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Monthly Archives: March 2010
Trying to Tame the Unknowable
By N. GREGORY MANKIW
Published: March 26, 2010
THE economy is recovering, in baby steps, from the financial crisis and deep recession of 2008 and 2009. A big question still looms on the horizon: What can policy makers do to prevent this kind of thing from happening again?
Perhaps the best place to start is to acknowledge what we cannot do. If recent events have taught economists and policy makers anything, it is the need for humility.
One thing we cannot do very well is forecast the economy. The recent crisis and recession caught most economists flat-footed. This is nothing new. We have never been good at foretelling the future, but when the news is favorable, others forgive our lack of prescience.
Some critics say the Federal Reserve should have foreseen the bursting of the housing bubble and its financial aftershocks. A few of them, having made the correct call themselves, are enjoying newfound celebrity.
Yet at any time, there are many forecasters with a large range of views. After the fact, a few will turn out to be right, and many wrong. Policy makers at the Fed don’t know in advance who will be the lucky few. Their best course is to rely on the consensus forecast and to be ready for the inevitable surprises.
Another thing we cannot do very well is regulate financial institutions.
When I was chairman of President George W. Bush’s Council of Economic Advisers from 2003 to 2005, I spoke openly about the need to reform regulation of Fannie Mae and Freddie Mac. I did not know when or how these government-sponsored enterprises would come crashing down, but I thought they posed undue risks for the economy and for taxpayers.
I was not alone in that judgment. While working on the issue, I consulted privately with an economist who had held a high-ranking position in the Clinton administration. He shared precisely my concerns, as did Alan Greenspan, who was then the Fed chairman.
Why was nothing done? Many members of Congress were worried less about financial fragility than about expanding access to homeownership. Moreover, lobbyists from these companies assured Congress that there was no real problem, while the sheer complexity of these institutions made it hard for legislators to appreciate the enormity of the risks.
I recount this story not because Fannie Mae and Freddie Mac were the main cause of the recent financial crisis — they were only one element — but because it shows the kind of problem we’ll encounter on a larger scale as we reform oversight of the financial system.
We should certainly aim for better financial regulation, especially for institutions with government-insured deposits. More transparency and more accurate assessment of risks are admirable goals. Higher capital requirements would be a step in the right direction.
There has been much talk about restricting the use of financial derivatives. Unfortunately, writing good rules is not easy. Derivatives, like fire, can lead to disaster if not handled with care, but they can also be used to good effect.
Whatever we do, let’s not be overoptimistic about how successful improved oversight will be. The financial system is diverse and vastly complicated. Government regulators will always be outnumbered and underpaid compared with those whose interest it is to circumvent the regulations. Legislators will often be distracted by other priorities. To believe that the government will ever become a reliable watchdog would be a tragic mistake.
So where does this leave us? We should plan for future financial crises, to occur at some unknown date for some unknown reason, and arm ourselves with better tools to clean up the mess.
Much focus in Washington has been on expanding the government’s authority to step in when a financial institution is near bankruptcy, and to fix the problem before the institution creates a systemic risk.
That makes some sense, but creates risks of its own. If federal authorities are responsible for troubled institutions, creditors may view those institutions as safer than they really are. When problems arise, regulators may find it hard to avoid using taxpayer money. The entire financial system might well become, in essence, a group of government-sponsored enterprises.
Another idea is to require financial firms to write their own “living wills,” describing how they would wind down in the event of an adverse shock to their balance sheets. It is hard to say whether this would work. Like real wills, the next of kin may well contest the terms when the time comes. That would slow the process and defeat much of the purpose.
MY favorite proposal is to require banks, and perhaps a broad class of financial institutions, to sell contingent debt that can be converted to equity when a regulator deems that these institutions have insufficient capital. This debt would be a form of preplanned recapitalization in the event of a financial crisis, and the infusion of capital would be with private, rather than taxpayer, funds. Think of it as crisis insurance.
Bankers may balk at this proposal, because it would raise the cost of doing business. The buyers of these bonds would need to be compensated for providing this insurance.
But this contingent debt would also give bankers an incentive to limit risk by, say, reducing leverage. The safer these financial institutions are, the less likely the contingency would be triggered and the less they would need to pay for this debt.
A few years ago, some people thought that major financial crises were a thing of the past. We know that was wrong. Despite our best efforts, more financial crises are likely to occur. As we recover from the last one, we should prepare for the next.
N. Gregory Mankiw is a professor of economics at Harvard.
“The economists you see on TV are often trying to predict the future, but that is hardly a random sample of top economists. Indeed, one reason I am not fond of TV appearances is that TV hosts frequently ask questions that presume PhD economists can see into the future better than others, whereas actual PhD economists know that very little of our training has anything to do with forecasting.”
A great article by Jim Hamilton at Econbrowser:
Why reform health care?
Amidst all the preoccupation with the procedural details of how health care legislation is likely to be implemented, I was glad to see Paul Krugman make the case for why reform is needed in the first place.
Americans overwhelmingly favor guaranteeing coverage to those with pre-existing conditions– but you can’t do that without pursuing broad-based reform. To make insurance affordable, you have to keep currently healthy people in the risk pool, which means requiring that everyone or almost everyone buy coverage. You can’t do that without financial aid to lower-income Americans so that they can pay the premiums. So you end up with a tripartite policy: elimination of medical discrimination, mandated coverage, and premium subsidies.
I find it helpful in thinking through these issues to consider two polar extremes of what the objective of health insurance is taken to be. In the first case, consider a group of people, all of whom are healthy at the moment, all of whom have the same risk of needing significant assistance with medical expenditures at some point in the future, and none of whom know whether they are the one who is going to need assistance. If the individuals each pool their resources, with the funds subsequently used to assist those for whom the needs arise, each of them would perceive themselves to be better off as a result of being included in the pool. Such health insurance is Pareto improving– everyone perceives themselves to be better off with insurance than without. And precisely because it is Pareto improving, private insurance markets have no difficulty delivering this kind of financial product.
Now consider the opposite extreme, namely a group of people each of whom already knows with perfect certainty who is going to need medical expenditures and who is not. In this case, if the funds of the group are pooled, with payments going from the healthy to the sick, it is not Pareto improving– those receiving the funds are better off and those supplying the funds are worse off. For this reason, the private market would never produce a financial product to implement this outcome, and describing such an arrangement as "insurance" is mislabeling. It is instead a pure income transfer policy.
We might make various arguments in favor of such an income transfer, such as going back to an earlier point in time before people knew the conditions to which they might be susceptible, and reason on this basis that the two cases are strictly comparable. This is the essential Rawlsian perspective on social justice, which argues that we should seek a distribution of resources that each member of the society would advocate if they could not know in advance which position in the society they would occupy.
But I think instead the more fundamental argument in favor of assisting the needy in the second example is one of compassion. Are we really prepared to insist, conditional on knowing who is who, that medical assistance only be provided to those who are able to pay? I think Krugman is correct that the vast majority of Americans would answer "no" to this question. Most of us want to help others we perceive to be in need, even if there is no direct benefit to ourselves from doing so.
But the question then becomes a very practical one– exactly how many dollars should the healthy surrender, and what’s the limit on what the funds will be used to pay for? Do the same moral principles call on Americans to provide health care for everyone in the world, or just those within our borders? And if the latter, do we cover those who came into the country illegally, or only legal residents and citizens? For whatever subset of humanity we do decide to cover, we’re still going to have to draw the line somewhere, and say no to certain procedures. When, where, and how shall we draw the line?
Now reality of course is a mix between the two polar extremes I’ve sketched above, though the discussion of "pre-existing conditions" suggests to me that we’ve definitely moved into the realm of issues raised in the second example rather than the first. And that’s why I believe it’s important for Americans openly to face the core underlying question that confronts us in that second example– how shall we make a determination of who is going to receive medical services, and which services are going to be provided?
Posted by James Hamilton at March 21, 2010 06:56 AM
一篇文章两年前投的，已经修改两次了。今天又被referee恶心了一把。这斯竟然又建议了三条修改意见，其中包括对模型搞个什么Bayesian estimate。这不是扯淡么，搞个Bayesian estimate又成一个新文章了。我老作的是two-country模型，要搞Bayesian estimate，光数据都要搜集一阵子罢。这个referee简直是混蛋透顶。第二次修改时，他除了提问题外，还具体要求了我们文章的格式。比如先present什么结果，后present什么。虽然当时并没有觉得他提出的方案有什么明显好处，还是按照他的改了。谁知道这家伙在新的report中居然说由于我们的文章被substantially rewritten，他又有了新的建议。这不是胡扯么，这些从写的部分都是按他上次的要求该的。别的什么也没加。真恨不得把他上次的report狠狠砸在这斯脸上。
下个月15号，财政部要公布currency report。在这个报告中，财政部要决定是否把中国列为汇率操纵国。根据目前情形，财政部很可能要这么做。如果中国真被列为汇率操纵国，美国贸易保护主义者就可以名正言顺地对中国进行制裁了。汇率操纵的定义在美国的货币报告中是，通过控制汇率来“阻碍贸易平衡的有效调整，或者在国际贸易中取得不公正的竞争优势(for the purposes of preventing effective balance of payments adjustments or gaining unfair competitive advantage in international trade).“
Chinn和Wei的发现并不是非常出人意料。在国际宏观经济学中，一个很有名的发现就是汇率和其他经济变量之间的脱节(exchange rate disconnect puzzle)。这个脱节有两层含义，一个是各种宏观经济变量，比如进出口，消费，投资等对汇率变动的反映不敏感。现在在波士顿大学的Baxter和Stockman (1989)发现大部分发达国家从固定汇率制度转入浮动汇率制度后，尽管汇率的波动变得很大，其他经济变量的波动基本维持不变。这种脱节有很多原因。一个是价格和汇率的脱节。汇率对贸易的影响主要通过价格。但在现实生活中，当一个国家的货币升值百分之一，它的出口价格上涨往往要远低于百分之一。如果汇率对价格的影响有限，那它对贸易的影响就很小。
汇率和其他经济变量之间脱节的另一个含义就是很难用经济变量来解释汇率的变化。最有名的是Meese and Rogoff puzzle。Meese和Rogoff发现用汇率模型中的经济变量去预测汇率变化时，这些变量基本没用。最近的一个解释就是汇率是一个资产变量，由人们的预期和未来的经济变量决定。所以，当前的经济变量没办法很好预测汇率。根据这种理论，汇率自动调节贸易平衡的功能就更是无中生有：进出口由目前市场上的需求和供给决定，而汇率由对未来预期决定。
This makes me wondering why the inflation rate in China can still remain subdued.
From today’s Financial Times:
India raises key rate to help fight inflation
By Joe Leahy in Mumbai
By Joe Leahy in Mumbai
March 19, 2010
India’s central bank on Friday announced a surprise 25-basis point increase in its key policy rates – the first rise in nearly two years – in a bid to head off inflation that is poised to cross into double digits.
In an unscheduled move, the Reserve Bank of India increased the “reverse repo rate”, the rate at which it absorbs money from the system, by 25 basis points to 3.5 per cent and the “repo rate”, the rate at which it lends to banks, by the same margin to 5 per cent.
The rises, which come a month ahead of the RBI’s next quarterly policy meeting, mark the beginning of what economists expect to be a long tightening cycle as regulators seek to foster India’s economic recovery while capping politically sensitive inflation.
“The timing is a surprise but the way inflation is behaving at the moment, they don’t have much choice,” said A. Prasanna, economist at ICICI Securities Primary Dealership in Mumbai.
For India’s ruling Congress party-led coalition, keeping a lid on inflation is seen as the number one political priority in a nation where governments have risen and fallen on the price of staple foods, such as onions.
India’s economy is expected to return to growth rates of more than 8 per cent this year as the country emerges from the economic crisis with its record as the world’s fastest growing large economy behind China intact.
But an expansionary government budget, growing domestic consumption and rising energy prices are driving up inflation, with the wholesale price index, the main measure of inflation in India, reaching 9.89 per cent year-on-year in February compared with 8.56 per cent a month earlier.
The February figure was the highest since October 2008 and above the central bank’s end-Marchforecast of 8.5 per cent.
“While the recovery in growth has proceeded broadly along expected lines, the inflationary pressures have intensified beyond our baseline projection,” the RBI said in a statement last night.
“With rising demand side pressures, there is risk that WPI inflation may cross double digits in March 2010.”
It said there was a need not only to contain inflation but to also send a signal to the market that regulators would not tolerate the inflationary trend.
While food prices were moderating, they remained “elevated”, and the rate of price increases among non-food manufactured goods was accelerating "quite sharply".
The move follows the RBI’s announcement in January of a 75 basis point rise in the cash reserve ratio, the proportion of deposits banks must keep with the central bank, to 5.75 per cent, to soak up excess liquidity.
ICICI Securities’ Mr Prasanna said he expected a further 25bp tightening at the next policy meeting.
“It’s going to be a long road ahead,” he said.