their working hours are little affected by wage changes. It is a different story for females and dependents, and once you include them in the sample, voilà you have the typical macro estimate of the elasticity, especially when the extensive margin (work or not work) is taken account of. In other words, macro and micro labor people are not talking about the same elasticity, so no wonder they are not getting the same estimates.

Why pay interest on deposits if depositors do not ask for interest?

In developing economies, savings decisions are characterized by an important lack of commitment. People are aware of this and try to overcome this with institutions that seem strange to us, like ROSCAs where you pay regularly into a club and you get your investment back without return at a random date. What seems foolish to us makes sense to someone who cannot resist spending (often out of necessity) but need to make a capital purchase. But then, why would banks pay interest on savings deposits, as they appear to do in these countries? People should be willing to save into illiquid savings vehicles for free, right?

Carolina Laureti and Ariane Szafarz show this is no that simple. Indeed, banks need the additional incentive of interest on illiquid savings to meet regulatory requirements for reserves. Also, the banks cannot differentiate well between rich and poor savers. The rich ones do not have this time consistency problem and require a return. Of course, one could have the interest rate increasing with the level of deposits, but that does not seem to be an option. In fact, I notice that, at least in rich countries, it is often the opposite, as if banks do not want large amounts in savings accounts. I wonder why.

The impact of valuation disagreement on asset prices

In properly functioning asset markets, the price is supposed to reflect the available information. Even when someone has privileged information, the price is supposed to reflect that as well, as the person with better information will buy or sell until the price is right. What if there is disagreement participants? Is this a sign of risk that is rewarded, or are things just averaged out?

Bruce Carlin, Francis Longstaff and Kyle Matoba have access to information from Wall Street mortgage dealers about their estimates of mortgage prepayment speeds. Their disagreement changes over time and this allows to show that more disagreement leads to a positive risk premium. Also, uncertainty in itself (as measured by price volatility) does not leads to trade volume bursts, you also need more disagreement. All this means that traders do form rational expectations, in particular because higher trading volume subsequently leads to lower disagreement.

Machiavellian missionaries

I have had recently the opportunity to chat with a missionary who has been working as a bush doctor in Western Africa. I find it quite admirable that a Westerner is willing to leave easy life aside and spend many years in the middle of an inhospitable nowhere to help others. Of course, the end goal is to spread Christianity, and I have no problem if these free health services are provided through a sponsor.

What I found very disturbing, though, was the approach to converting the locals. Indeed, missionaries tell these pagans that now that they know about God, Jesus and the Bible, they will go to Hell if they do not convert. They would have avoided that fate had they remained ignorant. The missionaries are devout Christians and believe this as well. Can we then really say they care about the locals? They willingly paint the pagans into a corner, threatening them out of nowhere with the worst possible outcome in their afterlife. What is then the point of making terrestrial life a little better? In the end, many locals would much worse off after the arrival of the missionaries.

Insure better against natural disasters

When Hurricane Sandy hit the East coast of the US, relatively few people died, there was considerable damage, but no long term consequences of significance are expected. The story is different with Hurricane Katrina, which inflicted damage of a similar order of magnitude but New Orleans and its surroundings are still feeling the hit. Look at similar weather events in developing countries and the recovery takes even longer, if ever. This should not have to do with the number of victims, as there is some evidence that sudden population drops actually improve conditions for the survivors.

Goetz von Peter, Sebastian von Dahlen and Sweta Saxena use data on natural catastrophes from a large reinsurance company and find that what matters for subsequent macroeconomic performance is not the cost of the damage, but the cost of the uninsured damage. It just so happens that the proportion of insured property increases with development. Yet another argument to encourage adoption of insurance policies in developing economies (I, II III, IV).

Large GDP shocks are permanent

Fiscal policy being in complete disarray and unpredictable in the United Sates, economic policy is currently limited to monetary policy. But even there, it is not blindingly obvious what the Federal Reserve should do. If economic activity is below potential (and is forecasted to remain so beyond the "long and variable lags" it takes for monetary action to have an impact), the monetary easing is in order. Define potential, and there disagreement starts. If you look at the evolution of GDP, you cannot help thinking that it went through a permanent downward shift and is now tugging along at the usual growth rate, simply a step below. This would mean we are ready to get off the zero interest rates:



That would go against the idea that there are no permanent shifts in GDP. But while there are usually no such shifts, maybe there are rare circumstances where they happen. Mehdi Hosseinkouchack and Maik Wolters test the unit root of US GDP not only at the conditional mean but also at the tails of the distribution using a quantile autoregression based unit root test. Ad they find that sharp declines in output, like the one we recently experienced, do indeed look permanent. We should therefore not expect GDP to get on the previous path, and this not treat the latter as our current potential GDP. Would the FOMC believe this? I doubt it.

Some people go to classical concerts to cough

Classical concerts comes with a set of very strict rules for the public: you cannot applaud while the music plays (the only exception being after opera arias), you are supposed to dress up, and there should be complete silence from the audience during the performance. And that urge to cough should be repressed until an applause. Yet, it turns out that coughing is more frequent during the performance.

Andreas Wagener ponders from an economic angle this apparent voluntary breach of concert etiquette. Norms at concerts are supposed to create conformity. Concerts are, to some extend, also a venue where you want to be seen. Being against the norm in subtle ways make you more remarkable. Parading naked would certainly get you noticed, but in a bad way. Coughing at the wrong moment also gets you noticed, but you can be excused unless you dared to go to the concert with a severe case of whooping cough. The cougher can always blame it on a bodily reflex that is unexpected and cannot be controlled. At it looks like the empirical evidence shows coughing is more prevalent in quiet moments of the concerts, when the benefit of coughing is the highest.

Concert halls will be packed in this flu season.

How costly is it to issue equity when capital gains are taxed?

What is the impact of capital gains tax on share prices? It should be rather high, as stock shares main point is to appreciate. But assessing this is difficult because people find all sorts of ways to avoid this tax, such as taking offsetting losses or exemptions. In addition, capital gains are only taxed when realized.

Harry Huizinga, Johannes Voget and Wolf Wagner find a trick to disentangle this. When there is a cross-border merger or acquisition, any assets subject to capital gains suddenly fall under a different tax jurisdiction as shareholders are located in different countries. As long as the M&A was operated with cash, a change in asset value should reflect the impact of the difference in capital gains taxes. From their database, the authors find that a one percentage point difference in taxes results in a 0.225% reduction in the share price at takeover, and calculating backwards this indicates that the effective tax rate is 31% of the statutory one. This means that the average capital gains tax in the OECD increases equity costs by 5.3%. It is then evident to find that where taxes are higher, takeovers are more likely to be financed by equity, as it does not imply a transfer of tax liability.

Why is barely anyone buying annuities?

I have written before about the fact that so few people take annuities upon their retirement. While several reasons have been proposed, the literature has dealt with them in isolation, which is not very useful.

Svetlana Pashchenko addresses all suggestion in one swoop by using a quantitative life-cycle model with uncertain lifetime and medical expenses, bequest motives and minimum guaranteed consumption. Calibrated to the US, the model determines four equally important factor that prevent annuities from becoming popular: 1) pre-annuitized wealth (pensions), 2) minimum annuity size, 3) illiquid housing wealth, and 4) bequest motives. Pricing of annuities, interestingly, is not a factor. Adverse selection is responsible for making them more expensive than actuarially fair, while it decreases annuity demand for the poor, it increases it for the rich (as they know they will live longer and have cash to buy annuities). Note that 3) is another puzzle to me, as reverse mortgages are also rare, and they would render housing wealth liquid.

Is the CRA responsible for the crisis?

An important component, if not reason, of the last recession has been the run-up in sub-prime mortgages until 2007. There has been much speculation what could have triggered this, for example distorted incentives in the supply of mortgages, poor evaluation of risk, or predatory lending practices. Also mentioned has been the Community Reinvestment Act, which was implemented to reduce discrimination of lending in poorer neighborhoods and, as its title indicates, encourage mortgage holding in these areas. Could the CRA be the big culprit?

Sumit Agarwal, Efraim Benmelech, Nittai Bergman and Amit Seru claim the CRA did lead to more risky lending. This is based on the fact that mortgages given around the time of CRA examinations were 15% more likely to default. That is not that much a surprise as poorer neighborhoods do have riskier mortgage holders and banks had incentives to lend more during those exam periods. The real question is whether the risk was assessed and priced correctly.

The paper is still of interest. It shows that the effect was the strongest among the large banks (those that got bailouts...) and was more important while mortgage securitization was booming. Banks thus are not clean here.

Teen sex: are female droping scruples due to the lack of men?

The marriage market unfortunately does not benefit from a mechanism design initiative like for kidney matching. It still is a difficult search with hits and misses. A not insignificant part of the process is the use of sex to attract potential matches. What would economists have to say about this?

Peter Arcidiacomo, Andrew Beauchanp and Marjorie McElroy model this market with a directed search model with male and females of different types and preferences. The search is directed in the sense that individuals look at the type of relationship (sex/no sex), the type of the person and the matching (mating?) probabilities. Clearly, if a gender outnumbers the other, it will go for matches that are high probability even though they are less-preferred. Beyond this, it is difficult to get results, thus they proceed to calibrate the model by using data from high school relationships. They conclude that men value sex more than women (big surprise) and that while some women would not have sex, they still agree to it because they are concerned they could miss on good matches when men are scarce. That could explain high rates of teen pregnancies is some parts of the US population where lots of men are in prison or simply not interesting because of low education compared to the women (the majority of high school drop outs are men).

The puzzling evolution of income inequality

There is good evidence now that income inequality is decreasing in some countries at an unprecedented pace. Income is the outcome of a series of factors, including human capital. So, what is happening with the human capital inequality? And what about countries?

Amparo Castelló-Climent and Rafael Doménech use the latest update of the Barro and Lee dataset on human capital to figure this out. They find that overall, income inequality has not changed in sixty years, but human capital inequality has significantly decreased. This has come through important improvements at the bottom of the distribution. The authors conclude that improvements in literacy are not sufficient to reduce income inequality. I would say that this is even worse. Indeed, the Barro and Lee dataset only counts years of education. But we know that the marginal contribution of an additional year of education decreases over an individual's schooling career. Thus improvements in literacy in developing countries should have had even better results in terms of income. At the aggregate level, the authors show the opposite, though. Puzzling.

Why so many debt defaults?

In the United States, declaring personal bankruptcy is an appealing way to get out of a bad debt situation and start with a clean slate because previous debts are set to zero. One would thus expect to see bankruptcy seen rather frequently used when people are unemployed. Yet, it appears that defaulting on debts is much more frequent and is used as an informal way to get unemployment insurance.

Kyle Herkenhoff established this and finds also that the many reason for default is not negative equity, but job loss and facing a borrowing constraint while debt payments constitute a large fraction of income. But when a person is cornered in this way, why not declare bankruptcy? Herkenhoff shows with a labor search model with individually priced debt that using default as unemployment insurance is worth more than the subsequent higher cost of credit. Mortgage relief measures are thus welfare enhancing, even though they lead to higher and more persistent unemployment.

PS: The paper title page says "Preliminary, do not cite." Then why put it in a widely distributed working paper series? Leave it hidden on your web page.

Why are prices sticky?

Why are prices sticky? I think it is crucial to understand this as it is the defining assumption of the whole New-Keynesian literature. Understanding this may have important implications on those models, as this can lead to differing rates of stickiness with changing circumstances, something the New-Keynesians conveniently choose to ignore. Oh, and there needs to be evidence of relevant stickiness, which is far from being firmly established.

Arthur Fishman finds one way to create price stickiness. Suppose that costs vary from time to time, the exact moment being random. Consumers must search for goods and learn about prices. Sellers can advertise, but it is costly. With some heterogeneity across consumers, some are going to be uninformed. Price rigidity then arises for two reasons: first, some sellers may forgo advertising if the expected duration of the current cost is too short; second, it is not worth advertising if a sufficient number of consumers does not search. This means that for price rigidity to arise, one needs cost flexibility. Kind of strange, isn't it? Even though there is some evidence that costs are more flexible than prices, the model has the implication that when costs become more flexible, prices become more rigid. Find that in the data.

Strange facts about inequality over the business cycle

The last recession has renewed interest about the distributional impact of business cycles. Clearly, not everyone is affected in the same way by a recession, and the massive policy interventions of the last few years also affected people differentially. For example, what what do we really know about the dynamics of inequality?

Virginia Maestri and Andrea Roventini use the database from a special issue of the Review of Economic Dynamics (which I discussed before). While the sample length is unavoidably short, including only a couple of recessions for every considered country, some general lessons can be learned: income inequality is counter-cyclical while consumption inequality is pro-cyclical. That is going to be tough to replicate in a theory. Imagine a recession. I can imagine that inequality becomes more severe because the people how typically have low incomes are more likely to lose their job. But why would consumption inequality be reduced? Unemployed workers do have lower consumption, and may in fact be more severely affected due to the lack of appropriate savings. So it must be that the consumption of the richer ones drops like a stone, and I do not see a model delivering this.

PS: I realize there was a large drop in income for the richest ones in this recession, and they recovered quickly. But this was not a typical recession.

PS2: And I still hate it when a paper starts on page 9, and the six last pages are back-cover material. What a waste.