Friday, August 14, 2009

Young's Tyranny of Numbers

I have always thought that an important part of the explanation of rapid growth of the so called Asian Tigers (Hong Kong, Singapore, South Korea and Taiwan) was productivity. Turns out that is not necessarily the case. LSE's professor Alwyn Young has this famous paper "The Tyranny of Numbers: Confronting the Statistical Realities of the East Asian Growth Experience". Young's estimates of productivity -a key feature of economic growth according to the neoclassical model- for these Asian countries is not particularly different from countries such as Mexico, Brazil or Canada.

The paper argues for a different reason why economic growth boomed in the region. A -sort of- one time shock of education, participation and investment. It seems that underlying fast growth is the laggard progress they had before World War II. So its not that they are particularly good at something. Nor it is that they are productive workers. Not even that real wages are low. These economies grew because they were far away from the needed level of capital human, investment and participation. Once they achieve these levels, employment along with exports pulled these economies.

When policy recomendations for countries like Mexico point to follow the Asian Tigers, the only thing there is to follow is the improvement of investment, participation and human capital levels, not necesarily the productivity indicators. Productivity should push prices down, but it takes more than that to increase aggregate output.

Mexican Senate organized a forum to recollect the opinion of experts to increase productivity and competition. According to Young's argument, competition should be addressed as a priority, including the increase in investment - GDP ratio. Taking official series at constant prices, the ratio's growth rate has lately fall to negative levels in Mexico. This should be a policy lesson.

Thursday, August 6, 2009

Lucas talks on the Critics of the Economics Profession

Robert Lucas from University of Chicago has a strong argument published in The Economist against those dooming modern macroeconomic models. It is worth reading.

A few thoughts from Animal Spirits

After completing the Animal Spirits book I have a few thoughts that I think deserve some discussion. I sustain that the book does not provide a way to model the Animal Spirits as defined by the authors. It does provide a list of topics and questions that macro guys should address soon if it wants to contribute to decisions among policy makers.

There are some interesting examples of how generalization in markets analysis may not be the right path to think of their behavior. The book includes an interesting and revealing example from Keynes.
It goes like this: Assume there is a beauty contest where judges are rewarded if they price contestants as the majority of judges does. With this simple assumption, it is farly straight to conclude that every judge chooses what he thinks every other judge will choose -maybe- instead of his true first preference. The latter illustrates perfectly how the stock market works.

I agree with a statement of Akerlof and Shiller: it is hard to believe that every single day there is an explanation for the recent stock market movements. I think that being a stock market columnist must require a vast stock of creativity, specially in days of many fluctuations.

Another example of "special" markets is a common one in Mexico. Physicians are rarely choose from the yellow pages. They get most of their patients because a satisfied patient recommends his services. Literature books are read not only because of their publicity, but because of some recommendation. So these two markets -physicians and books'- have in common that information is a strong determinant in decisions. This is not new, what is interesting is that prices may not reflect all information there is needed to make a "good choice".

The utility provided by a book -or a physician- can be explained by tastes, but the great supply makes it necessary to ask for a recommendation before making a transaction. So stock markets -books and physicians- may need a different framework to be analyzed.

Another part of the reading that kept me thinking is the efficiency wages theory and its implications in rigidities, it is indeed natural to conclude that this theory explains reality of rich countries. In poor countries the same effect of costly layoffs can be largely explained by unions.

There is another reality that can not be drawn out of the analysis: that is the skills and fairness issues in the problem of determining wages.
The latter is very important in recent tax design literature, and create a major problem arguing in favor of the non-negative slope Phillips curve.

We economist must always have in mind the important difference between normative and positive economics. The former must be the target, but the latter is our reality and must be understood too. If economist can diagnose what is wrong -using normative economics- we should also know how to deal with actual problems -with positive economics.

The book tries to take away the profession from a normative to a positive fashion, but both are essential, Skidelsky goes even further asking for a change in universities' economics programs adding a philosophical background and letting math aside.

Tuesday, August 4, 2009

A Big Obstacle Rebalancing Global Imbalances

The widely accepted assertion of macro theory which states that after a public budget deficit, a currency appreciation will follow can help to know when stop spending. Several mechanisms work and translate in to a -temporal- wealth effect for residents of the named country. This certainly could not contribute to an export rising.
This having said, it appears now that the future budget deficits of the U.S.' economy will play against economic growth. The latter is easily infered from Martin Feldstein's statement that even though savings in the U.S. are rising and could replace foreign one -known as capital inflows- there will not be a dollar depreciation which is a necesary condition for having economic growth and a current account re-balance.
Taking as a -disputable- truth that the increase in spending has helped improve the economic outlook world-wide, the effect pointed by Feldstein may perfectly work as a sign to know when to stop spending and let the economy re-balance by itself.

Wednesday, July 22, 2009

The need for new Macro

There is a vast consensus around the need for the -rapid- improvement of macroeconomics. It certainly can not be neglected. Although the path of the Animal Spirits may have a number of weaknesses, it argues boldly for reforming the way macro is done can not wait anymore. De Grauwe writes an interesting opinion about the latter.

Maybe the need for understanding the so called Herd Economics can help in completing macro models that fail to model the financial market as an imperfect market. The current macro profession crisis will also prove valuable for those in search of a thesis.

Sunday, July 19, 2009

Animal spirits -After some reading-

In a recent post, I described a lecture given by one of the authors. After the completion of the 9th chapter out of 14 my impressions have not changed much. The book proposes some new "variables" that modern economic theory does not use. The so called "animal spirits". Defined as a set of variables such as confidence, money illusion, stories and corruption.

The approach of the book can be shortly summarized in the following: Macroeconomics has taken too far rationality assumptions. After more than 100 pages, evidence and arguments presented are in my view far from conclusive.

The authors construct most arguments based not on facts but on frequent guessing. No doubt behavioral economics rely it's findings on an interesting psychological framework. No doubt it will eventually develop to a sounder stage. But the animal spirits theory contributes little to economic modeling.

It is hard in the profession to consider seriously a theory without a model to assess reality. Not to mention in economic policy-making. The only animal spirit that could be tested at present is the one that is based in stories. Something particularly similar to adaptative expectations. The Economist magazine made available a bold description of the current state of the economist profession in terms of those soft spots of macro.

This explanation is much more centered than Akerlof and Shiller's. It states an important fact too. We economist prefer an elegant and formal theory. Not because of vanity, but because science grows based on sound facts and abstraction of them. We now know for a fact that financial markets can not regulate by them selfs. It seems that this is the most notable weakness of modern macroeconomics, not the rationality assumptions for the rest of the economic agents, nor the microeconomic foundations that modern macroeconomist agree are important. Including recent advances of the Dynamic Stochastic General Equilibrium Models.

The article of the Economist says also, that we consider only theories that can be modeled. That is true. Again not for vanity but for its usefulness for real life problems. An example. Keynes's breakthroughs in economics translated in to reality with a deep and a comprehensive fashion until Hicks developed the IS-LM model, until then, keynesian theories were only provocative philosophical arguments.

Maybe behavioral economics will provide the theory for serious improvements of macroeconomic theory. The Animal Spirits book does not provide a model for this end.

Sunday, July 12, 2009

Is the IS-LM Model Outdated?

As an undergraduate student, I used to disdain the IS-LM model as an obsolete tool of macro policy analysis. In time I have come to the conclusion that there is not a sounder model out there. Despite its limitations -such as its static set up, ad-hoc nature and lack of microfundations- the IS-LM model provides accurate information on the behavior of some variables after a public policy decision.

The lack of microfoundations is important in second order. Lets not forget that it is, at the end, a general equilibrium model. Moreover, the IS-LM model is a synthesis of the goodnes of general equilibrium economics and comparative advantages of Keynesian economics.

Although Paul Krugman is lately a maverick economist, opposing to every other collegue, it is worth taking a look at Krugman's thoughts of the IS-LM model. Personally, I have more respect now for the model. Not because its limitations are minor, but because its usefulness has been proved over years of economic policy.

The fact that international agencies such as the IMF or central banks use the model -along with some dynamic stochastic general equilibrium- shows its value for the profession. I find it hard to believe that after tons of macro papers written out there, only a small proportion has proven useful for macro policy.

Two facts have changed my view of the model: First, I prefer to be an "engineer macroeconomist" in Mankiw's definition. Second, when learning advanced models of economic growth and policy, the IS-LM provides the right intuition. So it makes it easier to understand the important results.

Hopefully the current economic crisis will trigger interest in making economic modelling closer to reality. It is true, economic science evolves slower than it looks. Maybe modern macro models are over a path in o a new and more useful model than the IS-LM. In the mean time, it is not a waste of time to learn it well if you like macro.

Thursday, July 9, 2009

The Economist on Mexico's last Election

It is fairly straight to conclude that the following three years -before elections for President- will be the hardest of the Calderon administration. The Economist sum-up a clear picture of it.

The liberal magazine also displays the only way out of the "political gridlock", stating that co-governance with the PRI party is a necessary condition, with the implicit hope that the PRI will allow for critical reforms and thus would receive a country in expansion. If you are interested in estimated numbers of the low chamber composition, Eduardo's Blog provide some from the media.

The Economist's view of Mexico it's almost fully accurate, it only fails to mention the low proportion of total votes with respect to registered citizens, and all nule votes.

With the Congress majority leaned to the PRI party, much of economist's creativity should be invested in the next fiscal reform. VAT in food and medicines will not be an option.

Wednesday, July 8, 2009

IMF Issues Debt!

The IMF will issue debt soon according to the FT. The latter rises some interesting questions. How will IMF's debt affect economic variables? Will prices in countries be distorted? If so, in which countries lenders or borrowers? To what terms would be issued? John Cochrane explains how can long term debt be useful for a government trying to exchange present for future inflation. Will effects like this lack of importance?

It sounds like some details should be discussed, one thing for sure is that the US will stop receiving savings from surplus countries, if the dollar depreciates, trade deficit in the western hemisphere will fall, still, trade surplus in Asia will not necessarily fall.

Another interesting feature is that if the IMF's absorbs saving excess, the consumption and investment components of aggregate demand in rich countries will suffer. There are a few untied ends of the proposal, but it is probably in the right direction. A popular direction at present.

Monday, July 6, 2009

The Political Economy of the Next Fiscal Reform -After the election-

Results of the election show that the Revolutionary Party (PRI) will be the first minority in Mexican lower chamber with more than 210 seats. A strong position with respect to its present 106 seats. The official National Action Party (PAN), will have 133 seats a big lost from the former 206. In the last three years, history has recorded that whenever the PAN wanted to go ahead with any major reform, it had to agree with the PRI first.

Now all negotiations will be harder for the official party. Taken PRI's ambitions to return ruling Mexico in 2012 as given, a fiscal reform that raise the tax base or the marginal tax rate of existing tributes looks ever more difficult.

Taking a glimpse in to the future, and assuming the PRI is willing to raise tax revenue, the optimal strategy for the Democratic Revolution Party (PRD) will be -with emphasis- to condemn those taxes and then trying to re-gain the second place in voters' preferences. The PRD did very bad too in the recent election, it will have only 67 seats nearly half of its current number 126.

All the latter would leave the PAN in a historical weak position and as an all time looser. The PAN would present to the 2012 elections as a party with the poorest performance in both economic and public safety terms. Taken the last election as an advanced indicator of the 2012's, the PAN should focus in not loosing its place as the second major party.

One of the few ways a fiscal reform would take place, must involve the PRI's akcnowledgement of the fact that without enough revenues, Congress alocates fewer resources. At the same time, the fiscal reform should include all parties, so that none of them could make campaign against it.

Sadly, evidence of reforms including all parties in the current period shows that they have turned out to be weak when compared with its motivations. The latter is the case of the last fiscal, energy and voting system reforms.

Only reforms agreed by a small number of parties are near to satisfy the needs reality demands, such as the pension reform of the State workers of 2007.

Mexico's President will face tougher obstacles now, with its safety policy struggling to convince Mexicans it is the right way, an economý faltering and expected to grow slowly, added to low expected public revenues, the PAN has to take serious action and deal with the PRI, otherwise, the country of 2012 will be ever more distant from that promissed in 2006. Voters acknowledge that.

Wednesday, July 1, 2009

Animal Spirits -A First Glance-

Berkeley economics' professor George A. Akerlof and Yale's Robert J. Shiller recently published a book that awake interesting feedback so far. The title reads "Animal Spirits" invoking a popular phrase of J. M. Keynes regarding the underlying factors that come to play when it comes to investment decisions.

This already shows some biased in the convictions of the authors, which can be summed up in the following: governments should play a more active role in the economy than free-market advocates claim.

I have not read the book yet -I will soon- however, I have a clearer picture of its contains. Shiller visited recently the LSE and gave a lecture on it. One of the central points made was that, unlike we economist assume, individuals make decisions based in shakier, less technical premises. One in particular caught my attention. Akerlof and Shiller state that individuals base their decisions in "stories". This is, in someone else's experiences. Frankly, this falls in place if we look to how investment decisions are made in cities like Guadalajara, in Mexico.

It is fairly common to hear that someone decided to get in the carwash bussines because he heard how well someone else was doing. It is easy to replicate the latter in mobile phone stores, haircutt shops, caffe internet, real state buying, and so on. There are no feasibility studies behind, just stories from acquaintances.

Of course, it is true that not only Guadalajara corroborates Akerlof and Shiller's hypothesis, just as is true that there are hundreds of counter examples. Nevertheless, the "stories" story seems a lot like the forgotten adaptative expectations. So, in a way, the authors suggest that models -such as the modern macro models- should be re-assessed to include the latter and delete the "rational" approach.

This is my hope at least, otherwise it would be hard to model those indivuduals' "animal spirits". Still, there is some reading to do.

Monday, June 22, 2009

Alternative Approaches to solve Global Imbalances

The World Bank has proposed a provocative way to get the world out of recession: Expand developing countries aggregate demand. This really makes sense. Remember that current imbalances show that rich economies save too little, and emerging ones save too much.

Despite differences among emerging economies, one truth abides: imbalances must be corrected. There are three straightforward ways: either China, India, Brazil and alike consume more; the U.S. the U.K. Spain and alike save more; or both.

Some aspects of political economy in the second and third alternatives are important; they automatically imply that rich countries must renounce to some extent to its quality of life. Saving more resources imply consuming less, or as the basic economics lessons say: exchange more current consumption to get more future consumption.

The latter idea respects the same spirit as the World Bank's. According to this approach economic policy pulling aggregate demand should be seen, far more among developing countries than in rich countries. One setback of the World Bank's approach relies in the principal-agent issue. If rich countries are not credit worthy, then how a developing country can fulfill the lower-risk demand of financial markets?

The idea from the World Bank is clear, capital flows into emerging economies are just a quarter of what they just to be a year ago. Rich countries' currencies are appreciating, then higher risk aversion is a binding constraint in capital markets.

So there are at least two major obstacles to shift the power of aggregate demand from rich to emerging economies. However difficult, this would correct global imbalances, would also strengthen infrastructure in rich economies and would create jobs in developing ones. It will probably lower wages in the former and increase them in the latter. Sounds like a nice solution, if the loss of quality of life was not true. Unfortunately this sounds like a dead-end: there is not enough wealth for all countries in the world.

Neo-Classical theory states that further investment should be done in order to create wealth, this sounds like a feasible way out of the dead-end. The latter needs capital flows restored from rich to emerging economies, maybe this is a necessary endeavor the World Bank and the International Monetary Found will have to undertake.

Friday, June 19, 2009

Global Imbalances from the IMF

Olivier Blanchard wrote this piece in Financial Times. Consensus is growing stronger. China should consume more, US should consume less. As simple as that.

Monday, June 15, 2009

The Political Economy of the Next Fiscal Reform

Mexico will have to face a crude fact. A deep fiscal reform can not be postponed any more. In fact there are a few reasons to expect it in the last quarter of the present year. Starting with basic facts, Mexico's tax revenues are just above 8 percent of its GDP, there are just two countries in Latin America with a lower proportion, Haiti and Costa Rica. Lets just add to the latter that marginal tax rates in Mexico are just about the average of OECD countries, Value Added Tax (VAT) of 15 percent Corporate Income Tax (CIT) of 28 percent and the Personal Income Tax (PIT) with 4 brackets, its highest of 28 percent.

Another important fact that reveals the weakness of the present tax system is found in the figures of tax evasion and delusion. The Tax Management Service (SAT) published in 2006 that evasion of the entrepreneurial activities income tax (EAIT) for individuals related to earnings had a 5 to 1 ratio. This is, for every peso earned from this tax, 5 were not payed illegally. Taking the same ratio for the CIT it was 5 to 6. For the VAT it was 11 to 20, and for PIT 1 to 7. Clearly all efforts in the next fiscal reform should aim to EAITand the CIT.

In 2007, the last fiscal reform, an innovation of tax policy born. The Entrepreneurial Tax of Single Rate (so called IETU), became law after long discussions in the lower chamber. This tax aimed to reduce evasion of the CIT and the EAIT, however, its design has not helped to increase tax revenue since it looks to be far more pro-cyclical than the VAT, even though it works mostly as an indirect tax.

This is the current picture of the tax system, intermediate pollings in July have provide with a deterrent to propose major tax changes. It is also necesary to assess the fact that oil prices, although recently their trend is upwards, are still volatile, furthermore, they have just equalized the price projected in the public budget.

Government has invested a lot of effort, political capital and resources to the public safety issue, but is not clear that the latter helps to win the intermediate pollings. Moreover, without political support from opposition parties, a fiscal reform will not only will be weak but it may be impossible.

This is probably why Government has put a lot of attention to political campaigns lately. It surely needs to balance to its favor all votes of the lower chamber. This is also why we will not see a fiscal reform package until July. Of course it is not profitable in terms of votes to rise taxes, however, this may not be necesary since the problem are not the marginal rates, but the exception rules that apply in the CIT and the EAIT. Other tax reforms should aim to reduce inefficiencies in the production chain.

Unfortunately, there are some taxes in Mexico that are implemented not to increase efficiency and thus employment, but to protect some industries. Sugar refinery and alcohol processes are an example. Ecological taxes such as a higher price for gasolines will be surely evaluated. It is hard to avoid the latter discussion given a high positive correlation between income and car ownership, and income distribution and car traffic levels. The more income a city shows, the more cars it has.

A new fiscal reform will face the usual political obstacles, but it is becoming ever harder to stop.

Taintedness in Economics

Press and politicians have helped maverick economists to taint some terms in economics.

When people hear surplus, it is often associated to a positive stance of policy. Oppositely, a deficit is attached to a miss-management or to policy mistakes. What if there is no right and wrong? We have witnessed how China has build upon a huge trade surplus and is hard to defend the hypothesis that Chinese live considerably better now that when their international reserves were a third of today's. Wolf offers a chart with the current account balance to see how it has evolved.

It is also hard to argue in favor of a policy to save natural resources -such as oil- for the future. What happens if the next year a new source of energy leaves oil useless? Then a country would have had missed the chance to have an alternative revenue source, very well, with a surplus of oil.

It is a striking reality how few analysts -which you could classified as serious- do not attach an adjective after a number. They usually point at the advantages as well as the dis-advantages of some policy, or they name all positive and negative results of a policy.

One must be careful when forming an opinion and be sure that it relies in serious analysis and not just judgmental adjectives. Having said that, it is ever more worrisome that both China surplus and U.S.' deficits are still growing. This leads to the question of several students of economics: why are we economists so worried about equilibrium? It's natural answer should include an analogy: equilibrium in economics work as a compass to the captain of a ship. It tells us where we are heading, whether it is ever farther or closer to what a policy pursue.

Also, an equilibrium is a risk-free situation. We sure know all pros and cons of having a trade deficit or surplus, but we know it is riskier than having a trade balance. Let us not forget that inherently to a trade surplus build upon an overvalued exchange rate a country will face high inner prices and less improvement in productivity. Incidentally two of the necessary conditions to have long-run growth.

So an equilibrium must be pursued then, but surplus and deficits should not be tainted by positive or negative adjectives.

Sunday, May 31, 2009

Global Imbalances

The global imbalances story explaining the current crisis is gaining ever more adepts. It's fairly straight that U.S. officials claimed it, looking for guilt abroad will always be far easier, but now academics are pledging the same. Eichengreen wrote a piece based on the imbalances story that is worth reading.

Saturday, May 23, 2009

Quarterly GDP

Recent data from the statistics institute showed that Mexico's GDP decreased by 8.2 per cent. This is certainly the worst quarterly figure since the so called tequila crisis.

To have a broader perspective of the economic slump, it is necesary to state differences between both downturns.

First, clearly this is an external crisis, this is, it is not due to Mexico or any other emergent economy. Second,current crisis has not distorted prices in the same magnitude as in 1995. It is worth noticing that despite pressures on Mexican currency, the "pass through" has not pushed prices so high. Actually, inflation is only one eighth of that of the first quarter of 1995.

Third, this time around exports will not pull Mexico out of recesion. Worst, they are dragging it down. Take the following equilibrium condition that states how public and private domestic savings equal net capital outflows


There are two features that characterize the Mexican economy: it saves poorly and it's tax revenues are poorer. This implies that the left hand side of the latter equality is negative. This lead to conclude that the right hand side must be negative.

So far there is nothing different. However export intensive the Mexican economy is, the very nature of it's exports imply considerably high imports. Most part of exports are manufactured goods, so intermediate imported goods are needed.

So, XN is negative as it has been in the last 14 years or so. The only channel remaining to adjust is investment. A strong argument can be constructed to explain how the current economic slump is explained by the fall of in-flow capital and the expectation of poor investment returns.

Sadly the latter argument lead to conclude two things. First, Mexico will not grow until the exports demand grow, inherently there is little to do in economic policy. Second, it is a necesary condition for growth that capital flows reach back to Mexico.

One paliative to the current recesion could be found in the increase of T (a decrease in G would be possible too, however this looks politically harder in the current G boom all around the globe). As the equation shows this will re-balance the lack of domestic savings, painfully this means a revenue intensive fiscal reform.

Mexican policy-makers should aim to survive the storm then.

Friday, May 15, 2009

Negative Interest Rates? Seriously?

The latter discussion that has been going on about the possibility of the Fed pursuing a negative target of interest rate seemed shallow at first. But, honestly, there would be a few advantages of having inflation at a positive level soon.

So far we are certain that inflation is not a problem -though we are that it WILL BE because of debt issuing- so why is it too hard to think about having negative -real- interest rates?

Mankiw poses the thought in a provocative way and he says that it attracted a number of negative comments. So which is the right approach to conclude that negative interest rates are useful? First, you should be a dove in terms of inflation, that is, you price higher unemployment than inflation. Second, you must be convinced that a demand pull will put the economy on a stable path. Third, you have to neglect the fact that excess of borrowing got the U.S. Economy in to this mess, and the negative interest rate will not solve this.

Once those three conditions are met, then yes, a negative interest rate can pull the economy out of recesion. Lets assume that this is the case. Then it is useful to analyze some advantages of the scheme. First, inflation is better that deflation, and recent numbers show that deflation is already here. Even if future inflation can be a big issue, deflation should be avoided because the latter will imply that the former will not appear, by definition.

After deflation is avoided, a second possible advantage of having positive inflation in the current environment is that public debt would be inflated away, and this would prevent a default from the U.S. Treasury. This second possibility deserves deeper analysis, observe however, that it is equivalent in a certain fashion, to a rise in taxes without Congress. Lets not forget that this is one of the most regressive taxes there are. So the lower income layers of population will shoulder a considerably high part of the tax burden.

Furthermore, a negative interest rate scheme implies that capital tax revenues will not be positive. Another shock to inflation that may be overlooked is that in strict terms it is natural to expect dollar to depreciate. This would help to balance the current account of the U.S.

It is rather hard to forsee all consequences of negative interest rates, however, it is fairly straight that it would work as an increase in future taxes, the most distortive kind, the only positive side would be to inflate away debt.

Monday, May 11, 2009

Inductive and Deductive Methods in Economics

Lately, as a consequence of the economic events, the way economics should work as a scientific method and as a social science has been challenged. Eichengreen addresses how Economics should aim to a more inductive analysis fashion.

There are a few points in the same spirit that should be taken into analysis. First, is ever more clear that mathematical models are useful to test facts observed in reality. It is indeed frustrating that there are thousands of tons of papers about economics written, and despite the latter, bubbles in financial markets exist and policy makers are doubtful of the effects of public spending and tax multipliers.

Second, it's true, economic theory has advanced considerably in microeconomics, game theory, even in macro theory, however it is rather slow the process of applying theory to economic policy. Naturally, the question rose: when will developments in theory will help policy makers?

In years to come is fairly likely that research in macro will have to address specific problems, which prove directly related to reality and not with theoretical problems, such as existence or uniqueness of equilibrium.

This in turn gives an advantage to the keynesian and new keynesian economics approaches, as opposed to the classical one, the former are far easier to contrast in reality.

The latter implies that all of us who are interested in macro will have to put a lot -more- effort to empirical and programing techniques, whether they come from econometrics or from calibration.

All of the latter shows that the deductive method, in which a chain of logical facts is sufficient in order to prove one hypothesis has been seriously challenged.

Theory based in the deductive method should be regarded as a first step in the analysis, yet, making decisions without the appropriate empirical -inductive- evidence should be avoided.

An illustrative example of the latter appears in the interview Catherine Mansell made to Arnold Harberger. Harberger emphasizes that every economic policy recommendation and economic theory assertion must come from sound contrast with reality.

It is true, econometrics sometimes looks like some black magic that would tell the researcher what he wants to hear. This approach of econometrics should be corrected too.

Economists as social science researcher must base any conclusion in observation, with the valuable help of formality provided by mathematics.

Wednesday, May 6, 2009

Inflation Targeting and Central Bank Independence

Recently a number of articles from economist regarding Inflation Targeting (IT) and Central Bank Independence (CBI) have put some thoughts out there that must be analyzed carefully. Those articles aim at causes of the current financial crisis and up-to-date policy efforts to tame it.

A quick review of the pre-dominance of IT and CBI should include that, the former is the result of taking inflation as a great monetary phenomena. This is, inflation is less related to the real economy, and the premise that the biggest contribution from any central bank to economic growth is keeping inflation rates low -thus interest rates low, thus increasing rates of investment thus increasing aggregate demand.

The IT scheme provides information about future policy decisions by the central bank, clearly, if observed inflation is above the targeted one, interest rates will go up, and if current inflation is below the targeted one, interest rates MIGHT go down.

CBI, as Becker explains is important because if any central bank finance treasury fiscal deficits, the medium term result is a high rate of inflation. So both IT and CBI contribute to low inflation. Indeed the world has seen a period of low inflation rates in the last twenty years. We all know that there are two direct causes of rising inflation: 1) If Aggregate Demand expands or 2) if Aggregate Supply retracts.

The key issue evaluating IT and CBI is finding how does monetary policy controls prices? Is it through Aggregate Demand or Aggregate Supply or both? Both is the most accurate answer. When a central bank increases the interest rate, aggregate demand diminish as credit and investment are relatively more expensive. However, aggregate supply can expand since as the interest rate increases, expectations on prices fall, thus increases in wages are moderate and thus firms can expand output lowering prices at the end by those two channels.

The latter example illustrates that monetary policy is important both for consumers and firms. This approach lacks an important feature, market bubbles. Evidence suggest that when output is considerably weak, central banks aim for a loose monetary policy, this is, low interest rates achieved by an increase in money supply. This loose monetary policy creates, fairly as a consistent result, an excess of money holdings. The latter in turn creates an excess of savings and thus a great probability of the rise of a market bubble. As financial firms compete for the excess of savings, and interest rates are low, managers have greater incentives to invest in riskier assets.

So there is a strong argument that blame central banks for the existence of market bubbles. This leads to a first direct conclusion, CBI is a key feature because it guarantees low inflation and can decide with the least political bias whether or not to sustain low interest rates when output is weak. If this were not the case, every time a political decision implied a monetary stimulus a bubble could arise. Is fairly straight to conclude that is better to have bubbles as an undesirable outcome, than every time the economy is weak and politicians need votes.

As for the IT case, it is true that its results in terms of inflation are rock solid. However, Martin Wolf argues that it should address market bubbles as well. This argument needs further analysis. Lets not forget that recent evidence suggest that, in the short-run, there is an undeniable positive relation between low interest rates and market bubbles. So how can a central bank achieve a dual objective involving market bubbles and inflation? The short-run Phillips curve suggests that this dual objective would have a negative impact in output growth. But why should the central bank look at the unemployment rate when making monetary policy decisions?

What if the central problem with IT is precisely that it has not stopped worrying about output? Even in Volker's Fed mantaining interest rates "too high for too long" did not represent a massive breakdown in any system, it did pushed the U.S. recession, but the economy grew more than eight years in a row after that. Today, the Fed mantained interest rate "too low for to long" stimulating bubbles in house markets and later in commodities. We can conclude that "too high for too long" addressed inflation and "too low for too long" addressed unemployment.

From the last argument a strong conclusion should state: IT will not be enough, central banks should address bubbles too. It remains out of the question to add to the central bank's responsabilities low unemployment.

Wednesday, April 29, 2009

Mexico and the Swine Flu

The current outbreak in Mexico, fastly moving to different countries, presents itself as a great challenge, not only for authorities in Mexico City and Federal Government, but to all of us. We must learn to live a reality that struck one of the worst weaknesses of Mexico. A poor public health care system and the expensive private one.

Even though the probability of contagion is lower than having a car accident (yet) people is taking great caution. Maybe a good reason to be in panic is that if one gets sick, one is on the impression that health care system is particularly bad. Moreover, symptoms are easily mistaken with other kinds of flu, so going to the hospital at the least sign is an equilibrium strategy.

It is often written and said that ignorance is the mother of panics and chaos, media and governments at all levels have put a lot of effort to inform population about contagion means and preventive measures. They also have created a soup words in terms of the severe consequences of the illness. A common citizen must distinguish between probable cases of swine flu, corroborated cases and deaths.

So maybe the number of deaths, although considerably high for a flu, is lower than deaths claimed at traffic accidents related to alcohol. The very nature of this kind of disease is the reason that creates scarcity of anti-viral medicine and mask faces all over the country. One can not know instantaneously if is contaminated or not. A whole lab test is necessary. Panic would be certainly less if we all were doctors, or if we all could have a home test for it. But there is not, and timely attention is critical in the odds of get cured, so the equilibrium strategy is the same.

But one should take a second and evaluate that if one is contaminated with low probability with the swine flu, going to a hospital will only increase -exponentially- the probability of being contaminated. A self-fulfilling disease arise then. Because one entered the hospital without the swine flu, but walked out with it, contaminating people around.

The best way to go is getting all the RELIABLE OFFICIAL INFORMATION there is,and take all precautions, we will not always live in this Saramago-like setting. Patience and precautions.

Tuesday, April 14, 2009

Social Net Reform in Mexico

A few days ago the lower chamber in Mexico passed a reform that allow unemployed workers in the formal economy to withdraw a higher fraction of their pension savings once every five years, thus working as a kind of unemployment insurance. It is different form an unemployment insurance in some sense, workers are exchanging future consumption in order to get more consumption today, clearly because he/she is unemployed, so government is not subsidizing this benefit. Furthermore, rules established imply that withdrawing is a one time action every five years, as opposed to the social benefit in the United States where a monthly payment is made.

In macro terms this new rules are designed not to make a government further liable of pension resources, but to improve automatic stabilizers. Consumption will certainly increase in the short run, since unemployed workers will have a full month pay. In the long run consequences are less clear. It is true that the flow income of pensions will not stop, however, the inverted population pyramid demands ever increasing present savings. The reform will certainly not increase present savings.

The only way to escape a future (sooner) collapse of the pension system is to achieve a higher saving rate in future employees. This is, that current unemployed, with the expectation of getting a job sooner or later, will more than compensate for present withdraws.

The subject then is a good counter-cyclical measure, but it will not solve any pervasive incentive there is in Mexican pension system. In this context, further reforms to achieve perfect mobility across public systems (there are two public systems one for public service workers and the one for the rest of population). There are, otherwise, inefficiencies arising from people having, or looking for, more than one job in public sector, and alike.

Much more emphasis should be posed in automatic stabilizers yet, revenue tax is a mechanism that present a great gap between its present situation and its perfect functioning.

Monday, April 13, 2009

Agriculture Outcomes

For those of you who like to praise agricultural development as a priority of public policy, take a look of what Salvador has to say on the latest outcomes. Sadly, we need to think further over the incentive structure for this sector, in the mean time, a debate over food autarky must be addressed by experts, this is a valuable link.

Saturday, April 11, 2009

Is China finally helping with global imbalamces adjustment?

It is necessary to assess whether China is taking the right steps by increasing is money supply in such a magnitude, 25.5 percent. Clearly, global imbalances have as a starr the Asian giant, however, the increase in lending from its central bank to commercial ones is a risky move for the world as opposed to let the yuan appreciate.

Let's not forget than any country with a currency peg losses it's monetary autonomy. Thus, by increasing it's money supply, China is pressing further on the opposite direction of the appreciation needed. So how can this policy help global economy out of recession? It can not.

This policy can help China to get out of it's slow growth but it will not correct global imbalances. It is true that there are no incentives for China to correct it's huge trade surplus, but an increase in public spending -as opposed to a monetary one- can yield two desirable effects. First it will cause the yuan to appreciate, thus reducing further the trade surplus -recent figures show that it has dropped significantly in the first quarter of 2009 by 45 percent with respect the previous quarter. Second, it would drive domestic consumption up, increasing China's demand for imports and correcting further global imbalances, helping deficit countries such as the U.S., U.K. and Spain in their delevereage.

So, the increase on money supply is only good news for China and serious structural problems must wait to be addressed.

Thursday, April 9, 2009

Automatic Stabilizers and Adjustment

Further attention must be posed in the so called Automatic Stabilizers. A definition must include features that tame the business cycle, every direct tax that observes progressiveness is an example of an automatic stabilizer, in this way whenever the business cycle expands tax revenues increase, as opposed to when the business cycle contracts. This, however, leads to a direct increase in debt issued by governments to fulfill expenditure levels.

The latter explains, part of the efforts for stimulate the economy, the other part comes from discrete actions taken. The IMF estimates the impact of automatic stabilizers on the fiscal balance of Mexico, for example, around -0.3 percent of GDP for 2008 and -0.8 percent of GDP for 2009. They find a strong correlation between the size of the government -measured by the size of public spending relative to the size of GDP- and the size of the effect from the automatic stabilizers.

Why are they so important? Because they provide a mechanism to reestablish balance and control that is not subject to a political process. Their effectiveness depends on the design of the tax system. The personal income tax (PIT) provides an excellent example of this mechanism. As the personal income increases, the PIT assures a greater tax revenue for the government, remember the rule: the more you earn, the more taxes you pay relative to your income. The contrary is also true, thus in a recession low taxes paid by the PIT provide a positive incentive to work more hours than before, thus helping the economy getting out of recession.

Discrete measures, opposed to automatic stabilizers, depend heavily on political arrangements and incentives, so they can violate optimality, they can be allocated poorly and, most importantly, they do not allow persons to make their own decisions.

Other forms of automatic stabilizers can be find in social benefits and unemployment insurance, these help in recession times to increase consumption demand and tame the lack of income, both mechanisms at work increase further public spending.

Finally, an important stabilizer, although not from the tax system, is the external trade. The U.S.' trade deficit is back from historical high levels to those of 1999, the latter as a result of a decrease in import demands from the U.S. and a some adjustments on exchange rates that make its exports cheaper. In the long run imbalances will disappear, the cost is the painful unemployment.

Reforms that address the weakness of automatic stabilizers should be pursued in those countries with low levels of automatic adjustments. Mexico is one of them.

Modern Macro in the textbook

Mankiw is about to conclude the updating of his excellent Macroeconomics. It includes a new chapter that introduce to Dynamic Stochastic General Equilibrium Models (DSGE). These models are used in policy making and are at the frontier of Macro-research. If you are a Macro guy, take a close look at it.

As a Corolary, this models are used in a new branch of research called New Dynamic Fiscal Policy.

Wednesday, April 8, 2009

Diesel prices

Diesel prices at Mexico has stopped growing since the President announced an emergency economic program to stimulate growth and support household income. Before the announcement price fuels such as gasoline and diesel had an increasing path, the cause underlying ever higher prices was the high-historic-prices of oil, and thus, of fuel.

At the beginning of this series of increases, the diesel price in Mexico was only a third of that in the US. Subsidies to fuel in all 2008 reached 218 thousand millions of pesos, this is, almost 2 per cent of GDP. Now trucks syndicates claim that since international diesel prices has slumped, Mexican prices should too.

Government has not showed any intention to reduce diesel or gasoline prices, and it is the right thing to do. Let us not forget that tax revenues at Mexico are slightly above of 9 per cent of GDP, only Haiti has lower tax revenues in terms of its product. High fuel prices -or positive fuel taxes- happen to have a number of good features. First, they are a reliable source of tax revenues since their elasticity converges to zero. Second, they tax -whether implicitly or explicitly- the use of motor vehicles, thus the price of pollutants increase. Third, diesel pollutes much more -in relative terms- than gasoline, it is used in heavy work vehicles, thus, high prices provide an incentive to change motor technology.

The immediate answer to the latter argument is based in some kind of inflation pass-through from increases in fuel prices to overall inflation, specially of diesel since it is used in heavy trucks, which in turn transport food from one place to another.
Interestingly, there is no recent research of the latter subject, so maybe here is a case of the so called conventional wisdom, where it is easy to attach high (changes in) price levels to high oil prices, but correlation is not necessarily strong, at least not through channels thought.

A challenging counter-example is the correlation between changes and general price level changes in the U.S. Logic should lead us to conclude that since the U.S. consume much more fuel than Mexico and since prices can overshoot -like they did in 2008's summer- then, for example, food prices should have had increase considerably as a consequence of the former. They did not.

Take now the following fact. In September of 2007 a fuel tax was approved of 2 per cent. As political opposition sounded alarms on the consequences, Mexican government agree that the tax would be levied until January of 2008. Strikingly, consumer prices went up more in the last quarter of 2007 (by 0.505 percent on average) than they did in the first quarter of 2008 (by 0.495 percent
on average).

So, it should be interesting to measure whether Mexicans respond more to fuel price increase announces than actual higher fuelprices. If this is the case, an environmental tax is plausible, government should not lower diesel prices.

Tuesday, April 7, 2009

IMF's Flexible Credit Line for Mexico

As the G20 Summit developed, mexican authorities announced the agreement on a 47 thousand million dollars as a Flexible Credit Line (FCL) from the IMF. This is the first time the found offers financial help to Mexico and not the other way around. It is important to acknowledge that Mexico has a good record in macroeconomic achievements, at least for the last 15 years, and this credit line should be seen as a prize rather than a negative sign.

As it is defined contingent it will only be used in case of need, furthermore, it is available in a time when internacional financial flows are drying, not only for Mexico but for all emerging markets as the rich economies are deleveraging. The agreement looks like pure gold in moment of historic financial stress.

Still, there are many voices, mostly from left-wing politicians, arguing that this credit line is more public debt, or worse, that this violates the constitutional arrangement that Congress must aprove the level of indebtness every year. Both are political fallacies.

First, this FCL would not be public debt as it is not a security Mexican government must honor with future tax revenues. The credit would be paid only with international reserves generated by exports or direct foreign investment.

Second this credit would not be honored with future tax revenues. If this were to be the case, government would buy dollars from the central bank in order to re-pay the credit. This is a contradiction since the credit is already in the obligations side of the central bank's balance sheet.

Understandingly Mexican politicians are averse to sign any contract with the IMF provided such horror stories as Argentina's following found's guidelines. Let us not forget that argentinians failed in two basics of modern macroeconomics -controlled budget deficits and flexible exchange rate- anyway, even if the found drove Argentina to it's last crisis, the credit line has no conditions of use at all.

Assume Mexican central bank were to use the credit this would reveal that the demand for dollars is bigger than some international reserve level decided by the central banker. Thus, borrowed dollars will be bought in exchange of Mexican pesos, reducing money supply. Now how will the bank pay those dollars? With a healthier economy, foreign direct investment should increase causing a rise on international reserves. Oil sales should also provide a source of dollars. A natural question is: what happens if the latter two mechanisms do not work?

In this polar scenario Mexican government should have to issue dollar debt to be paid with future tax revenues. How can the last posibility be ruled out? Simply put, it can not be dismissed. Is true though that is far less likely to occur.

The right approach to the credit of the example can be reduced to a simple one: Mexico is bringing "future international reserves" to present. It is also true that the credit line will disuade present speculation from Mexican currency.

It may be possible that the credit turn in to public debt, however it is far less likely and advantages outweight risks from using it -if needed.

Wednesday, April 1, 2009

IMF Note for G20 Summit

It is available now, with date and forecasts relevant for the Summit.

Addressing Global Imbalances

As today's Martin Wolf column on the London Summit stress, there are roughly two approaches to solve the current global crisis. The first focuses in healing financial markets and pulling aggregate demand in advanced countries such as the US, the UK and Spain. The second focuses on re-balance the humongous savings surplus of fast-growing economies created over the last 18 years -Germany, China, India, Brazil, Japan are in this set of economies- is only resembled by the excess of consumption of some advanced economies -US, UK, Spain.

Wolf describes on depth the latter two approaches. A comprehensive solution should include at least three features: One, healing advanced economies financial systems. Two, de-leveraging financial balances of advanced economies -this opposes the spirit of taking US out of recession by increasing public spending and deficit. Three, a restructure of the global monetary system.

Of course there are several ways to deal with either of these three features. Addressing the first, healing the financial system, the recent plan labeled as the PPIP, unveiled by Secretary Geithner will re-start a market for toxic assets with no demand, however, it is difficult to anticipate whether or not this plan will re-start lending to the private sector.

About the second feature, de-leveraging advanced economies, aggregate demand in these countries should be increased, but not in an endogenously fashion but in the external sector one. There is one straight way to re-balance global economy, current debtors should increase exports to finish the umbalance. This exports should be targetted to creditor countries. The latter will address the excess of debt of the creditors, at the same time it should decrease the unemployment rate.

The third feature, is probably more complicated, what we do know is that in times where the IMF was trying to define its role in the present, it should absorb the explicit target of being the financial world's police, and probably help in the second feature, encouraging an increase in savings -increase in net exports- for the troubled economies and a decrease in the positive trade balance of theose with surpluses.

Monday, March 30, 2009

Department of Economics' Ranking

This is the latest Department of Economics Ranking.

Endorsed by REPEC, and cited by Mankiw in his Blog.

Informal economy

There is this book written by Mario Vargas Llosa -El pez en el agua- where he describes the approach of his presidential campaign for Peru in the late 80's.

His was a liberal approach to economic policy and civil rights, among several interesting ideas contained on the book, he points out how the so called informal economy -those economic agents performing activities out of the tax system, not necessarily in black markets- is a direct result of the gross bureaucracy and the inability of the State to provide legal certainty at zero costs.

The reading provides a new approach that fits with precision all conditions Mexicans face. It is straightforward to observe that, as Vargas Llosa says, law is a privilege for those go have a high income or political influence.

Can there be a case for defend all Mexicans involved in an informal activity in Mexico? Not for all of them maybe, but certainly for those who make a cost-benefit assessment and conclude that it is not worth it to be fully registered.

Take the following example. It is rather common that an employer offers to a worker a "word" contract instead of a signed one. The incentive for the worker to accept the offer consist of the advantage of not paying taxes, though not having social security, in exchange of a higher monetary wage.

Since public health services are of low quality, the worker of above can easily prefer to buy private insurance with the money he is not paying in taxes or social security.

There are no incentives for an agent to be part of the formal economy, he is not receiving quality services at all, on the contrary he must go through an awful bureaucratic system to get health services.

Welfare states are easily corrupted and transformed to under attain their objectives. It has been seen that Latin American state structures favor only those with political connections. This is, services assumed as public are in practice privatized, just as Hayek suggested in his Road to Serfdom.

The latter is an explanation for the existence of the informal economy. Moreover it attach full responsibility to the state structure for it's existence.