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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 clever trick for valuing the diminishing Zimbabwe dollar

"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:

Δpt = f(ut)+ pet - pt-1

where pt is the price level at time t, ut is the unemployment rate at time t, and pet 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:

Δwt = f(ut)+wet - wt-1

where wt 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

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

Edmund Phelps. Here is the announcement from Tyler Cowen.

Phillips Curve? Huh? Here is the story (old post of mine):
phillips01This scatterplot of the rate of change of wage rates and the percentage unemployment for the years 1861-1913 is the womb of an assumed relation that was later on baptized Phillips curve by Samuelson and Solow. Here is the non-photoshop-edited plot:phillips02"The crosses give the average values of the rate of change of money wage rates and of the unemployment rate in those years in which unemployment lay between 0 and 2, 2 and 3, 3 and 4, 4 and 5, 5 and 7, and 7 and 11 per cent respectively. <> The curve was fitted to the crosses. The form of equation chosen was

log(y + a) = log b + c log x

where y is the rate of change of wage rates and x is the percentage unemployment. The constant b and c were estimated by least squares using the values of y and x corresponding to the crosses in the four intervals between 0 and 5 per cent unemployment, the constant a being chosen by trial and error to make the curve pass as close as possible to the remaining two crosses in the intervals between 5 and 11 per cent unemployment. The equation of the fitted curve is log(y + 0.9) = 0.984 - 1.394 log x."[1]

A two-page summary of Phillips curve related stuff can be found here (New Evidence of the Old Phillips Curve, Cato Institute, 2002).

aut_philcurve I plotted the rate of inflation against the rate of unemployment in Austria for each year from 1962 to 2003. The message: Austrians figured out that price stability is a good thing but have no clue what to do against non-keynesian unemployment (The unemployment rate in Austria is highly persistent, it has been rising steadily during the past 30 years. see also Hysteresis)

[1] The Relation between Unemployment and the Rate of Change of Money Wage Rates in the United Kingdom, 1861-1957, A.W. Phillips, Economica, Vol. 25, Nov. 1958)

bmwtussi1A survey on transport-related issues was mailed to 2500 randomly selected individuals aged between 18 and 65 years in Sweden (response rate = 62%). The respondents were first asked how they would value certain attributes if they were about to buy a car for themselves (very important = 3, fairly important = 2, fairly unimportant = 1, and completely unimportant = 0) Then, respondens were asked to judge how the average Svensson would value these characteristics. Furthermore, a sample of 100 car-dealers (83 responses) in Sweden was randomly selected. They were asked questions about how the average Swede would value the same attributes. Results:bmwpapGo and read this paper for an interpretation of the results. The conclusion: "The present paper provides survey evidence that people do care about both status value and environmental performance when they are about to buy a car, and that we tend to be more concerned with status, and less concerned with the environment, than we would admit even to ourselves. Even though these findings are all inconsistent with conventional textbook theory, they are consistent with a simple modification of the standard theory, where self-image is an element of the utility function, e.g. as in the model by Akerlof and Kranton (2000, 2002). Hence, people derive utility from having a good self-image, and this self-image is determined in part by the perception of one’s own preferences.bmwtussi2 On average, people consider it bad to be concerned about status and good to be concerned about the environment. The suggested self-image model also includes an honesty effect that moderates the perception bias. We have also found evidence that people’s perceptions of others’ preferences are biased for two reasons (in opposite directions): i. People want to see themselves as better than others, implying biased perceptions of others in what is perceived to be a negative direction, and ii. People are influenced by preference falsification prior to the survey situation. For example, people will in daily conversation give the impression that they are much more concerned about the environment than they actually are. Consequently, people may believe that others are more concerned than they are, or, more generally, have preferences more in accordance with social norms than they do. The systematic biases that occurred in the survey situation have been assumed to exist due to self-image effects rather than self-presentation effects (through preference falsification), since the survey was perfectly anonymous. However, it cannot be ruled out that some respondents did not perceive the survey to be perfectly anonymous, and that they have perceived that they communicated with someone who could, at least partly, observe them. If so, parts of what has been interpreted as selfimage effects may in fact be self-presentation effects."

2006 Thomson Scientific Laureates in Economics:
2005 Thomson Scientific Laureates in Economics:

related items:
Who will win the next Nobel Prize in economics?, 2004, Marginal Revolution

via Greg Mankiw

The latest issue of the Journal of Financial Transformation reprinted (see "Nobel Laureate View") excerpts from Prof. Allais’ book (L’Europe en crise, que faire?: Réponses à quelques questions, pour une autre europe), published in 2005 in Paris. Sample this:
Globalization of the economy is certainly very profitable for a few groups of privileged people. However, the interests of these groups may no be shared by the rest of the population. Rapid and anarchic globalization will only lead to instability, unemployment, injustice, chaos and all sorts of misery, and will only be a disadvantage for everyone.<>

Undeniably, global free market policies put in place in Brussels are the major cause, and by far the most important are mass under-employment and growth reduction. To solve this, the European project should be based on the restoration of ‘community first’ position and the control of capital flows: the true condition of expansion, labor and prosperity. This principle is universally valid for all countries.

A sensible objective would be to allocate a minimum percentage, by product or product type, of E.U. consumption to be satisfied by E.U. production. A target average of 80% of E.U. consumption from local production seems reasonable.
Wow. If I had to choose between Maurice Allais' and John Nash's psychopathy, I'd took the latter. The next thing that Allais probably does is to lobby the French parliament for a law requiring the closing of all blinds to block out sunlight to stimulate the domestic candle industry. Not that "trade openness" is probably the only variable that consistantly produces a positive sign in growth regressions and that most economists will tell you that Europe's poor growth performance is caused by bureaucratic inertia, job-destroying labor regulations, and enterprise-stifling welfare provisions (It's not a coincidence that France came up only 35th in the Doing Business 2007 Report - right between Armenia and Slovakia.) Paradoxically--at least for the untrained mind--protectionist policies can even hurt the people who should be protected. For instance when the EU moved towards imposing limits on some types of surging Chinese textiles a large German newspaper reported that many European small and medium-sized enterprises (who make up 95% of the German textile industry) were teetering on the brink of closure since orders were not being shipped. Not only did market demand go unsatisfied because of artificially capped supply, but companies were confronted with penalties and warehouse charges. Probably the only intention behind Allais's book is that he want's to earn as much as Paul Krugman.

Here is the free version of Macroeconomic Derivatives: An Initial Analysis of Market-Based Macro Forecasts, Uncertainty, and Risk. I haven't read it yet but I intend to do so soon.

related items:
Economic Derivatives @ GS

A group of macroeconomists are sitting on a panel at a conference discussing developments in the discipline.

In a heated exchange, the New Keynesian says to the Real Business Cyclist: “You guys have put macroeconomics back twenty years with this nonsense!”

The Real Business Cyclist smiles and says “So you DO believe in negative productivity shocks after all.” [Source]