Category Archives: macroeconomics

Understanding Structured Finance

The phenomenon of structured finance or what is popularly known as securitization played an important role in the current financial crisis. The following two papers serve as a good guide to this aspect of finance and its implications.

Coval, Joshua, Jakub Jurek, and Erik Stafford. 2009. “The Economics of Structured Finance.” Journal of Economic Perspectives, 23(1): 3–25.

Adam B. Ashcraft and Til Schuermann, “Understanding the Securitization of Subprime Mortgage Credit,” Foundations and Trends in Finance 2, no. 3 (July 2008): 191-309.

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On the Desirability of Bubbles!

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

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

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

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

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

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Should you pay your smart investment advisor?

Came across following interesting quote by Bob Lucas Jr. It is an apt comment on the costly actions people are forced to take because of inflation!

In a monetary economy, it is in everyone’s private interest to try to get someone else to hold non-interest-bearing cash and reserves. But someone has to hold it all, so all of these efforts must simply cancel out. All of us spend several hours per year in this effort, and we employ thousands of talented and highly trained people to help us. These personhours are simply thrown away, wasted on a task that should not have to be performed at all.
Robert E. Lucas, Jr., 2000

Ref:

LUCAS, R. E., JR., “Inflation andWelfare,” Econometrica 68 (2000), 247–74.

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Cochrane on Krugman

As by now you must be aware that Krugman wrote this longish essay criticizing economics and economists for their failure to forsee the crisis. If you have not read it yet, you can do so here. John Cochrane of Chicago Booth School of Business has a well written rebuttal titled, “Why did Paul Krugman get it so wrong?”. You can access it here.

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Lucas’s Rebuttal of Critics of Economics!

Criticizing economics and economists is in vogue. As the clouds of crisis show little signs of abating, a segment of population (read writers!) seems to be doing extremely well by joining this bandwagon. Economists could spun some theories and math to refute at least some of these criticisms. But it would not do much in terms of disparaging the well written accounts of failures of economists and their theories. Unfortunately, amongst us who actually can communicate well do not seem to be of any help in this regard.

So for what it is worth, this piece by Bob Lucas Jr. does a good job of speaking for all of us who lack the wit and word of the New York Times best sellers but who still like to delve in the esoteric world of bizarre abstractions we call models!

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Myths about the Subprime Mortgage Crisis

Fed Reserve of Cleveland’s researcher has some interesting things to say about the current crisis:

http://www.clevelandfed.org/For_the_Public/News_and_Media/Press_Releases/2009/20090722.cfm

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Economics, Economists, and the Crisis

The Economist has some interesting perspectives on the state of economics and the crisis. To read click on the following links.

http://www.economist.com/printedition/displayStory.cfm?Story_ID=14031376

http://www.economist.com/printedition/displaystory.cfm?story_id=14030288

http://www.economist.com/printedition/displaystory.cfm?story_id=14030296

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On the Austrians and the New Keynesians!

Austrian Perspective on the Current Recession:

At a symposium on the crisis at a New England public university, a macroeconomist argued that the current crisis is precipitated by the Fed’s policy of making housing affordable to the common man. A public economist argued that this argument is completely wrong. The housing bubble was created because a large number of people wanted to live beyond their means. Whom do you think the Austrians will side with? Click here to find out!

2008 Arrow Prize in Macroeconomics:

A while back Bills and Klenow analyzed some price data for the US and arrived at the conclusion that prices on an average changed every five months implying that the prices were not as rigid after all as the Keynesians would like them to be. But is this average frequency of change in prices a good indicator of price rigidity and does it discredit the Keynesian perspective on the effects of monetary policy? Click here to find out!

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The Economic Globe

William Nordhaus and Chen Xi have created interesting graphics for the world economy which highlight the relation between geophysical variables and economic growth. To access this paper click here. To access the impressive rotating economic globe, click here.

Some food for thought for aspiring geoeconomists:

1. Economic deserts of the world are cold regions.
2. Other than in United States and Europe, much of the economic activity is clustered along coastlines.

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Race and financial deregulation

Policies can have unintended consequences and most of the time if we talk about them they are negative. However, financial deregulation in US might have had a favorable one; that of reducing the wage gap between whites and blacks. This weeks Economic Focus from the Economist comments on two papers which argue that it was indeed the case.

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