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March 28, 2015

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Posted: 28 Mar 2015 12:06 AM PDT

How Idealism Can Fight Climate Change

Posted: 27 Mar 2015 12:06 PM PDT

Robert Shiller:

How Idealism, Expressed in Concrete Steps, Can Fight Climate Change: Idealism combined with an intriguing application of economic theory may accomplish what international conferences have not: solve the seemingly intractable problem of global warming.
Despite periodic flurries of optimism, diplomacy has been largely disappointing. ... From an economic standpoint, international efforts until now have foundered on a fundamental "free rider problem." ... Why not just take a "free ride" and let others do the hard work? ...
But there are other ways to look at this... In a new book, "Climate Shock: The Economic Consequences of a Hotter Planet" (Princeton 2015), Gernot Wagner of the Environmental Defense Fund and Martin L. Weitzman, a Harvard economist, question that assumption. In a proposal that they call the "Copenhagen Theory of Change," they say that we should be asking people to volunteer to save our climate by taking many small, individual actions. ...
The world is a diverse and complicated place, however. In order to combat global warming, social movements aren't enough. We also need a concrete framework on a global scale.
In his presidential address before the American Economic Association in Boston in January, William D. Nordhaus of Yale proposed what he calls "climate clubs"..., a group of countries that agree to create incentives for people to reduce carbon emissions, while also erecting tariff barriers on imports from countries that are not members of the club. ...
To actually solve the extremely challenging problem of climate change, we may want to rely on both theories...

'Microeconomic Origins of Macroeconomic Tail Risks'

Posted: 27 Mar 2015 12:06 PM PDT

Microfoundations from Acemogl, Oxdaglar, and Tahbaz-salehi:

Microeconomic origins of macroeconomic tail risks, by Daron Acemoglu, Asuman Ozdaglar, and Alireza Tahbaz-Salehi: Understanding large economic downturns is one of macroeconomics' central goals. This column argues that imbalances in input-output linkages can interact with firm-level shocks to produce output fluctuations that are much larger than the underlying shocks. The result can be large cycles arising from small, firm-level shocks. It is thus important to study the determinants of large economic downturns separately. Macroeconomic tail risks may vary significantly even across economies that exhibit otherwise identical behavior for moderate deviations.
Most empirical studies in macroeconomics approximate the deviations of aggregate economic variables (such as the GDP) from their trends with a normal distribution. Besides analytical convenience, such an approximation has been relatively successful in capturing some of the more salient features of the behavior of aggregate variables in the US and other OECD countries.
Macroeconomic tail risks
A number of recent studies (see Fagiolo et al. 2008), however, have documented that the distributions of GDP growth rate in the US and many OECD countries do not follow the normal, or bell-shaped distribution. Large negative or positive growth rates are more common than the normal distribution would suggest. That is to say, the distributions exhibit significantly heavier 'tails' relative to that of the normal distribution. Using the normal distribution thus severely underpredicts the frequency of large economic downturns.
This divergence can be seen clearly in Figure 1. Panel (a) depicts the quantile-quantile plot of post-war US GDP growth rate (1947:QI to 2013:QIII) versus the normal distribution after removing the top and bottom 5% of data points. The close correspondence between this dataset and the normal distribution, shown as the dashed red line, suggests that once large deviations are excluded, the normal distribution is indeed a good candidate for approximating GDP fluctuations. Panel (b) shows the same quantile-quantile plot for the entire US post-war sample. It is easy to notice that this graph exhibits sizeable and systematic deviations from the normal line at both ends. Together, these plots suggest that even though the normal distribution does a fairly good job in approximating the nature of fluctuations during most of the sample, it severely underestimates the most consequential fact about business cycle fluctuations, namely, the frequency of large economic contractions.
Figure 1. The quantile-quantile plots of the post-war US GDP growth rate (1947:QI to 2013:QIII) vs. the standard normal distribution (dashed red line)

Acemoglu fig1 24 marNote: The horizontal axis shows quantiles of the standard normal distribution; the vertical axis shows quantiles of the sample data.

Input-output linkages, micro shocks, and macro risks
In recent work (Acemoglu et al. 2014), we have argued that input-output linkages between different firms and sectors within the economy can play a first-order role in determining the depth and frequency of large economic downturns. Building on an earlier framework by Acemoglu et al. (2012), we show that if all firms take roughly symmetric roles as input-suppliers to one another (in what we call a 'balanced' economy), not only GDP fluctuations are normally distributed, but also large economic downturns are extremely unlikely. In other words, absent any amplification mechanisms or aggregate shocks, microeconomic firm-level shocks cannot result in macroeconomic tail risks. More interestingly, this result holds regardless of how these firm-level microeconomic shocks are distributed.
Our subsequent analyses, however, establish that the irrelevance of microeconomic shocks for generating macroeconomic tail risks would no longer hold if the economy is 'unbalanced', in the sense that some firms play a much more important role as input-suppliers than others. More specifically, we argue that:
The propagation of microeconomic shocks through input-output linkages can significantly increase the likelihood of large economic downturns.
The implications of our theoretical results can be summarized as follows:
First, the frequency of large GDP contractions is highly sensitive to the nature of microeconomic shocks.
In particular, in an unbalanced economy, micro shocks with slightly thicker tails can lead to a significant increase in the likelihood of large economic downturns. This suggests that unbalanced input-output linkages can lead to the build-up of tail risks in the economy.
Second, depending on the distribution of microeconomic shocks, the economy may exhibit significant macroeconomic tail risks even though aggregate fluctuations away from the tails can be well-approximated by a normal distribution.
This outcome is consistent with the pattern of US post-war GDP fluctuations documented in Figure 1.
This observation underscores the importance of studying the determinants of large recessions, as such macroeconomic tail risks may vary significantly even across economies that exhibit otherwise identical behaviour for moderate deviations.
Finally, there is a trade-off between the normality of micro-level shocks and imbalances in the input-output linkages.
An economy with unbalanced input-output linkages subject to normal microeconomic shocks exhibits deep recessions as frequently as a balanced economy subject to heavy-tailed shocks.
Solving the 'small shocks, large cycles puzzle'
In this sense, our results provide a novel solution to what Bernanke et al. (1996) refer to as the 'small shocks, large cycles puzzle' by arguing that the interaction between the underlying input-output structure of the economy and the shape of the distribution of microeconomic shocks is of first-order importance in determining the nature of aggregate fluctuations.
Understanding the underlying causes of large economic downturns such as the Great Depression has been one of the central questions in macroeconomics. Our results suggest that the frequency and depth of such downturns may depend on the interaction between microeconomic firm-level shocks and the nature of input-output linkages across different firms. This is due to the fact that the propagation of shocks over input-output linkages can lead to the concentration of tail risks in the economy. This observation highlights the importance of separately studying the determinants of large economic downturns, as such macroeconomic tail risks may vary significantly even across economies that exhibit otherwise identical behaviour for moderate deviations.
Acemoglu, D, V M Carvalho, A Ozdaglar, and Al Tahbaz-Salehi (2012), "The network origins of aggregate fluctuations", Econometrica, 80, 1977–2016.
Acemoglu, D, A Ozdaglar, and A Tahbaz-Salehi (2014), "Microeconomic origins of macroeconomic tail risks", NBER Working Paper No. 20865.
Bernanke, B, M Gertler, and S Gilchrist (1996), "The financial accelerator and the flight to quality", The Review of Economics and Statistics, 78, 1–15.
Fagiolo, G, M Napoletano, and A Roventini (2008), "Are output growth-rate distributions fat-tailed? Some evidence from OECD countries", Journal of Applied Econometrics, 23, 639–669.

Paul Krugman: Mornings in Blue America

Posted: 27 Mar 2015 06:16 AM PDT

Conservatives have GNDS (good news derangement syndrome):

Mornings in Blue America, by Paul Krugman, Commentary, NY Times: ...remember how Obamacare was supposed to be a gigantic job killer? Well, in the first year of the Affordable Care Act..., the U.S. economy .,, added 3.3 million jobs — the biggest gain since the 1990s. ...
But recent job growth ... has big political implications — implications so disturbing to many on the right that they are in frantic denial, claiming that the recovery is somehow bogus. Why can't they handle the good news? The answer actually comes on three levels: Obama Derangement Syndrome, or O.D.S.; Reaganolatry; and the confidence con.
Not much need be said about O.D.S. It is, by now, a fixed idea on the right that this president is both evil and incompetent, that everything touched by the atheist Islamic Marxist Kenyan Democrat — mostly that last item — must go terribly wrong. When good news arrives about the budget, or the economy, or Obamacare ... it must be denied.
At a deeper level, modern conservative ideology utterly depends on the proposition that conservatives, and only they, possess the secret key to prosperity. As a result, you often have politicians on the right making claims like this one, from Senator Rand Paul: "When is the last time in our country we created millions of jobs? It was under Ronald Reagan."
Actually, if creating "millions of jobs" means adding two million or more jobs in a given year, we've done that ... eight times under Bill Clinton, twice under George W. Bush, and three times, so far, under Barack Obama. ...
Which brings us to the last point: the confidence con.
One enduring puzzle of political economy is why business interests so often oppose policies to fight unemployment. After all, boosting the economy with expansionary monetary and fiscal policy is good for profits...
As a number of observers have pointed out, however, for big businesses to admit that government policies can create jobs would be to devalue one of their favorite political arguments — the claim that to achieve prosperity politicians must preserve business confidence, among other things, by refraining from any criticism of what businesspeople do. ...
So, as I said at the beginning, the fact that we're now seeing mornings in blue America — solid job growth both at the national level and in states that have defied the right's tax-cutting, deregulatory orthodoxy — is a big problem for conservatives. Although they would never admit it, events have proved their most cherished beliefs wrong.

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