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February 4, 2013

Latest Posts from Economist's View

Latest Posts from Economist's View

Posted: 04 Jan 2013 12:24 AM PST
Did Democrats win:?
Battles of the Budget, by Paul Krugman, Commentary, NY Times: ...our two major political parties are engaged in a fierce struggle... Democrats want to preserve the legacy of the New Deal and the Great Society — Social Security, Medicare and Medicaid — and add to them what every other advanced country has: a more or less universal guarantee of essential health care. Republicans want to roll all of that back, making room for drastically lower taxes on the wealthy. Yes, it's essentially a class war.
The fight over the fiscal cliff was just one battle in that war. It ended, arguably, in a tactical victory for Democrats. The question is whether it was a Pyrrhic victory that set the stage for a larger defeat.
Why do I say that it was a tactical victory? Mainly because of what didn't happen: There were no benefit cuts. This was by no means a foregone conclusion...
There were also some actual positives from a progressive point of view. Expanded unemployment benefits were given another year... Other benefits to lower-income families were given another five years... Oh, and not only did Republicans vote for a tax increase for the first time in decades, the overall result of the tax changes ... will be a significant reduction in income inequality...
So why are many progressives — myself included — feeling very apprehensive? Because ... the G.O.P. retains the power to destroy, in particular by refusing to raise the debt limit — which could cause a financial crisis. And Republicans have made it clear that they plan to use their destructive power to extract major policy concessions.
Now, the president has said that he won't negotiate on that basis, and rightly so. Threatening to hurt tens of millions of innocent victims unless you get your way ... shouldn't be treated as a legitimate political tactic.
But will Mr. Obama stick to his anti-blackmail position as the moment of truth approaches? He blinked during the 2011 debt limit confrontation. And the last few days of the fiscal cliff negotiations were also marked by a clear unwillingness on his part to let the deadline expire. Since the consequences of a missed deadline on the debt limit would potentially be much worse, this bodes ill for administration resolve in the clinch.
So, as I said, in a tactical sense the fiscal cliff ended in a modest victory for the White House. But that victory could all too easily turn into defeat in just a few weeks.
Posted: 04 Jan 2013 12:06 AM PST
Posted: 03 Jan 2013 02:07 PM PST
Here's the introduction to a paper I'm giving at the AEA meetings. The model in the paper, which is a variation of the Brock and Hommes (1998) generalization of the Lucas (1978) asset pricing model, shows that bad advice from experts can increase the likelihood of harmful financial bubbles:
Bad Advice from Experts, Herding, and Bubbles: The belief that housing prices would continue to rise into the foreseeable future was an important factor in creating the housing price bubble. But why did people believe this? Why did they become convinced, as they always do prior to a bubble, that this time was different? One reason is bad advice from academic and industry experts. Many people turned to these experts when housing prices were inflating and asked if we were in a bubble. The answer in far too many cases – almost all when they had an opinion at all – was that no, this wasn't a bubble. Potential homebuyers were told there were real factors such as increased immigration, zoning laws, resource constraints in an increasingly globalized economy, and so on that would continue to drive up housing prices.
When the few economists who did understand that housing prices were far above their historical trends pointed out that a typical bubble pattern had emerged – both Robert Shiller and Dean Baker come to mind – they were mostly ignored. Thus, both academic and industry economists helped to convince people that the increase in prices was permanent, and that they ought to get in on the housing boom as soon as possible.
But why did so few economists warn about the bubble? And more importantly for the model presented in this paper, why did so many economists validate what turned out to be destructive trend-chasing behavior among investors?
One reason is that economists have become far too disconnected from the lessons of history. As courses in economic history have faded from graduate programs in recent decades, economists have become much less aware of the long history of bubbles. This has caused a diminished ability to recognize the housing bubble as it was inflating. And worse, the small amount of recent experience we have with bubbles has led to complacency. We were able to escape, for example, the stock bubble crash of 2001 without too much trouble. And other problems such as the Asian financial crisis did not cause anything close to the troubles we had after the housing bubble collapsed, or the troubles other bubbles have caused throughout history.
Economists did not have the historical perspective they needed, and there was confidence that even if a bubble did appear policymakers would be able to clean it up without too much damage. As Robert Lucas said in his 2003 presidential address to the American Economic Association, the "central problem of depression-prevention has been solved." We no longer needed to worry about big financial meltdowns of the type that caused so many problems in the 1800s and early 1900s. But in reality economists hardly knew what to look for, did not fully understand the dangers, and were hence unconcerned even if they did suspect that housing prices were out of line with the underlying fundamentals.
A second factor is the lack of deep institutional knowledge of the markets academic economists study. Theoretical models are idealized, pared down versions of reality intended to capture the fundamental issues relative to the question at hand. Because of their mathematical complexity, macro models in particular are highly idealized and only capture a few real world features such as sticky prices and wages. Economists who were intimately familiar with these highly stylized models assumed they were just as familiar with the markets the models were intended to represent. But the models were not up to the task at hand,[1] and when the models failed to signal that a bubble was coming there was no deep institutional knowledge to rely upon. There was nothing to give the people using these models a hint that they were not capturing important features of real world markets.
These two disconnects – from history and from the finer details of markets – made it much more likely that economists would certify that this time was different, that fundamentals such as population growth, immigration, financial innovation, could explain the run-up in housing prices.
The model in this paper examines the implications of these two disconnects and shows that when experts endorse the idea that this time is different and cause herding toward incorrect beliefs about the future, it increases the likelihood that a large, devastating bubble will occur.
[1] See Wieland and Wolters (2011) for an overview of the forecasting performance of macroeconomic models before, during, and after the crisis.
Posted: 03 Jan 2013 10:26 AM PST
Jonathan Gruber describes a "central tension" in online health exchanges: more choices and more competition versus standardization that makes choices between plans abundantly clear:
The health-insurance markets of the (very near) future, MIT News: An online health-insurance exchange is coming to your state. How effective will it be?

That is an increasingly important question in the United States. In June 2012, the Supreme Court upheld the legality of the country's Affordable Care Act, passed by Congress and signed into law by President Barack Obama in 2010. The program mandates private-sector health insurance for all citizens, and provides subsidies for those who otherwise could not afford it. Insurance-plan choices will be available through exchanges, or marketplaces; most people will be able to study plans and sign up for one online. As of December, nearly 20 states have elected to run exchanges themselves; the federal government will run the exchanges in other states.

And therein lies a key issue: Creating a consumer-friendly exchange is no easy task. It is hard enough to know what kinds of foods we should eat, which cars to drive, or which apps to use. Selecting an insurance plan is a far more complex decision.

"Health insurance is a confusing and difficult choice," says Jonathan Gruber, a professor of economics at MIT who specializes in health-care issues. "It's important that people make decisions in an organized and effective market. In that way they can make the best choices, and we can ensure the best level of competition among insurers." ...

Moreover, as Gruber readily acknowledges, state-run insurance exchanges must pull off a difficult balancing act. The point of markets is to provide competition, but academic research shows that when people are given too many choices, they struggle to select logical options for themselves.

"The tension that exchanges face," Gruber says, "is [having] enough standardization to make choice and competition work effectively, but not so much standardization that people can't find the plans that best fit their tastes. That's absolutely a central tension." To handle this challenge, policymakers and academic researchers will almost certainly have to collaborate in productive ways.

Indeed, plenty of research suggests that America's existing health-care offerings are already too complex. ...[more]...

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