Hayekian Macro
…Hayek argued that no individual is capable of understanding the full complexity of a market system. Instead, individuals only understand small bits of the total information. The main function of markets consists in aggregating this diverse information. If there were individuals capable of understanding the whole picture, we would not need markets. This was in fact Hayek’s criticism of the “socialist” economists who took the view that the central planner understood the whole picture and would therefore be able to compute the whole set of optimal prices, making the market system superfluous.
Rational expectations models as intellectual heirs of central planning
My contention is that the rational expectations models are the intellectual heirs of these central-planning models. Not in the sense that individuals in these rational expectations models aim at planning the whole, but in the sense that, as the central planner, they understand the whole picture. These individuals use this superior information to obtain the “optimum optimorum” for their own private welfare. In this sense, they are top-down models.
In a recent paper, I contrast the rational expectations top-down model with a bottom-up macroeconomic model (De Grauwe 2009). The latter is a model in which agents have cognitive limitations and do not understand the whole picture (the underlying model). Instead, they only understand small bits and pieces of the whole model and use simple rules to guide their behaviour. I introduce rationality in the model through a selection mechanism in which agents evaluate the performance of the rule they are following and decide to keep or change their rule depending on how well it performs relative to other rules. Thus agents in the bottom-up model learn about the world in a “trial and error” fashion.
Loop of Financial Doom
For the authorities, [excessive risk-taking by the financial sector] poses a dilemma. Ex-ante, they may well say “never again.” But the ex-post costs of crisis mean such a statement lacks credibility. Knowing this, the rational response by market participants is to double their bets. This adds to the cost of future crises. And the larger these costs, the lower the credibility of “never again” announcements. This is a doom loop.
Banking on the State, Piergiorgio Alessandri & Andrew G Haldane
Escaping the Liquidity Trap
Escaping from a Liquidity Trap and Deflation: The Foolproof Way and Others, Lars E.O. Svensson
Abstract
Existing proposals to escape from a liquidity trap and deflation, including my “Foolproof Way,” are discussed in the light of the optimal way to escape. The optimal way involves three elements: (1) an explicit central-bank commitment to a higher future price level; (2) a concrete action that demonstrates the central bank’s commitment, induces expectations of a higher future price level and jump-starts the economy; and (3) an exit strategy that specifies when and how to get back to normal. A currency depreciation is a direct consequence of expectations of a higher future price level and hence an excellent indicator of those expectations. Furthermore, an intentional currency depreciation and a crawling peg, as in the Foolproof Way, can implement the optimal way and, in particular, induce the desired expectations of a higher future price level. I conclude that the Foolproof Way is likely to work well for Japan, which is in a liquidity trap now, as well as for the euro area and the United States, in case either would fall into a liquidity trap in the future.
In which we learn about the relationship between profits and bonuses on Wall Street…
Hat-tip: Nancy Folbre, Economix
Reasons to be cheerful: the continuing decline of world poverty
Parametric Estimations of the World Distribution of Income, by Maxim Pinkovskiy and Xavier Sala-i-Martin
Abstract
We use a parametric method to estimate the income distribution for 191 countries between 1970 and 2006. We estimate the World Distribution of Income and estimate poverty rates, poverty counts and various measures of income inequality and welfare. Using the official $1/day line, we estimate that world poverty rates have fallen by 80% from 0.268 in 1970 to 0.054 in 2006. The corresponding total number of poor has fallen from 403 million in 1970 to 152 million in 2006. Our estimates of the global poverty count in 2006 are much smaller than found by other researchers. We also find similar reductions in poverty if we use other poverty lines. We find that various measures of global inequality have declined substantially and measures of global welfare increased by somewhere between 128% and 145%. We analyze poverty in various regions. Finally, we show that our results are robust to a battery of sensitivity tests involving functional forms, data sources for the largest countries, methods of interpolating and extrapolating missing data, and dealing with survey misreporting.
“What ended the Great Depression?”
This paper examines the role of aggregate-demand stimulus in ending the Great Depression. Plausible estimates of the effects of fiscal and monetary changes indicate that nearly all the observed recovery of the U.S. economy prior to 1942 was due to monetary expansion. A huge gold inflow in the mid- and late 1930s swelled the money stock and stimulated the economy by lowering real interest rates and encouraging investment spending and purchases of durable goods. That monetary developments were crucial to the recovery implies that self-correction played little role in the growth of real output between 1933 and 1942.
Christie Romer, What ended the Great Depression?
New paper by Obstfeld & Rogoff
Global Imbalances and the Financial Crisis: Products of Common Causes, by Maurice Obstfeld and Kenneth Rogoff
Introduction
Until the outbreak of financial crisis in August 2007, the mid-2000s was a period of strong economic performance throughout the world. Economic growth was generally robust; inflation generally low; international trade and especially financial flows expanded; and the emerging and developing world experienced widespread progress and a notable absence of crises.
This apparently favorable equilibrium was underpinned, however, by three trends that appeared increasingly unsustainable as time went by. First, real estate values were rising at a high rate in many countries, including the world’s largest economy, the United States. Second, a number of countries were simultaneously running high and rising current account deficits, including the world’s largest economy, the United States.
Third, leverage had built up to extraordinary levels in many sectors across the globe, notably among consumers in the United States and Europe and financial entities in many countries. Indeed, we ourselves began pointing to the potential risks of the “global imbalances” in a series of papers beginning in 2001. As we will argue, the global imbalances did not cause the leverage and housing bubbles, but they were a critically important codeterminant.
In addition to being the world’s largest economy, the United States had the world’s highest rate of private homeownership and the world’s deepest, most dynamic financial markets. And those markets, having been progressively deregulated since the 1970s, were confronted by a particularly fragmented and ineffective system of government prudential oversight. This mix of ingredients, as we now know, was deadly….
Update: See also this useful discussion of the paper at David Beckworth’s blog.
“No economy without economics”
Callon and 
alı
kan introduce the notion of “economization” in the first paper in a two part series in Economy and Society.
Economization, part 1: shifting attention from the economy towards processes of economization
This article proposes a research programme devoted to examining ‘processes of economization’. In the current instalment we introduce the notion of ‘economization’, which refers to the assembly and qualification of actions, devices and analytical/practical descriptions as ‘economic’ by social scientists and market actors. Through an analysis of selected works in anthropology, economics and sociology, we begin by discussing the importance, meaning and framing of economization, as we unravel its trace within a variety of disciplinary backgrounds. We show how in combination, these works have laid the foundations for the study of economization. The second instalment of the article, to appear in the next volume of Economy and Society, presents a preliminary picture of what it might mean to take processes of economization as a topic of empirical investigation. Given the vast terrain of relationships that produce its numerous trajectories, we will illustrate economization by focusing on only one of its modalities – the one that leads to the establishment of economic markets. With emphasis on the increasingly dominant role of materialities and economic knowledges in processes of market-making, we will analyse the extant work in social studies of ‘marketization’. Marketization is but one case study of economization.
The Paradox of the “Great Moderation”
In the Financial Development Index and Report, recently published by the World Economic Forum, Nouriel Roubini notes that,
Financial crises are pervasive phenomena both among advanced and emerging market economies. Moreover, in spite of the “great moderation” (a sustained period of high growth and low inflation) of the last two decades, financial crises have become more frequent and more virulent rather than less frequent and less severe. Paradoxically, such great moderation may have triggered asset and credit bubbles. Indeed, with low inflation, sustained growth, and lower nominal and real interest rates, given the loose monetary and credit conditions and the ability of borrowers to lever up again, the possibility of asset bubbles and credit booms has increased.
