First set of problems

Hand in the following exercises:

Students of SMK Micro:
Exercises: 1,2,3,4,5,6,10
Dead Line: 8 DEC 2009 (Tuesday)

Students of SMK Macro:
Exercises: 2,7,8,9,10,11
Dead Line: 10 DEC 2009 (Thursday)

Students of ISLB (ex-VTVK):
Exercises: 1,2,3,4,5,7,8,10.
Dead Line: 10 DEC 2009 (Thursday)

Economics 1rst Set of Problemsbueno

Taking out the trash

I reproduce a post written by G. Mankiw at his blog. It's quite clear that Mankiw and Krugman are not friends any more. The post was published on November 02 2009.

http://gregmankiw.blogspot.com/2009/11/taking-out-trash.html

The Obama administration’s “jobs created or saved” is just a way of saying “other things equal” in non-economese. Of course it makes sense to ask how many more people are working than would have been the case without a given policy — and every administration makes assertions along those lines. During the 2001 recession and its aftermath, how many times did the Bush administration claim that the recession would have been worse without its tax cuts? And while many of us quarreled with that claim, I don’t think I ever argued that other-things-equal arguments are nonsense on their face.

I don't usually respond to illogical cheap shots from around the blogosphere (life is too short). But when the cheap shot comes from a Nobel prize winner in economics, I will make an exception.

Paul Krugman says I should be ashamed of myself for calling into question Obama administration estimates of how many jobs have been "created or saved." Here is what Paul says,
Yet Paul is rebutting claims I did not make, and he is giving Team Obama more credit on this question than it is due. Here is what I wrote on the topic last February:

The 4 million job number is a counterfactual policy simulation of what the stimulus will do based on a particular model of the economy. As such, I have no objection to someone citing it in a policy discussion. In fact, macroeconomists use models to generate figures like this all the time. I have even done it myself.

But as an answer to the question "how can the American people gauge whether or not your programs are working?... What metric should they use?", citing the 4 million job figure is a non sequitur, or more likely a diversion. A metric has to be measurable, and the actual number of jobs "created or saved" by the policy will never be measurable from any data source.

That is, I do not object to claims such as,

A: "Based on our models of the economy, we believe there would be X million fewer jobs today without the stimulus."But it is absurd to suggest that you can say,

B: "We have measured how many jobs the stimulus has saved or created, and the number is X."Economists are capable of making statements such as A, but it is beyond our ken to make statements such as B. Statement B is,of course, much stronger than statement A, as it purports to be based on data rather than on models. Unfortunately, we are hearing statements like B much too often from administration officials. A good example is here, where can you "learn" that 110,185.36 jobs have been created or saved in California alone."

Invitation to the Students' Conference

MankiwReal Business Cycles

An example of in class presentation

AN example of good in class presentation. Moreover I remind you that together the slides you have to prepare an essay following the instructions given in my lectures.

PRODUCTIVITY GROWTH IN EUROPE AND THE USmodi

The financial crisis according to South Park

Principles of economics by Greg Mankiw. Creative proposal by his students of Harvard

Supply and Demand

BE SEP09 Supply Demand

PKarticle





http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html

Economic Donkeys

EARLY in the First World War, British generals decided to attack German trenches with an initial light bombardment, followed by infantry walking in close order across No Man’s Land. The result was tens of thousands killed in a series of military disasters, but the generals reacted with only small adjustments to their approach and essentially persisted in repeating the same mistakes for years. “The English soldiers fight like lions,” one German general remarked. “True. But don’t we know that they are lions led by donkeys?” was the reply.

Today, a year after global financial collapse and the ensuing tragedy for millions, our economic leaders are lining us up to suffer again (and again) through the same horrible experiences.

The collapse of Lehman Brothers in September 2008 demonstrated just how far our economic system in general and bank management in particular have gone awry. Lehman borrowed at low interest rates in global credit markets, and invested over half a trillion dollars of other people’s money in assets which, today, are worth next-to-nothing: failed ski hills in Montana, now empty suburban housing in California, and crazy bets on derivatives (options to buy or sell securities, in various complex combinations).

Worries about these failed investments sparked a run on the bank. And, after a mad weekend of trying to save Lehman, the U.S. “authorities” – meaning Henry Paulson (Secretary of the Treasury), Ben Bernanke (chairman of the Federal Reserve Board), and Timothy Geithner (President of the New York Fed) – decided to let it go bankrupt. Creditors, realizing no major bank is safe if our leaders might now let them fail, pulled cash from major financial institutions and bought relatively safe US Treasuries and UK Gilts.

Today Lehman’s senior debt trades at a mere 10 cents on the dollar, suggesting its $600 billion in assets were a mirage. This outcome is even more startling when compared to senior debt at Kazakhstan’s defaulting large banks, where management is now accused of serious malfeasance, yet that debt trades at 20 cents on the dollar – twice the price of Lehman’s debt.

At the G20 meeting of finance ministers last week, political leaders united behind two key steps which they claim will “prevent another Lehman”: tighter controls on the pay of executives and more capital for banks. France and Germany blame the crisis on lax regulation in Anglo-Saxon markets and excessive pay packets that encourage irresponsible risk taking. The British and Americans counter that European banks have too much debt (i.e., in the jargon, are “overly leveraged”), and need to raise more capital. The final communiqué proposes to do both, and we will hear more of the same at the upcoming G20 heads of government summit in Pittsburgh. But, in reality, both sides want only minor adjustments that cannot solve the real problems posed by our financial system.

Tim Geithner, now US Treasury Secretary, is pushing for higher capital requirements for banks, i.e., they need to have more shareholder funds to protect against future losses. But he surely knows that two weeks prior to its bankruptcy, Lehman’s management reported they were well-capitalized, with a tier one capital ratio of 11% — roughly twice what the United States currently considers is needed for a well-capitalized bank, and much higher than the American side is proposing in private conversations.

Christine Lagarde, France’s Finance Minister, and Angela Merkel, President of Germany, helped convince the G20 that bank compensation policies need to be amended to encourage long term incentives. They want compensation packages to be limited and bonuses to be locked up, so we can be sure employees’ incentives are consistent with the long term survival of their banks.

President Merkel and Minister Lagarde need to look no further than Lehman for a model of how to introduce a good policy to align incentives. The top management and many employees in the company were largely compensated in shares of the company which vested over many years, so when Lehman Brothers went down, it brought crashing down the lives and finances of its 20,000 employees. Dick Fuld, the highly compensated head of Lehman, lost many million dollars – and presumably a large part of his total wealth. Apart from criminal penalties (of the kind not seen for banking in a century), can we think of a better way of aligning incentives with the outcomes for a bank?

The real problem with our financial system is that our economic and political system work together to encourage excessive risk, and this risk in turn leads to cycles of prosperity and collapse. In 1998, a much smaller Lehman Brothers was placed in financial peril by the aftermath of the Asian financial crisis and failure of Long Term Capital Management, a major hedge fund. The Federal Reserve responded by lowering interest rates and other central banks followed suit. This reduced the cost of obtaining funds, effectively bailing out Lehman and other institutions in trouble.

As markets have grown to recognize how quick the Federal Reserve is to bail out institutions (and executives) in trouble, they naturally respond. In the 1990s, people talked about the “Greenspan Put” a term which derisively suggests that it is always safe to invest in risky assets, because the Federal Reserve is ready to bail out investors (a put is effectively a promise to buy an asset at a fixed price if you are unable to sell it to someone else at a higher price – this is a way to lock-in profits or limit losses on investments). However, in months following the collapse of Lehman, we learned that the “Bernanke Put” is even more valuable since Chairman Bernanke, alongside the Bank of England, the European Central Bank, and central banks in much of the rest of the world, is prepared to take drastic measures to prevent asset prices from falling when there are risks of global collapse.

This policy of responding to the aftermath of bubbles, rather than addressing them before they get going, through tighter regulation, has become the mantra of most central banks. It is usually combined with fiscal policy stimulus and other measures to support the economy. Each time banks fail, by bailing the system out again, we teach our finance sector a lesson: you can safely take too much risk because, when you lose, the taxpayer will pick up the bill. We also send a simple message to creditors: it is safe to lend to Goldman Sachs, or Barclays Bank, because taxpayers and our nations’ savers are standing by to cover your losses. Rational bank executives and creditors respond as any person would: creditors lend to banks at low interest rates, and our banks gamble heavily hoping to make large profits. Such a system is destined to fail, but the party can run for a long time.

While Ben Bernanke has done a wonderful job of preventing financial meltdown, his calls in 2002-2003 for very low interest rates, without fixing our financial system, contributed to the credit expansion that led us into the current mess. In the United Kingdom, the Conservatives plan to transfer regulatory powers to the Bank of England, despite the fact that, like the Federal Reserve, the Bank of England has been a key component of our ever growing cycles of credit expansion and bust.

The “collapse or rescue” decision forced by Lehman’s failure is a symptom of a much larger systemic problem. We need leaders, both in the financial world and in public service who recognize that our financial sector too often causes social harm. There is no doubt that it also provides valuable services that are vital to the well-being of our pensioners and savers, and help manage and mitigate risk for our corporations. Yet too often these activities cause losses, which, either directly or indirectly, become a burden on the rest of society.

The pre-crisis activities and portfolios of Barclays, Goldman Sachs, and other “survivors” of this crisis were only slightly different from Lehman Brothers or Bear Stearns, which failed. The “good” banks also securitized subprime assets, helped build the intricate web of IOUs between banks and insurance companies, and leveraged their balance sheets to enormous levels. The winners were not better, they were just smart enough to make sure someone else held the bad assets when the music stopped, and they were powerful enough to win generous bailout packages from their governments.

The danger we face is that, by bailing out these institutions and rewarding failed managers with new powerful positions, we have now created a much more dangerous financial system. The politically well-connected, knowing they will most likely do fine in the next crisis, is now highly incentivized to take even greater risk.

Once we admit this profound problem in our system, we can begin to think of the radical measures needed to solve it. There is no doubt these solutions will include much greater capital requirements, so that bank shareholders know that they face substantial losses if their ventures fail.

But, we also need to ensure that our regulators are not captured by the banks that they are meant to oversee. This means we need to put checks on financial donations to political parties, and we need to buttress our regulators with more intellectual firepower and financial resources, along with rules that ensure independence, in order to be sure they can act in the interests of the broader population.

We also need to close the revolving door, through which politicians and regulators leave office to earn their nest eggs in finance, and “financial experts” move directly from failing banks to designing bailout packages. The conflicts of interest are abundant and most dangerous.

Last week the UK’s chief financial regulator, Adair Turner, faced heavy criticism from the City, Chancellor Darling, Boris Johnson, and editorials in the Financial Times and Wall Street Journal. His main offense was daring to raise the issue of whether parts of our financial system have become socially dysfunctional, in an interview with Prospect Magazine. He called for greater capital requirements at banks, and he pondered how it would be possible for regulators to preserve the valuable parts of our financial system, while ensuring that regulation limited the harmful parts. These are eminently sensible questions which anyone with a public spirit should understand are critical policy issues today.

Sadly, these public rebukes to Lord Turner are a further indication that very few of our leaders are prepared to even discuss the real problem, let alone seek a sufficient solution. Smart people and well-organized governments can, as in the past, behave like donkeys.

By Peter Boone and Simon Johnson in the blog "The Baseline Scenario"

An edited and shorter version of this post appeared today in the Sunday Times (of London).