Saturday, June 30, 2012

The Negative Correlation Between Football Success And Economic Success

One observation that one can make regarding the current European cup in football (by "football" I mean of course the version where they actually mostly use their foots to move the ball just like name implies, not the American version where they mostly use their hands to move the ball) is that there appears to be a negative correlation between  how good countries perform on the football field and how well their economies.

Out of the more than 50 nations of Europe, plus countries that geographically are mostly or entirely in Asia including Turkey, Azerbaijan, Georgia, Armenia and Israel and non-independent parts of Britain like England and Scotland only 16 were allowed to enter. Yet all five of the so-called PIIGS countries managed to qualify themselves, while most relatively strong economies including Norway, Finland, Austria, Slovakia, Luxembourg, Turkey and Israel didn't make it, or as in the case of Poland was only present because it together with Ukraine hosted the event.

 And in the group play, only one of the PIIGS, Ireland, failed to be among the eight that made it to the quarter finals.

And of the remaining quarter finalists, England and Czechia represented countries that have slipped into double dip recessions. Only Germany represented a fairly strong economy with France economy coming in between the weak countries and Germany.

In the quarter finals, all remaining PIIGS except for Greece won and made it to the quarter finals. Then in the semi finals, the intra-Iberian penninsula match between Spain and Portugal ended with Spanish victory while Italy defeated Germany. Regardless of whether Spain or Italy wins tomorrow it will be the team from a country with a weak economy

So while far from perfect (had it been perfect, Germany wouldn't have defeated Greece in the quarter finals), there appears to be a negative empirical correlation between success in football and economic success. 

Is this correlation causal? Almost certainly not. Spain, Portugal and Italy's economic problems can hardly to any significant extent be attributed to excess spending on football, especially since it also generates a lot of revenue for them as well  Instead this is an example of how correlation doesn't necessarily imply causation.

What one can say however is that particularly in the country that wins tomorrow night's final, success on the football field at least provides comfort for that country when they try to fix their economic problems.

Friday, June 29, 2012

The Irony Of Individual Mandate In Presidential Race

In the previous post I pointed out that Mitt Romney only a few years ago passionately defended the legal mandate to purchase health insurance. Obama on the other hand argued against it.
And of course, since it was upheld because it is a form of taxation, Obama again violates his 2008 election pledge not to raise taxes on families earning less than $250,000.

So now we are going to have a presidential race where the person who previously defended and implemented in Massachussetts a policy will argue for its nation wide repeal while his opponent will defend a policy he argued against until after he was elected.

Thursday, June 28, 2012

Notes About Health Care Ruling

The most unexpected thing about today's ruling in the U.S. Supreme Court about Obama care wasn't so much that it was approved with a narrow 5-4 margin, but that the swing vote was John Roberts and not Anthony Kennedy. Usually it is Kennedy that is the swing vote, while Roberts is considered to be part of the conservative bloc, together with Clarence Thomas, Antonio Scalia and Samuel Alito. But now it would seem then that the Supreme Court has four reliable liberals, three reliable conservatives and two swing voters.

 As for the ruling, two things should be noted. First of all, it is clear that the mandate to buy health insurance means a reduction in the freedom of Americans. Secondly, it is however also clear that it is no more so than existing welfare state programs like Medicare and Social Security, where people are in effect through the tax system forced to buy health insurance and pension insurance for when they become older than 65. So if Obamacare is unconstitutional, then there wouldn't have been any reason not to consider Medicare and Social Security as unconstitutional, something that few leading Republicans would openly argue for.

As for the political impact, Mitt Romney is the big loser. Some argue that he is a winner because the health care insurance mandate is unpopular, but I disagree considering that he as recently as 2007 called it "ultimate conservatism" and has yet to renounce his old statements he simply has no credibility arguing against Obamacare.

Tuesday, June 26, 2012

Eastern Europe Growing Old Before It Grows Rich

Many pundits have argued that China could "grow old before it grows rich". Though the extent of ageing of China's population is exaggerated (despite it's "one child" policy, its actual birth rate has been higher than in Eastern Europe-or Taiwan, South Korea or Japan) that may be true, though the size of its population still means that it will likely become the world's biggest economy.

What seems clear is that Eastern Europe is growing old before it grows rich. In the last post I noted that per capita GDP in Estonia was only €12,000, compared to €32,000 in Germany. But what about the other Eastern European countries? I limited myself to Eastern European countries that are members of the EU simply because the convenient and reliable data source known as Eurostat that I've used here only included them. However, non-EU members like Ukraine (see my discussion of Ukraine's poverty here), Moldova, Serbia or Albania are generally even poorer than those that are part of the EU so including them would only have further supported the conclusion of this post.

I used the 2011 GDP numbers provided by Eurostat and divided them with the latest population figures. For Slovenia, Slovakia and Estonia no exchange rate conversion was needed because they have the euro as currency. For Latvia, Lithuania and Bulgaria I needed to convert them according to the fixed exchange rate that their currencies have to the euro, but that was relatively unproblematic since the exchange rates have been the same all the time. For Czechia, Hungary, Poland and Romania it was more problematic since their currencies have a floating exchange rate, meaning the results will differ somewhat depending on what date you use for the exchange rate. For simplicity I simply used the latest exchange rate for them.

Here then is the results, the 2011 per capita GDP for the 10 ex-communist Eastern European members of the EU:

1) Slovenia €17,400
2) Czechia  €14,000
3) Slovakia €12,700
4) Estonia   €12,000
5) Latvia  €10,000
6) Hungary € 9,800
7) Lithuania € 9,600
8) Poland €9,500
9) Romania €6,800
10) Bulgaria €5,200

As you can see, all but three, namely Slovenia and the two countries that used to be part of Czechoslovakia are even poorer than Estonia and even the richest Eastern European country, Slovenia, is far poorer than Germany and most other Western European countries. The only Western European country poorer than Slovenia is Portugal who had a per capita GDP of €16,100 . However, all the other Eastern European countries are even poorer and-most significantly poorer. And everyone is far below the income level of most Western European countries (€30,000 to €40,000).

With the labor force soon starting to shrink dramatically because of the lagged effect of the collapse of birth rates in the early 1990s, it seems safe to say then that most, if not all, Eastern European countries will grow old before they grow rich.

Sunday, June 24, 2012

Eastern Europe's Coming Labor Force Implosion

Although the collapse of communism in Eastern Europe was overall clearly a good thing, one has to concede that the transition away from it did cause a lot of hardship for many people, especially since it was usually done in an incompetent and corrupt way. As a result of this widespread hardship, many felt that they couldn't afford children and birth rates across Eastern Europe plummeted in the early 1990s.

 In Poland for example, the crude birth rate (births per 1000 people) fell from 18.2 in 1985 to only about 10 in the 1990s. Because it has been roughly 20 years since the early 1990s and because people born then would therefore be in their late teens now, we can see this collapse in the change in the number of 15-19 year old.

In Estonia for example, the overall population was roughly unchanged at 1.34 million between 2007 and 2011, but the number of 15-19 year olds fell by nearly 28%, from 102,500 to 74,400 Some people, when analyzing Baltic state demographics has misinterpreted these numbers as signs of mass emigration as 15-19 year olds are usually counted as part of the working age population. Yet in reality most 15-19 year olds are still in school something that both means that they usually still live with their parents and therefore don't make decisions about emigration and it also means that they are effectively not part of the working age population even if official statistics say they formally are. The latter means that though the formal labor force in Estonia and other Baltic and Eastern European countries have already begun to shrink significantly, the number of people that really have jobs or are searching for them hasn't begun to shrink significantly-yet.

If we look at the next age group, 20-24 year olds, it has only shrunk by about 0.5% between 2007 and 2011 and the number of 25-29 year olds actually increased, numbers that first of all refute the hypothesis of mass emigration at least for Estonia and secondly means that in 2011, the labor force hadn't effectively shrunk even though it had formally done so because of the massive drop in the number of 15-19 year olds.

However, 15-19 year olds in 2011 will of course be 20-24 year olds in 2016 and 25-29 year olds in 2021, and as the 2011 15-19 year group gradually move to the 20-24 year group, this means that the real labor force will start to shrink rapidly in the coming decade. This will only get worse as the number of 10-14 year olds in Estonia was even fewer than the number of 15-19 year olds, 61,400 compared to the 74,400 who were 15-19 year olds and the 105,700 who were 20-24 year olds.

The total drop in the number of young workers will therefore over the next decade or so will therefore be more than 40%! The exact magnitude of this demographic collapse probably differ somewhat between different Eastern European countries, but given that Estonia was one of the best run of the Eastern European countries after communism, it is at least as likely that the numbers in most countries will be worse, not better, than in Estonia.

As Estonia and most other Eastern European countries have high unemployment, this needn't put a stop to growth during the coming years. Germany for example have managed to grow somewhat in recent years despite a shrinking working age population by both reducing unemployment and increase the labor force participation rate. However, as the labor force will begun to shrink dramatically, growth in Eastern Europe will be strongly inhibited, especially since their relative poverty (GDP per capita was only €12,000 in Estonia in 2011, compared to €32,000 in Germany) will make it more difficult for them than for Germany to attract the kind of workers they need.

Saturday, June 23, 2012

Given Political Restraints, The Fed Has Little Power

A number of people, mostly on the left, but also some right of centre economists or pundits like Scott Sumner, Steve Chapman and Ramesh Ponnuru are dissatisfied that the Fed isn't doing more to inflate. For the moment, I'll ignore the issue of whether it would be desirable if it was feasible (I think long time readers can guess what my view on that subject is), and instead focus on the issue of whether it is feasible.

The short answer is that using its current methods it's not feasible to any significant extent, and only using methods that are impossible because of political restraints would it be feasible. The irrational status of U.S. treasury securities as "safe havens" have in fact pushed down yields so low at the moment, with the 10-year yield being only 1.67%, that further "quantitative easing" or "operation twist" have only very little room to push down yields further. And considering how the several percentage point drop in interest rates so far have had only very little effect, there is little reason to believe that even another full percentage point would have any significant effect. When people are optimistic, a percentage point change can have great effect, but when people are pessimistic as they are now it will only have very little effect.

Some of the above mentioned people have asserted that by merely stating as a formal target that it wants to achieve nominal GDP growth of 4 or 5%, or raising the inflation target to 3 or 4% this will get the job done without any purchases or twists because investors, as well as corporate decision makers and consumers, know better than to fight the Fed and this behavioral change will cause the target to be achieve, sort of like how guards in a labor camp can get inmates to work by threatening to shoot those who don't, a threat that makes everyone work even though no one has been actually shot. If it makes investors, corporate decision makers and consumers more optimistic it could indeed work.

However, this presupposes that everyone actually believes that the Fed has the power to enforce it in case people are unwilling to go along, and as was concluded above, it really doesn't have that power. And as most people probably realize it, the Fed's threat would be as powerless as the threats by a prison guard to shoot inmates when the prisoners are aware that he has run out of ammo.

This doesn't mean that it is impossible to achieve a significant increase in inflation if one is capable and willing to use what one might call unorthodox methods. I myself have previously suggested legalizing counterfeiting, and when thinking about it I can now come up with various other schemes that would achieve a lot more inflation, like large scale purchases of stocks, printing (or electronically generating) massive amounts of money and simply giving it away to people and buying large quantities of for example Spanish and Italian bonds.

 Why legalizing counterfeiting is politically impossible should be obvious. Large scale purchases of stocks is politically impossible because it would mean government ownership of the means of production...well, I think that is sufficient explanation of why it wouldn't be accepted by Congress. Simply giving away newly printed or electronically generated money would in effect be the same as a fiscal "stimulus", which won't be accepted in Congress. And buying bonds from Italy, Spain and other troubled European countries, which would first of all directly lower the dollar's exchange rate and secondly ease the market anxiety that causes the "safe haven" demand for U.S. treasuries that makes conventional quantitative easing ineffective, would be viewed as "bailing out Europe" and would therefore also be rejected.

 So, unless someone can come up with a more clever scheme that would be effective while not being politically controversial, the Fed lacks the power to generate the kind of extra monetary inflation that the above mentioned people calls for.

Friday, June 22, 2012

Portugal Making Biggest Improvements

The perhaps best indicator of whether the more indebted euro area countries are really making progress in reducing its reliance on foreign loans is the change in their current account balances. So far this year, Portugal stands out as the country making the biggest improvements, while neighboring Spain is seeing the smallest improvements.

Portugal had during the first four months of 2012 a current account deficit of €1.41 billion, compared to €4.1 billion in the same period in 2012. This means the deficit is down to roughly 2.5% of GDP, a sharp reduction from the more than 10% of GDP it had as late as 2010.

 Italy, saw its deficit decline by 46%, from €27.8 billion in January-April 2011 to €15.1 billion in the same period 2012. The Italian deficit is equivalent to roughly 3% of GDP.

 Greece saw its deficit decline by 40%, from €9.4 billion in January-April 2011 to €5.6 billion in January-April 2012. Its deficit is however still equivalent to more than 8% of GDP, and even if you adjust for the fact that its deficit for seasonal reasons is traditionally bigger in the beginning of the year, we are still talking about a deficit of around 5% of GDP, which is of course far too high.

Spain hasn't released its April numbers yet, but in the first quarter, its deficit fell by just 12%, from €16.85 billion to €14.85 billion. Adjusted for seasonal effects this is equivalent to a deficit of about 3% of GDP. So while we're seeing improvement in all countries, it is insufficient, especially in Greece and Spain, while Portugal has made the biggest progress.

 What about Ireland? Well, its statistics lag the most of all, as it won't release even first quarter numbers until Friday next week. But Ireland eliminated its deficit already last year.

Wednesday, June 20, 2012

The Fed Gets Even More Twisted

So the Fed has decided to extend "Operation twist" where it sells short-term U.S. government securities and buys longer termed securities. This will likely have little or no effect on short term yields while lowering long term yields, and will therefore lower overall borrowing costs for the U.S. government.

This is clearly good for the U.S. government who will benefit at the expense of the suckers who are stupid enough to buy its "securities". But considering how low yields are at the moment, the effect on the real economy will be very small. And even that effect will come entirely or almost entirely in the form of higher than otherwise inflation. So, this new "twisted" move will not reinvigorate the U.S. economy.

Monday, June 18, 2012

Objective Standards For Assessing Recoveries

After having been mired in a deep slump for years, Iceland have recently started to experience a recovery, albeit only a weak one, causing some inflationists, such as Paul Krugman,  to hail Iceland as a role model and proof that devaluation works.

It should be noted however that although growth has recently been positive in Iceland, the absolute level of output remains well below the previous cyclical peak, and that the same inflationists that hail Iceland have dismissed Estonia's much stronger recovery by pointing to how Estonia's output is still below its previous cyclical peak, making their evaluations of recoveries hypocritical and inconsistent.

But leaving the issue of double standards aside, what is the correct standard by which recoveries should be evaluated. Should we compare current GDP to the level at the previous cyclical peak or to the level at the cyclical low or to some other standard?

That depends actually on what the purpose of your evaluation is. Is the purpose to assess whether or not the current state of the economy is satisfactory, or is it to assess the effects of policies implemented during the slump?

If it is the former, then the correct standard is to compare it to the level at the previous cyclical peak. And as long as output is below it, we can clearly say that the current state of the economy is unsatisfactory, which in the cases of Iceland and Estonia means that both economies still aren't good.

If it is the latter, then the correct standard is to compare it to the level before the policies were implemented

In the case of Estonia and its spending cut programs this means comparing current output to the levels of late 2009, and since they were implemented the economy has grown fast.

In the case of Iceland, we can see that its entire devaluation (or more strictly depreciation) took place throughout 2008, and that its currency has been basically stable and in fact appreciated slightly in value since then. After having fallen dramatically more or less gradually during 2008, with the euro being worth 92 kronor in December 2007 and then falling so that it took 191 kronor to buy a euro in late December 2008, it stabilized after that so that it traded at 188 against the euro in December 2011 Yet in the first year of the devaluation (between Q4 2007 and Q4 2008), it's economy contracted by 2%  and then contracted an additional 8.2% in the year to Q4 2009 and it remained in Q4 2011 6% lower than in Q4 2008 and 8% lower than in Q4 2007. We can clearly see that devaluation was followed by a really deep slump and it was only several years later, after its exchange rate had stabilized that a modest recovery started.

To the extent one should use "different standards" for assessing Iceland's and Estonia's recoveries, we can therefore see that it should be made in the opposite way that Krugman and others have done, because Estonia's spending cuts came after almost the entire slump was over and was followed by a strong recovery, while basically the entire slump in Iceland came after its currency started to depreciate and its modest recovery started only a long time later after its currency had stabilized.

Sunday, June 17, 2012

Direct Effects Of Debt Crisis Can't Entirely Explain British Deficit

Those who disagree with my contention that the increasing British trade deficit is a sign of an overvalued pound may argue that the increase simply reflects the euro area debt crisis. 

However, during the latest year, the total monthly trade deficit in goods rose by £2.7 billion, from £7.4 billion to £10.1 billion, while the deficit with the euro area alone only rose by £1.6 billion, from £1.9 billion to £3.5 billion. The deficit also rose by £400 million with other non-euro area EU countries and by £700 million with countries outside the EU.

By contrast, Germany was able to compensate the drop in its trade surplus with other euro area countries by increasing its surplus with both non-euro area EU countries and with countries outside the EU.

So while the general drop in demand the crisis hit countries explain some of the British export weakness, an overvalued pound has weakened it further while also contributing to increased competitiveness of imported goods in the British market. 

Friday, June 15, 2012

Why The Pound Is Overvalued

One of the more bizarre developments in the recent debt crisis is that government bonds from one of the countries with the most messed up public finances, Britain, has been considered a "safe haven", ignoring that not only have Britain a large debt and deficit, but it has also a central bank that relentlessly tries to lower the value of its currency, something that also means that anyone nstupid enough to buy British bonds will see the value of their investments reduced.

However, in recent years, though the Bank of England has been successfull in pushing up domestic price inflation to an average of 3.5% per year (a lot higher than in all other major advanced economies) the foreign exchange rate of the pound has actually increased the latest year, trading recently at 1.25 against the euro, up from the 1.10 to 1.15 range  This increase in the pounds exchange rate of course reflects the above mentioned "safe haven" status that causes investors to demand pound denominated assets.

The combination of much higher inflation and a significant nominal exchange rate appreciation is of course that the real exchange rate has soared, making British exports very uncompetitive. We should therefore not be surprised that the British trade deficit rose to a new high in April as exports plunged.

In some other countries with a strong currency, the effects on the trade balance is to a large extent cancelled out by the increase in real interest rates caused by disinflation/deflation , but as British real interest rates have been strongly negative.

With a rapidly increasing trade deficit and negative real interest rates, it seems clear that the British pound is one of the most overvalued currencies around.

Wednesday, June 13, 2012

Krugman On Latvia & Labor Mobility

Responding to the recent recovery in Latvia, Paul Krugman tries to dismiss it by saying the recent drop in unemployment is due to emigration, and while he writes that labor mobility isn't bad, it's not a model for all of Europe, because "somehow having all of Europe move to someplace else in Europe doesn’t quite seem like a sustainable proposition".

Well, if you phrase it in the stupid way Krugman did, then it makes no sense. But no one is suggesting that all of Europe should move somewhere else in Europe. What does make sense however is if unemployed workers in for example Greece, Spain or Latvia move to countries where their skills are wanted by employers. This will (except perhaps in the construction sector which is a special case for reasons I explained here) reduce unemployment in the countries of origin of these workers  And large parts of Europe, most notably the German-speaking countries  Germany, Austria, Liechtenstein, Switzerland and Luxembourg  but also Norway and Åland, have low unemployment and are likely having labor shortages in some sectors.

This doesn't mean that increased labor mobility, even outside of the construction sector, will alone come even close of solving all problems in Europe, but while the effect wouldn't be very big it would still be positive.

Finally, it should be noted that Krugman is wrong to assert that the drop in unemployment in Latvia is entirely or even mainly due to emigration. The main cause is an increase in the employment rate by about 7% (4 percentage points) since the low in early 2010,  and the drop in population reflects to a large extent the effects of the dramatic drop in Latvia's birth rate in the early 1990s something that for obvious reasons means that there will be a lot fewer youngsters in their late teens by now.

Sunday, June 10, 2012

Greece Vs. Finland

Greece and Finland are both in the geographic eastern periphery of the euro area, except that Greece is in the south east and Finland is in the north east. In terms of population, though Greece is almost exactly twice as big as Finland, having 10.8 million people versus 5.4 million for Finland.

However. the most recent quarter, Finland actually surpassed Greece in terms of economic size, despite the fact that Greece has twice as big population. In the first quarter Greece had a GDP of €47.19 billion versus €47.42 billion for Finland. First quarter GDP was for seasonal reasons lower than usual in absolute terms in both Greece and Finland, but since the seasonal effect appears to be basically the same for both countries, this has little or no relevance for their relative position.

So despite being twice as many as the people of Finland, the Greeks can't produce more. To what extent this reflects bad behavior from the Greeks and to what extent it reflects good behavior from the Finlanders can be discussed, I for one think it reflects on both, though mostly the former. 

Friday, June 08, 2012

Household Survey Is More Erratic

Permabulls Brian Wesbury and Robert Stein argues that because the household survey say a much bigger gain (422,000) in jobs than the payroll survey's (69,000), the payroll survey underestimates the strength of the U.S. job market. That might have been plausible if that had been a consistent pattern, but that is not the case as the household survey showed significant drops in employment in March and April even as the payroll survey showed gains. In fact for the last 3 months as a whole, the payroll survey showed a bigger increase (279,000) than the household survey (222,000).

This illustrates that the household survey is more erratic and volatile than the payroll survey and that with regard to short-term economic trends, the payroll survey is more reliable. The household survey number could however  be useful if the household survey is consistently either stronger or weaker than the payroll survey than that would be reason to suspect that the payroll survey either underestimates or overestimates strength in the job market. However, when it comes to short-term economic trends, which is what Wesbury's and Stein's comments were about, then the payroll survey is more reliable.

Thursday, June 07, 2012

Estonia's President Attacks Krugman

A reader has tipped me that Estonia's President Toomas Hendrik has on his twitter-account attacked Paul Krugman after Krugman in a recent blog post .tried to dismiss Estonia's recovery because it happened after a depression-like slump (I analyzed this argument here in response to another Keynesian). Hendrick is also upset about how Krugman previously called Estonia a "wasteland".

endrik ilves@IlvesToomas
Let's sh*t on East Europeans: their English is bad, won't respond & actually do what they've agreed to & reelect govts that are responsible.

6 Jun 12 ReplyRetweetFavorite
 toomas hendrik ilves@IlvesToomas
But yes, what do we know? We're just dumb & silly East Europeans. Unenlightened. Someday we too will understand. Nostra culpa.

6 Jun 12 ReplyRetweetFavorite
 toomas hendrik ilves@IlvesToomas
Guess a Nobel in trade means you can pontificate on fiscal matters & declare my country a "wasteland". Must be a Princeton vs Columbia thing

6 Jun 12 ReplyRetweetFavorite
 toomas hendrik ilves@IlvesToomas
Let's write about something we know nothing about & be smug, overbearing & patronizing: after all, they're just wogs:…

Personally, I prefer a less emotional and more fact filled response to Krugman and others, like the one I wrote, but then again twitter doesn't allow lengthy arguments (that's the main reason why I haven't joined twitter), and it is still interesting and refreshing to see the President of a country responding to Krugman's misleading writings about his country.

Monday, June 04, 2012

4% Growth Is "Flat"?

Jason Rave argues that Estonia isn't an example of successful austerity since supposedly growth has been flat since late 2010 and since GDP is still well below the pre-crisis level.

But regarding the first point we should first of all notice that as Rave himself writes, the budget was balanced in early 2010, meaning that the extremely high 2010 growth numbers of 8-9% provide the best test of the effects of austerity policies.. While growth did in did slow down in 2011 and the first quarter of 2012 from those extraordinarily high levels, it was still 4% in Q1 2012, the third highest in the EU after Latvia and Lithuania.

While Rave is correct to note that the absolute level of GDP is still significantly below its pre-crisis peak levels, that isn't relevant for evaluating policies implemented after the initial slump.

A somewhat better argument for dismissing Estonia as an austerity success story is that they were in part lucky. Strong recoveries in Sweden and to a lesser extent also Finland helped boost Estonia's exports to those countries,. Yet even if you adjust for that, Estonia's performance the last two years have been strong.

Saturday, June 02, 2012

Why Are Certain Yields So Ridiculously Low?

Continued worries about Spain and Greece, increasing signs that the weak U.S. recovery is getting even weaker and signs that the British and euro area slumps are deepening are continuing to push bond yields in countries that are perceived "safe havens" to even more absurdly low levels. There are now three countries (Switzerland, Japan and Denmark)  with 10-year yields below 1%, another four (Germany, Sweden, Finland and the U.S.) with yields below 1.5% and another three with yields below 2% ( Britain, Holland and Austria).

Switzerland 0.52%
Japan          0.82%
Denmark     0.97%
Germany     1.17%
Sweden      1.18%
Finland       1.44%
USA          1.45%
Britain        1.53%
Holland      1.53%
Austria       1.99%

Note that this "safe haven" status is not based on whether a country deserves it or not. British, American and Japanese government finances are messed up badly and of the above only Switzerland and Sweden have balanced budgets and a low debt level, with the remaining five countries coming in between with regard to the strength of their public finances.

Nor is it a matter of whether a country is inside or outside of the euro area, as Germany, Finland, Holland and Austria have the euro as currency and as Denmark is also a part of the euro bloc as its currency have a fixed exchange rate to the euro.

Nor is this status necessarily permanent. 6 months ago, yields were rising significantly in Finland and Austria due to market distress, to 3% and nearly 4% at most, respectively. Yet now yields have been cut in half for both.

Central bank manipulation is however one factor. The ECB's covert "quantitative easing" through banks have for example helped hold down euro area yields generally. Low yields in the U.S. and Britain may perhaps to a small extent be related to expectations of more "quantitative easing". However, if that had been the most important factor, the dollar and the pound would have depreciated in value. Instead, particularly the dollar has in fact appreciated in value, indicating that investor demand for "safe haven" assets is the most important factor.

Instead it seems clear that self-fulfilling whim from the markets is the most important factor. Investors have decided that these assets should be seen as "safe havens" and that is what makes them that. Ironically though, the only thing that's "safe" with most of them is that the people who buy them will lose some of their money, something that given the irrationality of it isn't undeserved.

Friday, June 01, 2012

Noah Smith's Argument For Mathematical Economics

Noah Smith argues the case for using mathematical models. He does acknowledge some downsides witb such models.

There are advantages to telling your stories in English [or other verbal languages, my correction] instead of in Math. One is that you can be more flexible - you can add stuff to your story, or be ecumenical in your view of the world, without being worried about pesky internal contradictions. The other advantage is that you can explain your ideas to a wider class of people, who either don't understand Math or can't be bothered to read through it.

Smith however fails to note that the use of Math also means that you have to make theories wrong deliberately, such as how the requirement in Lagrange multiplier that the partial derivative in equilibrium must always be zero, something that for examples excludes the existence of entrepreneurs since their action presupposes that there are unexploited profit opportunities.

Smith then argues the case for mathematical models

Of course, there are disadvantages as well. One is that you can't give quantitative predictions: If we deviate from NGDP Level Targeting by X%, how much will our incomes go down? And so forth. This problem can be solved by using simple "ad-hoc" or aggregate-only models, which are fairly easy for most people to grasp and can be modified without much effort.
Well, first of all, it should be emphasized with regard to quantitative predictions, that first of all even if they can be given correctly in a certain case, it won't have theoretical significance since all quantitative relationships only apply to a specific time and place. Remember, economic theory deals with universal relationships, while statistical relationships are really just quantitative forms of economic history.

 And secondly, while some econometricians may claim otherwise it is impossible to exactly pinpoint the ceteris paribus causal effect of certain policies even in a specific time and place. One can however make rough estimates of the causal effects by analysing changes in various relevant statistics. But that doesn't require and is probably not even aided by econometric analysis, and it is definitely not even aided by stating economic theory mathematically.

Smith then uses a second argument:

Then there's the second disadvantage of English storytelling, which is internal consistency. Formal models rely on their assumptions, but once you choose your assumptions, your conclusion is forced by the Math. With English storytelling, you can state conclusions that don't follow from your own assumptions, and often no one will be the wiser.
I don't want to sink to the lows of certain advocates of mathematical economics, who hint that opponents oppose it because they are too stupid or lazy to learn advanced mathematics, but the fact is that it is possible to detect logical flaws in verbal logical reasoning if you really think through things.

Since economics like other sciences should be as easy to understand as possible, we should at any case strive to make it  (including logical flaws in arguments) as easy to comprehend as possible, so that we can avoid the distraction from the issue of how the economy works, that the way that economics is expressed represented (and of course the insulting hints about your opponents intelligence).

Trying to express the theories in formal terms is indeed probably a good way to better and quicker detect possible logical flaws in economic reasoning. However, I don't really see why formal terms need to be  expressed in advanced mathematics, rather than normal verbal languages. Aristotles' classical formal syllogistic logic was expressed in verbal terms, such as

All humans are mortal
Aristotle was a human
Therefore, Aristotle was mortal

Here the premisses of the argument that Aristotle are explicitly stated, and we can clearly see that assuming that the two premises are correct, and they clearly are, then the conclusion is also correct. This kind of formal reasoning can of course be made in economic contexts as well, for example.

People respond positively to economic incentives
Tax cuts on labor improve economic incentives to work
Tax cuts on labor will make people respond [by working more]

 Noah's third argument is the most incomprehensible:
If Sumner used formal models, I could at least go and do a statistical test of the model (for example, a Full Information Maximum Likelihood test) against the available macro data. Sure, no one would pay attention if the test rejected the model - the data are crappy and the econ profession lacks generally agreed standards for scientific disproof - but at least I could do it.
So, statistical tests of mathematical models can't really settle economic theoretical disputes, but it should still be done, because it can be done. Sort of arguing that while astrological forecasts won't give you any hints of the future you will actually face, you should still pay attention to them because it is possible to do so.