Category Archives: current economic issues

What can scrapping larger currency notes do?

Today Narendra Modi, the Prime Minister of India made a surprise announcement to scrap Rs. 500 and 1000 notes- by Nov 8 midnight these notes will cease to be a legal tender. Indian citizens will get couple of months to exchange these notes for the denominations that are still legal tender. The government will introduce new Rs. 500 and Rs. 2000 notes later. According to media reports, the aim of this move is to reduce black money in the economy, tackle potential fake currency allegedly being circulated by Pakistan and curb corruption. The question of course is would such a move be helpful in achieving these objectives.

Would such scrapping reduce the total currency in circulation? It most likely will as people find it hard to convert all their currency hoards in time for denominations that are legal tenders. This one time reduction in money in circulation could help control for inflation and possibly redistribute resources away from the commodities and services bought by such cash. However, this effect might only be temporary. The new Rs. 500 and Rs. 2000 notes will become the new store of value for people who have a need to hoard and transport large amount of cash. The time period between abolition of current high denomination notes and introduction of new ones will be the time when hoarding black money would be difficult. But ultimately, if the government thinks that black money is a function of availability of high denomination currency notes then not much will change in the long run. To make sure hoarding and transportation of cash is difficult on a more long term basis, it might be advisable to reduce high denomination notes permanently and possibly have it done simultaneously by other countries as argued in this recent article from the Economist.

To address the problems of black money and corruption on a more permanent basis, we will have to look at root causes of these phenomenon. Not all black money is illegal- the monthly cash transaction between you and your maid is also a part of the black economy. Every time you decide not to insist on a receipt for your transaction, you are participating in the black economy. Hundreds and thousands of Indians participate in these transactions on a daily basis contributing to the black economy. So behavior of common people is a part of the problem and solution. There is also an element of redistribution in corruption. If there is lack of equal opportunity and/or presence of persistent inequality, corruption might serve as a way of redistributing money from the haves to the have nots. Sometimes black economy might be a reaction to excessive state regulation and corruption. There is a rich literature that looks at the causes and consequences of shadow or informal or black economies. See Schneider and Enste (2000),  a comprehensive survey published in the Journal of Economic Literature.

Therefore to seek a long term solution to problems of black money and corruption we might have to dig deeper than just surprise scrapping of higher denomination notes.

Update: Read my critique of the Arthakranti proposals here. Looks like some of the ‘wisdom’ behind Modi’s move came from that!

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Economics of Brexit

After slowly recovering from the shocking news of Brexit in the morning, I decided to browse the internet to see what the experts are saying. Two interesting articles stood out. Lawrence Summers writes in the Washington Post about implications of Brexit for the US and the global economy. The main concerns are summed up nicely in the following paragraph:

The effects on the rest of the world will depend heavily on psychology. I continue to be alarmed, as I wrote in this space a few days ago, that this unexpected outcome in the U.K. will raise the specter of “Trump risk.” If the U.K. can vote for Brexit perhaps the United States can vote for Donald Trump. I fear this possibility will lead to a freezing up of spending decisions particularly on the part of internationally oriented businesses.  The odds of U.S. recession beginning within the next 12 months are now in the 30 percent range. Also noteworthy is that an environment of increased risk aversion and flight to quality will complicate Japan’s problem of generating inflation and China’s challenge of attaining currency stability.

The rising xenophobia and racism on both sides of the Atlantic are primarily to be blamed on mismanagement of risks of globalization-the main point made by Maitreesh Ghatak of the LSE and summarized below in one of the paragraphs from the article:

Why then is immigration such a hot-button issue, shaping the discussion around the Brexit debate as well as the Trump campaign? The reason is that economic dislocation caused by impersonal market forces inevitably results in a search for visible scapegoats. No doubt xenophobia and racism is at work among some of Trump and Brexit supporters. But these are symptoms of a deeper problem. The economic reason behind the wave of xenophobia, whether it is the anti-immigrant rants of Donald Trump or UKIP (UK Independence Party) leader Nigel Farage, is really a misdirected rage at visible scapegoats of globalisation.

The next thing to see is what is going to happen to EU and the UK itself given that Scotland predominantly voted “remain” in the referendum. Fingers Crossed!

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Economics of Immigration

However strong the moral and humanitarian case for immigration is, people across the western world seem to be deeply divided on the issue primarily because of the perceived negative impact of immigration on their current living standards. In the US this is evident from the political rhetoric surrounding current Presidential race and in the UK in relation to the question of staying or exiting from the EU (Brexit). I think a couple of recent papers on these issues could throw some more meat at the debate and strengthen the public discourse.

Linsensova and Sancez-Martinez (2016) talk about the long term impacts of lower migration to UK. Here is a summary of their findings.

This paper looks at the possible scenarios of migration policy should the UK leave the EU. The paper uses an OLG model which brings together labour market, fiscal and other macroeconomic effects in one framework. It also adds a dynamic perspective, differentiates between natives and different categories of immigrants and captures age and qualification compositional effects. The paper compares the two migration scenarios: Leave and Remain. By 2065, in the Leave scenario, aggregate GDP and GDP per person are 9% and 1% respectively lower compared to Remain scenario. Reduced migration after leaving the EU has a negative impact on the public finances, because of higher dependency ratio. This requires an increase in taxation of about £400 per person (2014 pounds) in 2065. The results are sensitive to the assumptions that change productivity of the labour force and dependency ratio.

A paper presented at the 2016 ASSA meetings by Jeffrey Sachs talks about the need for an international migration regime. It has some interesting suggestions for research that would help develop a clearer perspective on what such regime should look like.  Reading this paper also reminded me of an interesting paper by Jess Benhabib titled, “Optimal Migration: A World Perspective“. Here is what the paper has to say about the level of migration that would maximize world welfare.

We ask what level of migration would maximize world welfare. Welfare is assumed to be a weighted average of the utilities of the world’s various citizens, but the weights are also country specific. Using a calibrated one-sector model, we find that unless the weights are heavily biased toward the natives of rich countries, the extent of migration that would be optimal far exceeds the levels observed today. The claim remains true in a two-sector extension of the model. All versions of the model assume that migration is the only redistributive tool.

In general, it looks like if we just think narrowly about the impact of immigration on a particular country or a geographical area, the answer may or may not be convincing. But if we think about the issue in terms of the welfare of the world economy, there seems to be a sufficiently strong argument for moving people from the developing countries to the developed ones. The main problem is that the costs and benefits of migration are not only economic in nature. There are significant non-economic adjustment costs as people belonging to different cultural and social backgrounds come together. Also, there is a significant time dimension to all the costs and benefits with costs somehow perceived to be more pronounced in the short run and benefits spread over the long run. Unfortunately, the political debate on both sides of the Atlantic has been feeding off the fear that is primarily based on short term costs like rising unemployment which is often more localized and sector specific than being pervasive. The rising religious fundamentalism across the globe has only fueled this fear suggesting that the case for making academic discourse more accessible to general public has never been stronger!

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Economics of Gun Ownership and Violence!

Some pearls of wisdom from a university President, “I’ve always thought that if more good people had concealed-carry permits, then we could end those Muslims before they walked in and killed them,” he said during the school’s convocation, before teasing the students about his own gun.” You can find the news here.
Notwithstanding the obvious shameless religious fearmongering the statement enthuses, I thought the following might be worth thinking about or at least have students of economics talk about:
In a game with two actions- have a gun or not, is “have a gun” a dominant strategy making gun ownership a Nash equilibrium of a Prisoners Dilemma? More so, once everyone carries a gun, will we automatically never use ours, as argued in the case of nuclear arms race? What do you think?
On the other hand, there is also an argument of negative externality of gun ownership. The recent shooting in San Bernardino lead to a $17 million expenditure on treating the 250 odd victims, out of which $12 million came from tax payers pockets. This makes gun ownership a strong case of negative externality- and we know how to correct those- tax gun ownership heavily. Of course the question is what is the optimal tax rate- certainly a fruitful research question!

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Strange Defeat: An Exchange

Since EPW decided not to publish any further correspondence between Jaydev and Mason & me, I am giving the link to Mason’s blogpost on the subject below:

Of course, I had a response to their response, which EPW decided not to publish! So for those who are interested here it is:

On Modern Macro: A Response to Jaydev and Mason
Parag Waknis

In what follows, I try to address the concerns raised by Jaydev and Mason in their extremely civilized and professional criticism, “A Response to Waknis” in November 2, 2013 issue of this journal!

Optimizing agents and the EU debt:
Financial markets not being able to price the EU debt correctly prior to the crisis does not contradict the rational optimizing framework really. It only reflects the ambiguity that comes with a monetary union that is not a fiscal union. Hence, even though the default probability might not have been same across members, absence of a severe shock, investors may have perceived it as so. Despite the significantly different fiscal situations of member countries, convergence of inflation across the EU members might have supported such valuation. But a shock as severe as the US financial crisis can force investors to reevaluate their portfolio positions in order to minimize risk and that is what seems to have happened. Given that asset prices are conditional variables and that pricing being a discovery process, this response of investors actually seems reasonable and not so off the mark from the optimizing benchmark.

I am not arguing for only one kind of microfundaions. A rational optimizing agent is a useful benchmark in macroeconomic modeling but may not be appropriate for answering all the questions macroeconomists ask. Several alternative avenues of modeling expectations have been explored in the literature and sometimes confrontations with data have helped explain the disagreement between reality and the theoretical benchmark (See Sargent (1999)). Macroeconomists face special problems in terms of evaluating a policy as they only have model economies at their disposal. Then search has to be for policies that are robust to several different model environments. Hansen and Sargent (2008) develop an agenda along these lines.

In short, there is substantial heterogeneity in macroeconomics and there are enough examples of how macroeconomists have pushed forward the research agenda to address basic methodological issues and limitations. Concentrating ones critique on certain frameworks that gain primacy and generalizing it to the whole field at best betrays ignorance or at worst belies an ideologically motivated critique!

Unemployment in the US and Europe:
The difference between European and US unemployment is not a new phenomenon. European unemployment on an average has been consistently higher than the US for past 30 years. Prior to 1970, EU countries had similar unemployment durations as the US but lower inflows to unemployment keeping their unemployment rate low. After 1970 this changes, though. The inflows to unemployment remain the same but the typical duration of unemployment is much longer in EU countries than in the US making EU unemployment rate higher. So how do we account for this reversal in the comparative unemployment regimes despite the persistency of institutions in both the continents? Ljunqvist and Sargent (2008) provide an answer. They show that the unemployment effects of higher unemployment insurance and employment protection depend on the amount of economic turbulence represented as skill depreciation at moments of involuntary separation.

At any given point of time in their economy, there are two types of job separations. One is voluntary- people who quit their current job to look for another and possibly a better one. These people are secure in their skills and do not experience a skill depreciation when they quit a job. In contrast to these workers are those who are laid off. These contribute to involuntary separations and imply skill obsolescence. Economic turbulence is defined as negative shocks to laid of workers’ earning potentials. Given this description of the economy, which pretty much sums up the economic environment that workers in the EU and the US faced after 1980, it is not hard to see how generous and long lasting unemployment benefits would provide a higher incentive to the unlucky workers for staying unemployed keeping the unemployment rate in the EU higher than the US up until recently.

The recent change in employment benefits in the US seems to have altered this situation bringing unemployment rate in the EU and the US closer. So the authors should not be surprised that in 2009 US and EU rates are identical. The US workers are staying unemployed longer like those in EU there by pushing up the unemployment rate even though the inflows to unemployment pool have not changed substantially. As I mention in my response, Mulligan (2012) confirms that increases in unemployment benefits has been one of the reason for increasing the unemployment duration. In a similar vein but highlighting a different mechanism, Hagedorn (2013) show that the increased unemployment benefit eligibility during the great recession affected the rate of job creation contributing to the higher unemployment in recent periods.

The example of Denmark and Norway that the authors provide only highlights that there is substantial heterogeneity within Europe but most of the numbers seem to be on the higher side pulling the average well above that in US. Taking a survey of the literature on this issue, Blanchard, Bean and Mucnhu (2006) argue that most of the theories that have been put forward regarding the labor market institutions explain the persistently higher unemployment rate in EU quite well, with a caveat that differences in labor market institutions within the EU countries might explain the differences within the EU countries.

While ridiculing the suggestion that unemployment has increased in the US because of increased unemployment benefits during the Great Recession, the authors suggest that “One useful contribution that I might make is interviewing unemployed workers, and asking them how they are enjoying the vacations they have chosen. We expect he will find the answers most stimulating (Italics are mine)”. As an answer let me give this graph from an “undergraduate macroeconomics’’ text:

Source: Cowen and Tabarrok (2013), Modern Principles: Macroeconomics, Worth Publishers, 2nd Edition, pp. 5.

So the unemployed seem to be vacationing in the several thousand universities across the US! To be fair to the academic bent of this article and journal, research shows a differential impact of unemployment on graduate school enrollment rates according to gender and GPA (see Johnson 2013 as an example). As far as ability is function of economic conditions, I do not think that life of an unemployed is an easy one.

Government Expenditure Multiplier:
I said in my response that if the expenditure multiplier is 1.5, then a dollar of government spending adds at best 50 cents to the GDP. I was hoping that the authors would be careful enough to read that as net addition to the GDP. So just to clarify, I do not regard this situation as crowding out. However, an estimate below 1 does mean crowding out. Also, many of these estimates are based on defense spending in the US and entail an increase in distortionary taxation. A government expenditure increase on some different category of spending or financed in a different way may have different impact. For example, infrastructure spending might have a positive impact on productivity of the private sector (Ramey 2011). This may not provide a sufficient rationale for increasing government spending in a developed country like the US that already has a huge stock of infrastructure but definitely does so for a developing country like India that falls short on that front.

However, by saying, “most empirical economists prefer estimates on the higher end”, the authors seem to suggest that most government spending either is financed in a non-distortionary way and/or it is spent on commodities that affect the private sector productivity. I am not quite sure if that is true. If government spending rises through changing unemployment benefits eligibility, would it have similar incentive effects as funding defense research projects?

About Aggregate Demand:
What role does aggregate demand play in causing business cycles? According to Old/New Keynesians the answer is possibly shortage in aggregate demand, most of which comes through reductions in autonomous investment. I don’t necessarily disagree with this, even though I do not agree with their reasoning behind such shortage* . The important question however, is whether government spending can plug this shortfall in spending and prop up the economy out of recession or would the effect of government spending depend on what might be the cause behind decline in spending? For example, if consumers have already built up a lot of debt and hence are holding spending back in economic downtimes, then would giving them additional money make them actually spend it? There is ample evidence from the analysis of the 2008 tax rebate to suggest that it does not. Most of the extra money was used by households to repay back some of the accumulated debt. So the immediate impact of a tax rebate was increased savings. According to Sahm, Shapiro and Slemrod (2010), the distribution of survey answers to questions about the use of tax rebates in 2001 and 2008 corresponds to an aggregate MPC after one year of about one-third.

Another aspect of recessions, especially after a severe crisis, is destruction of match capital or relationship capital as argued by Andolfatto (2010). Relationships like firm/worker, creditor/debtor, supplier/retailer, etc. are destroyed by the crisis and rebuilding them might take time. This would be especially true if these matches looked good ex ante but not ex post. How does government spending help in this case? May be instead a permanent tax cut might help!

The point is that we should know why aggregate spending is falling short, if at all, in order to see what government policy might work. If the national income was just an identity, then it might have worked to spend and plug the hole. However, there are actual people taking economic decisions and hence the effect of a policy on structure of incentives in the economy matters. Otherwise why not argue for infinite government spending?


*It is typical of the Keynesian school to assume nominal stickiness in wages or product prices. However, note that the failure of markets to clear as implied by price or wage stickiness is not enough to generate stickiness in the aggregate price level required to cause a shortage of aggregate demand. See Barro (1977) for an example of early theoretical work showing this.


Andolfatto D, 2010, Deficient Demand: The Deflated Balloon Hypothesis. Link accessed on November 5, 2013.

Barro, Robert J., 1977. “Long-term contracting, sticky prices, and monetary policy,” Journal of Monetary Economics, Elsevier, vol. 3(3), pages 305-316, July.

Blanchard, Bean and Munchau, 2006, European Unemployment: The Evolution of Facts and Ideas, Economic Policy, Vol. 21, No. 45.

Mulligan, Casey, 2012, “The Redistribution Recession- How Labor Market Distortions Contracted the Economy” Oxford University Press, New York.

Ramey Valerie A., 2011b. “Identifying Government Spending Shocks: It’s all in the Timing,” The Quarterly Journal of Economics, Oxford University Press, vol. 126(1), pages 1-50.

Hagedorn M, 2013, Unemployment Benefits and Unemployment in the GreatRecession: The Role of Macro Effects, NBER Working Paper 19499, October.

Ljungqvist L and T Sargent, 2008, Two Questions about European Unemployment, Econometrica, Vol. 76, No. 1, pp. 1-29.

Johnson M, 2013, The impact of business cycle fluctuations on graduate school
Enrollment, Economics of Education Review 34 (2013) 122–134

Sahm Claudia R., Matthew D. Shapiro and Joel Slemrod Household Response to the 2008 Tax Rebate: Survey Evidence and Aggregate Implications, , in Tax Policy and the Economy, Volume 24 (2010), The University of Chicago Press

Sargent T, 1999, The Conquest of American Inflation, Princeton University Press, Princeton and Oxford.
Hansen L P and T Sargent, 2008, Robustness, Princeton University Press, Princeton and Oxford.

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NBER Summer Institute

An interesting and informative summary by John Cochranne of NBER summer institutes on Economic Fluctuations and Growth and Asset Pricing.

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Picking on Piketty!

So like many other fellow bloggers, amateur economists, savant economists, and Nobel laureate Paul Krugman, I have my copy of Capital. This time the author is Thomas Piketty and not Mr. Marx though. I am yet to read the book- not sure if I will ever get to it amidst semester ending, grading and fulfilling research requirements. So I wanted to get a quick take on what macroeconomists have to say about the book. Not surprisingly, Steve Williamson had a post- but he was yet to read the book. So I guess we will have to wait for his critical comments or not as he is more into figuring out what Fed should be doing! Meanwhile this following comment by Tony on Steve’s post provides a good critical view:

Piketty’s book does not contain explicit references (to the best of my knowledge) to the two-decade-old body of work on macroeconomics and inequality beginning with Huggett and Aiyagari. Neither does the book’s online appendix, but if you follow the links provided in this appendix to other papers that Piketty and co-authors have written you will find references to some of this work. (That does not count as a citation in my book but it shows at least that Piketty is evidently aware of some of this work.) But for reasons that are unclear to me Piketty does not seem persuaded by papers like Castaneda, Diaz-Gimenez, and Rios-Rull (JPE, 2003) which match most of the facts about U.S. income and wealth inequality with parameters calibrated more-or-less reasonably. Instead in his book (which I have still not yet finished) and in a very recent paper (April 2014) with Zucman he seems to favor fairly mechanical models with multiplicative shocks to individual wealth accumulation. These models generate power laws for the upper tails with coefficients that evidently depend on the now-infamous “r-g” (i.e., the difference between the interest rate and the growth rate). But he does not make much of an attempt to calibrate them as do Benhabib et al (Econometrica et al, 2011). My overall impression so far is that Piketty does not really engage the existing literature on income and wealth inequality. Maybe this is because he focuses almost exclusively on the upper upper right tail of the wealth distribution (not just the top 1% but the top 0.1%). Krusell and Smith and Castaneda et al and others do a pretty good job of matching the top 1% but perhaps (and I am not sure about this) less well on the top 0.1%. But then in his book he makes bizarre statements like “the profession [has an] undue enthusiasm for simplistic mathematical models based on so-called representative agents”. He knows this is not true! (He was even a discussant for Quadrini and Rios-Rull’s forthcoming chapter on “Inequality in Macroeconomics” in the Handbook of Income Distribution.) Inexcusable.

There is also this article from 2012 on VOX that might interest you. And as the famous econblogger Noah Smith once tweeted: stop spelling Piketty as Picketty 😉

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Fiscal Stimulus: Old Keynesian vs. New Keynesian

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

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


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Austerity or Fiscal Stimulus?

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

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Kalecki-Krugman Deconstructed!

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

You can read Steve’s analysis here and here.

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