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December 22, 2007

Economist's View - 4 new articles

Greg Mankiw: How to Avoid a Recession

Greg Mankiw says the Fed doesn't need any help from fiscal policy in fighting a possible recession, not yet anyway:

How to Avoid Recession? Let the Fed Work, by N. Gregory Mankiw, Economic View, NY Times: The economy is teetering on the edge. Many economists, as well as online betting sites, put the risk of recession next year at about 50 percent. Once we get the final numbers, we might even learn that a recession has already begun.

The question on the minds of many in Congress and in the White House is this: What they should be doing now to keep the economy on track? The right answer: absolutely nothing.

This advice isn't easy for politicians to follow. Because economic downturns mean fewer jobs and falling incomes, they are painful... Voters can confuse inaction with nonchalance and send incumbents packing. But..., voters should be wary of politicians eager to treat every economic ill. Sometimes, ... wait-and-see [is] the best we can do.

Congress made its most important contribution to taming the business cycle back in 1913, when it created the Federal Reserve System. Today, the Fed remains the first line of defense against recession.

The Fed's control over the money supply is a powerful lever to move overall demand for goods and services. ... The influence of interest rates on the economy is particularly strong in housing, where buyers are rate-sensitive. Because housing woes are the source of the current slowdown, the Fed's tool kit is well suited for the task at hand.

The recession-fighting effects of monetary expansion, however, are not limited to the housing market. When lower interest rates make fixed-income investments less attractive, investors turn to the equity market and bid up stock prices. Higher stock prices, in turn, make consumers wealthier and more eager to spend. They also make it easier for corporations to expand their businesses with equity financing.

By making United States bonds less attractive to world investors, lower interest rates from a monetary expansion also weaken the dollar in currency markets. A depreciation of the currency is not in itself to be feared. ...

A weak currency is a problem if it results from investors losing confidence in an economy. The most damaging cases are the episodes of sudden capital flight... This outcome is unlikely for the fundamentally sound American economy, but fear of it is one reason that Treasury secretaries maintain public fealty to a strong dollar.

But if a weakened currency comes about because the central bank is trying to stimulate a lackluster economy, ... depreciation is not a malady but just what the doctor ordered. A weaker currency makes domestic goods more competitive... The dollar's falling value is one reason exports of goods and services have grown more than 10 percent in the past year.

The Fed constantly monitors all these developments to ensure that the economy has the stimulus it needs, but not too much. ... As the economy flirts with recession, ... the ... Fed has cut its target for the benchmark federal fund rates to 4.25 percent from 5.25 percent last summer. It is a good bet that we will see further cuts... And if the chance of a recession turns into a real recession, you can count on it.

Admittedly, monetary policy can sometimes use an assist from fiscal policy. If an economic downturn is deep, if a recovery is anemic or if the Fed is running out of ammunition, Congress can help raise aggregate demand for goods and services. In 2003, the Fed had cut its target interest rate all the way to 1 percent, the economy was still suffering..., and there were increasing worries about deflation. A tax cut was a good complement to monetary expansion to get the economy going again...

Today's situation is different. The Fed has plenty of room to cut rates further, if it deems such cuts necessary. At the moment, recession is only a possibility, and inflation is a bigger worry than deflation. In this environment, there is no need for a short-run fiscal stimulus. Congress is better off focusing on longer-term problems...

The Fed is now coming under heat for not having prevented the subprime crisis, for not fully anticipating it once it was inevitable, and for not responding more vigorously now that it has occurred. Daniel Gross ... has gone so far as to liken the Fed and its chairman, Ben S. Bernanke, to FEMA and its erstwhile head Michael Brown.

The truth is that the current Fed governors, together with their crack staff of Ph.D. economists and market analysts, are as close to an economic dream team as we are ever likely to see. They will make their share of mistakes, but it is too easy to find flaws when judging with the benefit of hindsight. The best Congress can do now is to let the Bernanke bunch do its job.

I am not as sure as Greg is that falling interest rate will provide the needed stimulus in this economic environment, and thus I would think it prudent to begin planning and setting contingency plans for fiscal policy, plans that can be implemented immediately should things begin to look any worse. If we wait, given the recognition, legislative, implementation, and effectiveness lags in fiscal policy, it may be too late to react once the signs of a more severe problem are evident. Hopefully, we won't need to use fiscal policy, but just in case, we should be ready.

Compulsory Voting

Should U.S. citizens be forced to vote?:

A vote rule to rein in the free riders, by Peter Singer, Project Syndicate: As an Australian citizen, I voted in the recent federal election there. So did about 95 per cent of registered Australian voters. That figure contrasts markedly with elections in the United States, where the turnout in the 2004 presidential election barely exceeded 60 per cent. In congressional elections that fall in the middle of a president's term, usually fewer than 40 per cent of eligible Americans bother to vote. There is a reason why so many Australians vote. In the 1920s, when voter turnout fell below 60 per cent, parliament made voting compulsory. Since then, despite governments of varying political complexions, there has been no serious attempt to repeal the law, which polls show is supported by about 70 per cent of the population. ...

In practice, what is compulsory is not casting a valid vote, but going to the polling place, having one's name checked off, and putting a ballot paper in the box. The secrecy of the ballot makes it impossible to prevent people writing nonsense on their ballot papers or leaving them blank. While the percentage of invalid votes is a little higher where voting is compulsory, it comes nowhere near offsetting the difference in voter turnout. Compulsory voting is not unique to Australia. Belgium and Argentina introduced it earlier, and it is practised in many other countries, especially in Latin America, although both sanctions and enforcement vary. ...

When voting is voluntary, and the chance that the result will be determined by any single person's vote is extremely low, even the smallest cost -- for example, the time it takes to stroll down to the polling place, wait in line, and cast a ballot -- is sufficient to make voting seem irrational. Yet if many people follow this line of reasoning, and do not vote, a minority of the population can determine a country's future, leaving a discontented majority. ...

If we don't want a small minority to determine our government, we will favour a high turnout. Yet, since our own vote makes such a tiny contribution to the outcome, each of us still faces the temptation to get a free ride, not bothering to vote while hoping that enough other people will vote to keep democracy robust and to elect a government that is responsive to the views of a majority of citizens.

But there are many possible reasons for voting. Some people vote because they enjoy it... Others are motivated by a sense of civic duty that does not assess the rationality of voting in terms of the possible impact of one's own ballot.

Still others might vote not because they imagine that they will determine the outcome of the election, but because, like football fans, they want to cheer their team on. They may vote because if they don't, they will be in no position to complain if they don't like the government that is elected. Or they may calculate that while the chances of their determining the outcome are only one in several million, the result is of such importance that even that tiny chance is enough to outweigh the minor inconveniences of voting.

If these considerations fail to get people to the polls, however, compulsory voting is one way of overcoming the free-rider problem. The small cost imposed on not voting makes it rational for everyone to vote and at the same time establishes a social norm of voting.

Australians want to be coerced into voting. They are happy to vote, knowing that everyone else is voting, too. Countries worried about low voter turnout would do well to consider their compulsory model.

As much as I'd like to see turnout go up, I can't support compulsory voting. It's not because of any worry that voters will be uninformed, irrational, or anything like that, it's more that it seems like an impingement on freedom.

Morality and Economic Performance

Guido Tabellini presents new evidence on the role of morals for economic outcomes:

Morality matters for economic performance, Guido Tabellini, Vox EU: Economic backwardness is typically associated with a wide range of institutional, organisational and government failures Рand these along many dimensions. In numerous poor or stagnating countries, politicians are ineffective and corrupt, public goods are under-provided and public policies confer rents to privileged élites, law enforcement is inadequate, and moral hazard is widespread inside public and private organisations. There is not just one institutional failure. Typically, the countries or regions that fail in one dimension also fail in many other aspects of collective behaviour.

An influential body of research in economic history, political economics and macroeconomics has shown that both economic and institutional backwardness are often a by-product of history Рappearing in countries or regions that were ruled centuries ago by despotic governments, or where powerful élites exploited uneducated peasants or slaves (North 1981, Acemoglu, Johnson and Robinson 2001). But what is the mechanism through which distant political and economic history shapes the functioning of current institutions?

In a recent working paper (Tabellini 2007), I argue that to answer this question we have to look beyond pure economic incentives, and think about other factors motivating individual behaviour. One of these factors is morality. Conceptions of what is right or wrong, and of how one ought to behave in specific circumstances, exert a strong influence on behavioural aspects that directly affect economic outcomes. The list included voters' demands and expectations, citizens' participation in group activities, the extent of moral hazard inside public organisations, and the willingness of individuals to provide public goods.

Values also evolve slowly over time, as they are largely inherited from previous generations. Thus morality, defined as individual values and convictions about the scope of application of norms of good conduct, is an important channel through which distant political history can influence the functioning of current institutions.

Generalized Morality and Trust

Is there any evidence supporting this idea? Exploiting attitudes revealed by opinion polls in The World Value Surveys (Inglehart et. alii 2000), I seek to capture a distinction between values consistent with "generalised" vs "limited" morality. Conceptually, the distinction concerns the scope of application of norms of good conduct (whether towards everybody or just in a narrow group with which the individual identifies). Generalised morality means that individual values support a generalised application of norms of good conduct in a society of abstract individuals entitled to specific rights.

To measure the diffusion of norms of generalised vs limited-morality at an aggregate level, I rely on two variables. The first is generalised trust towards others (Trust). This variable has been extensively used in many studies, with two alternative interpretations – as belief about the behaviour of others, and as an indicator of moral values and trustworthiness. The two interpretations are not mutually exclusive. Beliefs are likely to be extrapolated to others' normative conceptions of how one ought to behave. Moreover, experimental evidence supports this additional interpretation of Trust as an indicator of individual values. The second variable seeks to measure the values transmitted from parents to children, exploiting a question that asks about the qualities that are appreciated in children. As an indicator of diffusion of generalised morality, I take the percentage of respondents who appreciate respect and tolerance for others in children (Respect). To reduce the scope of measurement error, I consider the average of these two variables, Trust and Respect.

The evidence

In the paper, I consider evidence from a variety of sources and present two main findings. First, distant political institutions left a mark in current values, as measured by Trust and Respect. This is evident from individual data on 2nd generation US citizens. Descendents of immigrants from countries that over a century ago were ruled by more democratic political institutions are today more likely to display generalised trust. It is also confirmed by aggregate data on European regions. Within European countries, Trust and Respect are more widespread in regions where centuries ago executive powers were constrained by the prerogatives of independent judiciaries, or by a Chamber of political representatives. Although the precise mechanism of cultural transmission remains to be pinned down, the inference that political history influences current attitudes and values is robust and not dependent on controversial identifying assumptions.

The second finding concerns the contemporaneous link between values and institutional or economic outcomes. This link emerges from a variety of samples. Aggregate cross-country data reveal that countries where generalised morality is more widespread have better governance indicators and specialise in sectors that rely on well-functioning legal institutions. European data also shows that regions with more Trust and Respect are more developed today, and have grown faster since the mid 1970s. Within Italy, voters in regions with higher indicators of generalised morality are also more willing to punish political incumbents who misbehaved.

Since values are endogenous, causality here can be inferred only under additional identifying assumptions. The method of identification exploits the slow-moving component of values. In the cross-country data, I use grammatical rules of the language spoken in the country as an instrument for values. The idea is that language evolves very slowly and its grammatical structure reflects distant ideas and cultural traditions that no longer matter for the functioning of institutions except through current values. In particular, two rules governing the use of pronouns in spoken conversations are correlated with current cultural traits as measured by Trust and Respect. The correlation is strong both within multilingual countries and across countries speaking different languages. I then consider the component of current values explained by these two grammatical rules, and show that it is robustly correlated with indicators of the current quality of government, and with patterns of specialisation in production. If these grammatical rules are not also directly correlated with other unobserved determinants of the dependent variables, this is evidence of a causal effect of values on governance outcomes and on comparative advantages in specific sectors.

In the within-country data, I exploit a similar methodology, except that I use distant political history in the region as an instrument for current regional values. These regions have been part of a unitary state for over 150 years, but before unification they were governed by very different political institutions. Identification assumes that, after taking into account indicators of economic development at the time of unification, distant political history matters for economic performance only through regional values. The component of current regional values explained by distant political history is strongly correlated with current economic performance in the region. Under the identifying assumption, this is evidence of a causal effect of values on economic development.

These empirical findings do not precisely pin down the mechanism through which values influence economic and institutional outcomes. There are several possible channels of influence, such as the functioning of political institutions, including local governments, or the organisation of production, or the willingness of citizens to respect the law. In fact, all these channels could be relevant, and the working paper presents evidence that, in Italian regions with better values or with a tradition of political independence, voters are more willing to punish incumbent politicians accused of criminal behaviour.

Concluding remarks

This line of research points to an exciting new research agenda. Three questions in particular seem important.

First question: how do individual values influence institutional outcomes? In principle, this can happen in several ways, through bureaucratic behaviour, through voters' behaviour, or by making citizens more or less law abiding. Which of these alternative channels is more important in practice?

Second, how do values evolve over time? Why do current values reflect the functioning of political institutions in the distant past? What is the precise mechanism of cultural transmission for values supporting generalised morality? Does it take place within the family, or in other environments? Does it reflect purposeful deliberation or is it an unintended by-product of other activities?

But perhaps the most important question of all concerns the policy implications of these findings. What policy instruments are more appropriate to an environment with adverse cultural traits, and which policy interventions ought to be avoided? Does political decentralisation facilitate the acquisition of favourable values, and is self-government something that can be learnt through experience? And what can be done to facilitate this collective learning process? The promotion of economic development would become much easier if we could answer these questions.

References

Acemoglu, D., Johnson, S., Robinson, J., 2001. The Colonial Origins of Comparative Development: An Empirical Investigation. American Economic Review 91(5), pp 1369-1401.

North, D. C., 1981. Structure and Change in Economic History. New York: Norton.

Tabellini, G. 2007.

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