Growth theory and data teach us that, at least in developed countries, economies tend to converge in the long run: the dispersion across regions or nations of per capita income (or similar indicators) tends to decline. While this is a long term phenomenon, there is a priori no reason to believe this is a constant process.
Eldon Ball, Carlos San Juan and Camilo Ulloa study total factor productivity in agriculture across US states. While they indeed find a general trend towards convergence, it turns out that its speed is much faster during recessions. Why would this happen? If we follow Schumpeter, the worst firms should be dropping out during a recession, thereby relatively increasing TFP in the worst areas. And voilà, you have faster convergence. But only farm-level data would tell whether my conjecture is true.
What if the US looses its reserve currency privilege?
Since the Bretton Woods agreement in 1945, the United States have enjoyed the so-called "Exhorbitant Privilege." During the fixed exchange rate regime, the US could conduct monetary policy without regard to what was happening in other countries. The US dollar was a reserve currency, which also helped the US maintain low interest rates and a guarantee that US dollars (and Treasury bonds) would always find a buyer. With flexible exchange rates, not much has changed. But with the recent shenanigans in a Congress that considered reneging on its debt, the likelihood of this advantage changing has dramatically increased. What would the consequences of the loss of the Exhorbitant Privilege be?
Wenli Cheng and Dingsheng Zhang study this scenario using a general equilibrium model where a peripheral country (say, the Asian economies) pegs its currency to the money of a central country (say, the United States), the latter being used as the vehicle currency for international trade. In addition, the foreign exchange reserves of the periphery are invested in government bonds of the center. This means that no matter what current account deficit of the center, it is always financed by the periphery. Yet the center may be tempted to inflate it away. This limitless and to some extend free borrowing is the Exhorbitant Privilege.
Now remove it by assuming that the periphery does not want to invest in the center, either because it views the Treasury bonds are excessively risky or because it does not peg to the dollar any more. This would lead to a dramatic readjustment of the terms of trade to favor the tradable sector of the center. This decpraciation of the dollar would be more pronounced of the center is incapable of raising taxes and finances its debt with inflation. This already all sounds familiar.
Wenli Cheng and Dingsheng Zhang study this scenario using a general equilibrium model where a peripheral country (say, the Asian economies) pegs its currency to the money of a central country (say, the United States), the latter being used as the vehicle currency for international trade. In addition, the foreign exchange reserves of the periphery are invested in government bonds of the center. This means that no matter what current account deficit of the center, it is always financed by the periphery. Yet the center may be tempted to inflate it away. This limitless and to some extend free borrowing is the Exhorbitant Privilege.
Now remove it by assuming that the periphery does not want to invest in the center, either because it views the Treasury bonds are excessively risky or because it does not peg to the dollar any more. This would lead to a dramatic readjustment of the terms of trade to favor the tradable sector of the center. This decpraciation of the dollar would be more pronounced of the center is incapable of raising taxes and finances its debt with inflation. This already all sounds familiar.
About very large risk aversion estimates
The equity premium puzzle is an enduring challenge to our estimates of risk aversion. Indeed, as Rajnish Mehra and Edward Prescott have highlighted, the only way to reconcile a standard model with the observed long-term equity premium is to assume a risk aversion coefficient of 10, while micro-estimate hover around two. This puzzle has been resolved a little bit in various way, most prominently by taking into habit persistence and some other deviations of the standard CRRA or CARA utility functions. But all this still boils down to a risk aversion parameter that is linked by an identity to the intertemporal elasticity of substitution (it is the inverse). But we know how to disentangle the two.
Xiaohong Chen, Jack Favilukis and Sydney Ludvigson estimate a model with the recursive preferences of Larry Epstein and Stanley Zin and Philippe Weil. This is not obvious to do because to estimate the coefficient of risk aversion in this context, one needs a measure of claims to future consumption. Here this is overcome by estimating nonparametrically the continuation value of the consumption process from within the model. The result is that the elasticity of intertemporal substitution is above one, and the coefficient of risk aversion is somewhere between 17 and 60. These are huge numbers. But they still imply a rather modest and sometimes even negative risk premium.
Xiaohong Chen, Jack Favilukis and Sydney Ludvigson estimate a model with the recursive preferences of Larry Epstein and Stanley Zin and Philippe Weil. This is not obvious to do because to estimate the coefficient of risk aversion in this context, one needs a measure of claims to future consumption. Here this is overcome by estimating nonparametrically the continuation value of the consumption process from within the model. The result is that the elasticity of intertemporal substitution is above one, and the coefficient of risk aversion is somewhere between 17 and 60. These are huge numbers. But they still imply a rather modest and sometimes even negative risk premium.
Aid and remittances as hedges against food price shocks
Food is a substantial part of household expenses in developing economies, and in many of the latter foreign aid and remittances from emigrants provide a substantial part of national income. As world food prices have been subject to large fluctuations lately, causing much grief and even riots, it is natural to ask whether aid and remittances can provide some smoothing against the effects of these fluctuations.
Jean-Louis Combes, Christian Ebeke, Mireille Ntsama Etoundi and Thierry Yogo use a cross-country panel data set to study this question. First, they confirm that food fluctuations have a notable impact on aggregate consumption, especially in the poorest economies. Second they find that aid and remittances do help, and remittances seem to be more efficient at hedging. Indeed, an aid-to-GDP ratio of 29% is theoretically necessary to absorb food price fluctuations, while 9% is sufficient is for remittances. Only Mozambique and Nicaragua satisfy the first, while a few more countries satisfy the second.
Jean-Louis Combes, Christian Ebeke, Mireille Ntsama Etoundi and Thierry Yogo use a cross-country panel data set to study this question. First, they confirm that food fluctuations have a notable impact on aggregate consumption, especially in the poorest economies. Second they find that aid and remittances do help, and remittances seem to be more efficient at hedging. Indeed, an aid-to-GDP ratio of 29% is theoretically necessary to absorb food price fluctuations, while 9% is sufficient is for remittances. Only Mozambique and Nicaragua satisfy the first, while a few more countries satisfy the second.
How is China now planning its economy?
Since 1978, China has undergone a fundamental and very successful reform from a planned economy towards a market economy. But one should still keep in mind that this is still an autocratically governed country where technocrats call the shots at all levels. China is still working with five-year plans and the economy is still tied to administrative goals. SO how does economic planning work in China nowadays?
Gregory Chow offers some insights, in particular on how this planning has recently become more important due to the global economic crisis. Administratively, policy is guided by the five-year plans, which interestingly have recently included new sections on welfare and management of society, making apparent some worries about the adverse effects of market economies and rapid development (or democracy when people can complain?). The remarkable part of these plans is that explicit targets are set, and policy is in a major way oriented towards these targets. Of course, the government still controls directly a considerable number of state-owned enterprises. And it has the traditional tools of policy in a market economy at its disposal to influence the rest of the economy. These policies are coordinated at all levels thanks to the very central nature of government.
In some sense it would also be good for market economies to also set some targets for policy. In fact, this is what politicians should be arguing about and then let technocrats put policy in place to achieve these targets. I would not mind targets like putting a man on Mars by 2020, making sure everyone in covered by health insurance by 2015, get 50% of commuting kilometers on public transportation, or defense expenses being completely dedicated to defense (and not attack) by 2015, for example. In fact, the World Bank has well-defined targets for developing economies. In do not see why this should not be applicable for developed ones. At least it would make governments capable of rallying support for some goals and be explicitly accountable.
Gregory Chow offers some insights, in particular on how this planning has recently become more important due to the global economic crisis. Administratively, policy is guided by the five-year plans, which interestingly have recently included new sections on welfare and management of society, making apparent some worries about the adverse effects of market economies and rapid development (or democracy when people can complain?). The remarkable part of these plans is that explicit targets are set, and policy is in a major way oriented towards these targets. Of course, the government still controls directly a considerable number of state-owned enterprises. And it has the traditional tools of policy in a market economy at its disposal to influence the rest of the economy. These policies are coordinated at all levels thanks to the very central nature of government.
In some sense it would also be good for market economies to also set some targets for policy. In fact, this is what politicians should be arguing about and then let technocrats put policy in place to achieve these targets. I would not mind targets like putting a man on Mars by 2020, making sure everyone in covered by health insurance by 2015, get 50% of commuting kilometers on public transportation, or defense expenses being completely dedicated to defense (and not attack) by 2015, for example. In fact, the World Bank has well-defined targets for developing economies. In do not see why this should not be applicable for developed ones. At least it would make governments capable of rallying support for some goals and be explicitly accountable.
Policy risk and the business cycle
The US economy seems stuck in its tracks, and many blame uncertainty about future public policy, including me. Indeed, private firms are currently sitting on a lot of cash and are making very good profits, yet they are not investing or hiring. This really looks like a wait-and-see game. But it this justification well-founded or is it just a cheap excuse to justify higher than usual profits in the face of high unemployment?
Benjamin Born and Johannes Pfeifer put some structure into these arguments by taking a standard New Keynesian model and adding uncertainty about monetary and fiscal policy. They measure this by looking at tax rates and monetary policy shocks with time-varying volatility. Previous literature already looked at the impact of aggregate uncertainty, which policy makers can do little about. But policy uncertainty is another matter. And there is hope, as Born and Pfeifer show that the impact of policy uncertainty is not that important (but much larger than uncertainty about productivity shocks) thanks to monetary policy reaction through a Taylor Rule. So that is somewhat reassuring, but then the size of the current policy uncertainty is an order of magnitude larger than when this paper was written, and monetary policy is bound by non-negative nominal interest rates.
Benjamin Born and Johannes Pfeifer put some structure into these arguments by taking a standard New Keynesian model and adding uncertainty about monetary and fiscal policy. They measure this by looking at tax rates and monetary policy shocks with time-varying volatility. Previous literature already looked at the impact of aggregate uncertainty, which policy makers can do little about. But policy uncertainty is another matter. And there is hope, as Born and Pfeifer show that the impact of policy uncertainty is not that important (but much larger than uncertainty about productivity shocks) thanks to monetary policy reaction through a Taylor Rule. So that is somewhat reassuring, but then the size of the current policy uncertainty is an order of magnitude larger than when this paper was written, and monetary policy is bound by non-negative nominal interest rates.
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