In economics the questions are always the same - only the answers change:

Estimated impact on GDP of a permanent increase in government purchases of 1 percent of GDP (Cogan et al.):
Cogan et al. (Feb 2009) conclude:

In this paper we used a modern empirical approach to estimate government spending multipliers.. We focused on an empirically estimated macroeconomic model - the Smets-Wouters model - recently published in the AER.

We find that the government spending multipliers from permanent increases in federal government purchases are much less in new Keynesian models than in old Keynesian models. The differences are even larger when one estimates the impacts of the actual path of government purchases in fiscal packages, such as the one enacted in Feb 2009 in the US or similar ones discussed in other countries. The multipliers are less than 1 as consumption and investment are crowded out. The impact in the first year is very small. And as the government purchases decline in the later years of the simulation, the multiplier turns negative.

The estimates reported here of the impact of such packages are in stark contrast to those reported in the paper by Christina Romer and Jared Bernstein.

Crowding out of consumption and investment in the Feb 2009 stimulus legislation:

keywords: gamma, vega, convexity (i.e. not some mystery Black Swans), complexity (stocks vs. tranches of CDOs), right-way contract, swapping country risk, systematic alpha, naked vs. covered

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via Infectious Greed

The Economist:
MANY economists are unsettled by the idea of a generation of “Depression babies”—people who grew up during the Depression and, scarred by the poor stockmarket returns of their formative years, were unusually risk-averse in their investments throughout their lives. Standard models assume that individuals use all available information about the present and past to make financial decisions, not that choices are disproportionately affected by their personal economic experience.

Yet new research from Ulrike Malmendier of the University of California at Berkeley and Stefan Nagel of Stanford University seems to confirm that people born at different times make very different financial choices, even in similar economic environments. Here is the whole story. Here is the paper.

DuBridge Distinguished Visitor Lecture
California Institute of Technology

This paper* explains why modern societies are less polygynous than less-developed societies:

Men in less-developed economies prefer quantity over quality [=skill] in wives and children. The explanation is rather intuitive. Rich men in less-developed economies are not efficient at producing quality children because they tend not to have high human capital themselves. Therefore, they have a low demand for quality children and, consequently, a low demand for quality women who can help them produce quality children. As a result, women in less-developed societies are valued only for the quantity of children they can produce, and not the quality. This makes all women very close substitutes for one another, which keeps the price of all women low enough for richer men to acquire multiple wives.

In more advanced economies, richer men tend to have high human capital and, therefore, they are more efficient at producing human capital in children. This creates a high demand for quality in children and in women, because quality women are complements in the production of high-quality children. Thus, all women are not close substitutes in the marriage market in advanced societies. Higher-quality women are a scarce resource, which drives up their price in the market marriage market and makes polygyny less affordable for wealthy men.

The main implication of the model can be summarized as follows: male income inequality generates polygyny, but female inequality in the marriage market reduces it. As the return to human capital increases, women who can create high-quality children more efficiently are increasingly valued in comparison to low-quality women.

The main empirical prediction is that the composition of inequality, not just the level, is an important determinant of the degree of polygyny in society. Secifically, societies should be more polygynous in countries where variation in overall wealth inequality is determined more by differences in nonlaber income (capital and inherited wealth) versus income variation generated by differences in the levels and returns to human capital investments.

* Eric Gould et al., The Mystery of Monogamy, American Economic Review, American Economic Association, vol. 98(1), pages 333-57, March 2008.

Hayek and the Economics of Capitalism
2008-01-29 18:00 s.t., University of Vienna

The Federal Reserve Bank of Boston's Research Center for Behavioral Economics and Decision-Making recently held a two-day symposium called Implications of Behavioral Economics for Economic Policy:

Behavioral economics is motivated by a range of empirical facts that are at apparent odds with assumptions of standard economic theory. But while behavioral approaches are becoming common in academia, it is unclear how behavioral models should inform economic policymaking in general, and central banking in particular. This conference discussed the implications of behavioral economics for macroeconomic policy, with special attention to the regulatory and monetary policy responsibilities of central banks.

Given the anxiety about the housing market and the amount of hate and vitriole directed at central bankers of late, two papers are of particular interest:

• Behavioral Economics and the Housing Market
  The housing market is of particular interest to both behavioral economists and policymakers. Behavioral models have linked housing prices to loss aversion on the part of sellers as well as speculative mania on the part of buyers. For policymakers, understanding the linkages between the housing market and the wider economy proved critical for forecasting output growth in 2006 and 2007. This session will explore whether policymakers need behavioral tools to understand housing. Can we make sense of this market using standard theories of asset prices and investment? Or does “psychology” come into play?
• Should Central Banks Maximize Happiness?
  The Congressional mandate of the Federal Reserve is to pursue both price stability and full employment. But how should trade-offs between volatility in inflation and unemployment be viewed in the light of recent research on the determinants of individuals’ life satisfaction?

"A German would rather say he had inherited his fortune than say he made it himself."

Hans-Werner Sinn

Quoted in "Cultural Matters" (Wall Street Journal Europe, February 12, 2007; p. 13) by Edmund Phelps. Excerpt:

"There are two dimensions to a country's economic model. One part consists of its economic institutions. These institutions on the Continent do not look to be good for dynamism. They typically exhibit a Balkanized/segmented financial sector favoring insiders, myriad impediments and penalties placed before outsider entrepreneurs, a consumer sector not venturesome about new products or short of the needed education, union voting (not just advice) in management decisions, and state interventionism. Some studies of mine on what attributes determine which of the advanced economies are the least vibrant -- or the least responsive to the stimulus of a technological revolution -- pointed to the strength in the less vibrant economies of inhibiting institutions such as employment protection legislation and red tape, and to the weakness of enabling institutions, such as a well-functioning stock market and ample liberal-arts education.

The other part of the economic model consists of various elements of the country's economic culture. Some cultural attributes in a country may have direct effects on performance -- on top of their indirect effects through the institutions they foster. Values and attitudes are analogous to institutions -- some impede, others enable. They are as much a part of the "economy," and possibly as important for how well it functions, as the institutions are. Clearly, any study of the sources of poor performance on the Continent that omits that part of the system can yield results only of unknown reliability.

Of course, people may at bottom all want the same things. Yet not all people may have the instinct to demand and seek the things that best serve their ultimate goals. There is evidence from University of Michigan "values surveys" that working-age people in the Continent's Big Three differ somewhat from those in the U.S. and the other comparator countries in the number of them expressing various "values" in the workplace.

The values that might impact dynamism are of special interest here. Relatively few in the Big Three report that they want jobs offering opportunities for achievement (42% in France and 54% in Italy, versus an average of 73% in Canada and the U.S.); chances for initiative in the job (38% in France and 47% in Italy, as against an average of 53% in Canada and the U.S.), and even interesting work (59% in France and Italy, versus an average of 71.5% in Canada and the U.K). Relatively few are keen on taking responsibility, or freedom (57% in Germany and 58% in France as against 61% in the U.S. and 65% in Canada), and relatively few are happy about taking orders (Italy 1.03, of a possible 3.0, and Germany 1.13, as against 1.34 in Canada and 1.47 in the U.S.).

Perhaps many would be willing to take it for granted that the spirit of stimulation, problem-solving, mastery and discovery has impacts on a country's dynamism and thus on its economic performance. In countries where that spirit is weak, an entrepreneurial type contemplating a start-up might be scared off by the prospect of having employees with little zest for any of those experiences. And there might be few entrepreneurial types to begin with. As luck would have it, a study of 18 advanced countries I conducted last summer found that inter-country differences in each of the performance indicators are significantly explained by the intercountry differences in the above cultural values. (Nearly all those values have significant influence on most of the indicators.)

The weakness of these values on the Continent is not the only impediment to a revival of dynamism there. There is the solidarist aim of protecting the "social partners" -- communities and regions, business owners, organized labor and the professions -- from disruptive market forces. There is also the consensualist aim of blocking business initiatives that lack the consent of the "stakeholders" -- those, such as employees, customers and rival companies, thought to have a stake besides the owners. There is an intellectual current elevating community and society over individual engagement and personal growth, which springs from antimaterialist and egalitarian strains in Western culture. There is also the "scientism" that holds that state-directed research is the key to higher productivity. Equally, there is the tradition of hierarchical organization in Continental countries. Lastly, there a strain of anti-commercialism. "A German would rather say he had inherited his fortune than say he made it himself," the economist Hans-Werner Sinn once remarked to me."

Phelps (1967) and Friedman (1968) defined the natural rate of unemployment.

Friedman did it in words:

"At any moment of time, there is some level of unemployment which has the property that it is consistent with equilibrium in the structure of real wage rates. At that level of unemployment, real wage rates are tending on the average to rise at a 'normal' secular rate, i.e., at a rate that can be infinitely maintained so long as capital formation, technological improvements, ect., remain on their long--run trends. A lower level of unemployment is an indication that there is excess demand for labor that will produce upward pressure on real wages. A higher level of unemployment is an indication that there is excess supply of labor that will produce downward pressure on real wage rates. The 'natural rate of unemployment', in other words, is the level that would be ground out by the Walrasian system of general equilibrium equations, provided there is imbedded in them the acutal structural characteristics of the labor and commodity markets, including market imperfection, stochastic variability in demands and supplies, the cost of gathering information about job vacancies and labor availabilities,
the cost of mobility, and so on."

Friedman tried to link the natural rate to the Walrasian system. Thinking about this more technically this could mean that the natural rate of unemployment is caused by imperfect competition in the labor market.

Phelps did it in terms of the augmented Phillips curve:

Δp_t = f(u_t)+ p^e_t - p_t-1

where p_t is the price level at time t, u_t is the unemployment rate at time t, and p^e_t is the expected price level in period t formed at time t-1.

After some time (and a long thought which is described in Phelps (1995)) Phelps arrived at the following Phillips curve:

Δw_t = f(u_t)+w^e_t - w_t-1

where w_t is the money wage.

Here, the story goes as follows: The unemployment rate might move to so low a level that, to moderate the associated quit rate, every firm wants to offer its employees a better real wage as an inducement not to quit with such readiness; but as alle firms pass along the implied money wage increase, the price level increases in proportion, an increase that is unexpected; to keep the unemployment rate down, there must be a succession of such wage increases and hence continually unexpected inflation-- greater than whatever rate was expected.

In other words, the quit rate of employees is a decreasing function (an idea which leads to the new Keynesian "efficient-wage hypothesis" by Yellen (1984)) of firm's relative wage. For simplicity, only the relative wage and the unemployment rate determine the quit rate. The striking idea is now that uⁿ (the equilibrium steady state unemployment rate) is such that f(uⁿ)=0 and uⁿ > 0.

Now look at the natural rate of unemployment without considering monetary policy. Looking at Friedman's statement, the natural rate is an equilibrium of imperfect competition.

In this sense the natural rate of unemployment requires this: A steady-state (Nash) equilibrium. The steady-state assumption was already mentioned by Phelps. Why do we need this assumption? Basically one needs a fixed number of workers (employed or unemployed) and vacancies (unfilled or filled). There are other labor market inflow specifications which are more complicated. Closely related to this labor market inflow specification is the following labor market paradoxon, which is not understood or recognized by many (including all politicians): Rising number of employment and the one hand and rising unemployment rate on the other hand.

For example, this fact has been observed in Austria since 2000.

This paradoxon can be simply explained if we look at the inflow into the labor market. Besides unemployed and employed workers there is third group namley people who are "out of the labor force" meaning that they currently have no job and moreover do not receive unemployment benefits (hence are not regarded as unemployed). If such people enter the labor market (filling a vacancy) employment rise but on the other hand some workers are laid off which influences the unemployment rate.

The natural rate is a (Nash) equilibrium, since imperfect competition, assuming that agents behave somehow strategically, requires a non-cooperative solution concept. But in such models we are usually confronted with the problem of multiplicity of equilibria. Well, this is mainly a problem for interpreting the natural rate(s). Here, I don't want to mention stability of refinement issues, which partly determine the convergence behavior since behind any equilibrium concept there is an implicit dynamic process.

related items:
Today's Nobel Prize in Economics, Mahalanobis

References:
Phelps, Edmund S. 1967. "Phillips Curves, Expectations of Inflation and Optimal Unemployment Over Time," Economica, Vol. 34, No. 135, (August), pp. 254-281
Friedman, Milton, 1968, "The Role of Monetary Policy", AER, Vol. 58, No. 1, (March), pp. 1-17
Yellen, Janet L., 1984, "Efficiency Wage Models of Unemployment", AER, Vol. 74, No. 2 (May), pp. 200-205.
Phelps, Edmund S. 1995, "The origins and further development of the natural rate of unemployment", Cambridge University Press, Chapter 2, pp. 15-31