Sam and Janet go to College

My reading list on the overlapping generations model has already generated some questions. Rather than respond in the comment section to each question individually, I will answer these questions in a new post. Here goes.

In a comment on my previous blog Brian Romanchuck has a “good grounding in mathematics” and he “understands the [overlapping generations] models.” He is my ideal reader. Brian raises a number of points that may be shared by others with a similar background. If you also have a good grounding in mathematics and you think you understand the models: this post is for you.

The Great Blog Debate about Debt: A Reading List

I applaud everyone who has weighed in on the Great Blog debate about debt (Simon,  Bob,  me, and others too numerous to link. All of the issues that have been raised on Nick's blog were the topic of frontier research in economics journals in the 1950s -- 1970s.  Nick has links to earlier posts here.

The paper that started all of this (at least in the English speaking world) was by Paul Samuelson. "An exact consumption-loan model of interest with or without the social contrivance of money", Journal of Political Economy 1958, Vol 66 No. 6. The French lay claim to an earlier version by Maurice Allais, but that's another story. 

Samuelson's paper was a revelation to economists because it provided an example where markets don't work. In Samuelson's example, there is an equilibrium, (people optimize taking prices as given and all markets clear) that can be improved upon by a government institution. Samuelson's paper is a good starting point for those who would like to read more about this.

Sam and Janet Learn about Debt

In a recent post on the (non)-importance of debt buildup worldwide, Antonio Fatas makes the point that debt is not necessarily a problem. While I agree with that statement: a great deal hinges on the qualification “not necessarily”.  

Paul Krugman goes further than Antonio. According to Paul debt is “money that we owe to ourselves”. That is at best misleading and at worst;  false. Money is money we owe to ourselves. Debt is money that some of us owe to others. 

Lessons from the Great Galactic Depression

A long time ago, in a galaxy far far away, there were two planets orbiting a star, not unlike our own sun.  The inhabitants of these planets share a common ancestry but, over the years, they have developed somewhat different temperaments. 

The names of these planets are difficult to pronounce in English, but we will call them Nordus and Sudus. The name of their star is Sol.

Nordus, being further away from Sol, has a colder climate than Sudus and its inhabitants are known to be frugal and patient. The Sudusians, in contrast, live for the moment. Using the language of economics, earth people would say that the Sudusians have a higher rate of time preference. 

Why the ECB Should Take More Risks

Mrs. Merkel and Mr. Schäuble are worried. The ECB is planning to buy the sovereign debt of its member states and Mr. Schäuble doesn't trust his southern European partners. He thinks that Portuguese, Spanish and Italian debt is risky and he knows that Greek debt is.

Bankers are supposed to be boring. And central bankers are supposed to be boring in spades. What would happen if the Fed were to bet the farm, buying shares in an internet start-up that subsequently goes bust? The public purse would be on the hook for the loss. At least, that’s the theory. That theory is wrong.

The central banking business plan is a money-spinner beyond a venture capitalist’s wildest dream. Buy an asset, any asset, and pay for it by issuing little pieces of colored paper. Collect the interest payments and dividends from the assets and use them to pay for your house, your car and a holiday in Spain. If you happen to be the central bank of a sovereign state, pay the interest and dividends to the treasury to help reduce the tax bill of your citizens.

Does it matter which assets you buy? Conventional wisdom says yes. A central bank should buy safe assets, typically promises issued by its own national government that will never fall in value. The Fed buys T-bills on the private market. The Treasury pays the interest and principal to the Fed, and the Fed turns around and pays them straight back to the Treasury. The point of all of this is to keep enough of the little pieces of colored paper passing from one person to another to “oil the wheels of trade”.

Financial crises as global sunspots

I have just written a new working paper, 'Global Sunspots and Asset Prices in a Monetary Model', that is available on the NBER website here. The paper is a continuation of research on financial markets that I began in 2002, (2002a, 2002b) and it provides intellectual ammunition to support a proposition that I put before the UK parliament in April of 2012. We must develop a new institution that is designed to counter financial market volatility. 

My paper explains three asset pricing puzzles that are difficult to reconcile with the now standard representative agent approach to macroeconomics. First, asset prices are volatile and persistent and price dividend ratios are predictable. Second, long lived risky assets earn 5% more on average than short term government debt. And third, the volatility of asset prices changes through time. I argue that all of these puzzles are caused by the simple fact that we cannot buy insurance over the state of the world we are born into.

Secular stagnation: a neo-paleo-Keynesian perspective

I first posted this piece back in January but it got deleted by from my blog by mistake. Since secular stagnation is back in the blogosphere with a vengeance: its time to repost it.

In a recent piece on his blog, David Beckworth has taken another swing at the secular stagnation hypothesis. Secular stagnation is a term coined by Alvin Hansen in a 1938 article in which he claimed that public expenditure might be required to maintain full employment.

Here is Alvin, as quoted by David...

"The business cycle was par excellence the problem of the nineteenth century. But the main problem of our times, and particularly in the United States, is the problem of full employment. ... This is the essence of secular stagnation— sick recoveries which die in their infancy and depressions which feed on themselves and leave a hard and seemingly immovable core of unemployment."

Hansen is writing in 1938, before Keynesian economics had been forever altered by Samuelson's bastardization of Keynes' key idea: that high involuntary unemployment is an equilibrium that can persist for decades.