Articles in the print edition of The Economist

This is an archive of my published writings in the print edition of The Economist, in chronological order:

Being Mario Draghi

Sep 22nd 2012 | from the print edition

THE life of a European central banker was far simpler in the early days of the euro zone than it is now. “€conomia”, an interactive game on the website of the European Central Bank (ECB), harks back to these gentler times. It is designed to explain, “in a simplified way, how monetary policy works”, and allows players to pretend that they are Mario Draghi, the ECB’s president.

The instructions have a clarity that induces nostalgia: “Keep the inflation rate just under 2% and stable. Raise the interest rate to push inflation down. Lower the interest rate to push inflation up.” Players are told the growth rate of real GDP, the inflation rate, the growth in the money supply and the level of joblessness. Extra guidance is provided by a ragtag group of advisers, including a hippy, a narcoleptic and a gambler—which may be how Bundesbank officials now view their euro-zone colleagues.

Players set policy every quarter and each game lasts for a total of eight (notional) years. The game assesses performance every two years, with “stars” awarded to those who can keep the average rate of inflation between about 1.7% and 2% with minimal volatility. When prices rise too quickly, or fall too rapidly, the game abruptly ends on a stern warning about social stability. Yet even when the game ends early due to “rapid” inflation (meaning 8% over a two-year period), unemployment stays oddly low, at only 2.5%.

€conomia badly needs an update if the ECB really wants to educate Europeans about its current job. Players need more data on sovereign-borrowing costs, cross-border deposit flows and Target 2 balances. They should also have many more tools at their disposal, such as unlimited loans for troubled banks and programmes to buy unlimited amounts of sovereign debt.

The objective of the game is ripe for change, too. Instead of stabilising the rate of euro- zone inflation, players should prevent any country from leaving the single currency. The crisis-hit countries will exit if they become trapped in recession but the northern-tier nations will quit if their domestic inflation rates exceed an annual average of, say, 3%. Anyone who succeeds should go on the shortlist to be the next ECB president.

Asking the experts (co-written with Greg Ip)

Oct 6th 2012 | WASHINGTON, DC | from the print edition

BARACK OBAMA and Mitt Romney have spent many months and hundreds of millions of dollars trying to convince the public that electing the other man would lead to economic catastrophe. They have fought to a draw: voters today are almost evenly split over which man would do a better job on the economy.

But whom would the experts pick? To find out, The Economist polled hundreds of professional academic and business economists. Our main finding should hearten Mr Obama. By a large margin they rate his overall economic plan more highly than Mr Romney’s, credit him with a better grasp of economics, and think him more likely to appoint a good economic team (see chart). They do not hold the perpetually disappointing recovery against him; half of respondents graded his record as good or very good, compared with just 5% who said that about George Bush in our poll four years ago. “It all depends on the counterfactual,” said Justin Wolfers, an economist at the University of Pennsylvania’s Wharton School, referring to how bad things might have been without the president’s emergency measures.

But Mr Romney can take heart from a deeper dive into the numbers. The Economist polled two groups: research associates of the National Bureau of Economic Research, the country’s leading organisation of academic economists; and the outlook panel of the National Association for Business Economics. The academics gave Mr Obama much higher marks than Mr Romney, which may in part reflect partisan preference: fully 45% of them identified themselves as Democrats, and just 7% as Republicans.

By contrast, the forecasters, a much less partisan crowd, consistently assigned Mr Romney higher scores. Democrats and Republicans were equally represented in this group, at 22% each. Roughly half of both groups were either independent or declined to state an affiliation. Among these independents, and these are probably the most compelling numbers, Mr Obama’s platform still got a higher grade than Mr Romney’s, but by a much smaller margin than in the group as a whole. The independents, by a slim margin, thought Mr Obama would name a better economic team, but also believed that Mr Romney has the better grasp of economics.

While we cannot claim that this is a scientific sampling of economists’ opinions, our sample is reasonably large: 312 of the 902 NBER research associates responded, as did 51, around half, of the NABE forecast panel’s members.

Devilish details

Interestingly, opinions of Mr Obama became less favourable as questions turned from the general to the specific. On tax reform, entitlements (Social Security, Medicaid and Medicare) and the deficit, respondents gave the two men roughly equal grades. The independents, by a clear margin, preferred Mr Romney’s approach to all these issues. So although the public on balance dislikes the proposal of Mr Romney and Paul Ryan, his running-mate, to convert Medicare to vouchers, our economists were much better disposed to it, especially in comparison with Mr Obama, who has offered no overall solution to the programme’s insolvency other than to cut fees to providers and experiment with new ways to deliver care. “Medicare plan? Keep everything as is and wait for Santa Claus?” snorted one independent.

Of Mr Romney’s promise to cut income-tax rates by 20% and pay for it by closing loopholes, John McLaren, a Democratic economist from the University of Virginia, said: “The only plausible result is a tax cut for high-income taxpayers, a tax increase for middle-income earners, and a huge increase in the deficit.” But Mr Obama’s alternative, a patchwork of tax hikes on corporations and the rich, did not garner much enthusiasm either. His “support for tax reform is positive but of questionable sincerity given his ‘commitment’ to impose higher marginal rates on higher incomes,” one Republican noted.

On two specific issues, economists—both the full sample and the independents—clearly preferred Mr Obama: by 58% to 10% they thought he would handle China better than Mr Romney, and by 63% to 15% they thought he would make wiser appointments to the Federal Reserve. Like many past candidates, Mr Romney has been confrontational towards China on the campaign trail, promising to label it a currency manipulator on his first day in office, which went over badly with perhaps the only segment of the electorate that is solidly pro-free trade. “We have to assume Romney is lying about most of his plans,” one Republican academic observed.

Many who dislike Mr Obama’s policies disagree on their flaws. Several people who gave low marks to the 2009 stimulus bill accused it of being too small; others, like Dartmouth’s Eric Zitzewitz, thought that “the lack of attention to efficiency undermined both the first stimulus’s effectiveness, and the political will for a second stimulus.” Many critics of the president’s health reforms would have preferred a single-payer system. One Democratic academic said a “complete overhaul [was] needed, not a Band-aid.”

The president’s least popular policy was his financial-reform package—though critics again disagreed on why. Laurence Ball of Johns Hopkins blamed Mr Obama for failing to “put up much of a fight against Wall Street lobbyists,” while an independent NABE economist remarked that “2,300 pages is evidence of very bad drafting”. The biggest complaint was that the reform did not address the vulnerabilities that existed in the financial system before the crisis, in particular the “too big to fail” problem. One independent NABE economist concluded: “It would have been more effective to put a couple of the miscreants behind the financial crisis in jail.”

Parsing public payrolls

Oct 27th 2012 | WASHINGTON, DC | from the print edition

A PUBLIC-SECTOR job is usually a cushy way to ride out a recession. Not this time. Austerity has bitten deeply into public payrolls as governments lay off workers, slice wage bills, or refuse to hire replacements for retirees. Of 37 countries examined by the IMF, only four have increased spending on public-employee labour costs since 2009: Germany (where the tally of workers has risen), South Africa, Turkey and Argentina. What about the toll on the numbers of government workers?

This question is harder to answer than it might seem. France has not published the number of public employees since the end of 2009, for example. Public-sector workers sit in lots of different categories, from civil servants to employees of utility companies. But the broad trend is clear (see chart): headcount is being slashed in many places.

British public-sector employment has fallen by a thumping 7.4% since the peak in late 2009 (excluding workers, like teachers in privatised schools, that have been recategorised). Spain is fast catching up: government payrolls there have fallen by 5.6% in the space of just nine months (although they grew briskly in prior years). But the standout country is Greece, where government payrolls have shrunk by 16.3% since the peak in early 2009—comparable with the decline in Greek private-sector employment.

These numbers look puzzling, given complaints from the Greek private sector that the public sector has escaped the burden of austerity. It is true that Greek government workers have avoided sackings; true, too, that the state sector remains bloated. But the retrenchment in spending is still for real: contract employees have not had their agreements renewed and some workers who were worried about future pension cuts took early retirement instead.

Such tactics are common. The firing rate of government workers in America has not changed since 2001, for example, even though municipal payrolls (where the majority of the public sector is employed) have fallen by 3.3% since 2008. The problem for Greece, which was still locked in negotiations with creditors this week, is that doing more than others is never quite enough.

Crisis mismanagement

Oct 27th 2012 | from the print edition

IN JULY 2008 the Federal Deposit Insurance Corporation (FDIC) closed IndyMac, a Californian lender. Anyone who had more than $100,000 in savings suffered heavy losses, including a woman who had just deposited her son’s life- insurance benefits after he was killed in Afghanistan. Later that year the government insisted that derivatives contracts sold by AIG, the failed insurer, would be honoured at a cost of tens of billions of taxpayers’ dollars.

Is the government too deferential to the concerns of the big banks and insufficiently attentive to the needs of ordinary people? Yes, according to two new books: “Bailout” by Neil Barofsky and Sheila Bair’s “Bull by the Horns”. Both accounts correct other, more triumphalist histories of the financial crisis, such as David Wessel’s “In Fed We Trust”, which came out in 2009.

Mr Barofsky was asked to serve as the Special Inspector General for the Troubled Asset Relief Program (TARP) by the outgoing Bush administration. He was an inspired choice, a tough New York prosecutor who had led fraud cases against futures brokers that hid losses and predatory mortgage lenders. Earlier in his career, Mr Barofsky charged dozens of Colombian Marxist guerrillas, narrowly avoiding assassination in Bogotá. But he was not interested in leaving a job he loved to fight turf-obsessed bureaucrats. Mr Barofsky accepted the assignment only after his boss made an earthy appeal to his sense of patriotism: “Who else is going to protect the public from what could be a $700 billion clusterfuck of fraud?”

Indeed, Mr Barofsky reports that no one in the Treasury Department and almost nobody at the Federal Reserve seemed concerned that some might try to exploit the government’s largesse. Whenever Mr Barofsky tried to ensure that banks were using TARP funds to make loans—the stated purpose of the programme—he was told that it would be impossible because “all money is green”. Yet the bankers themselves had no problem telling journalists how they planned to use the cheap capital to buy competitors or hoard cash for a rainy day. Mr Barofsky’s team was able to add safeguards to some of the Treasury’s worst ideas only thanks to pressure from Congress and the media.

Ms Bair was asked to run the FDIC when the job seemed hopelessly boring: no insured bank had failed between June 2004 and February 2007. Yet she quickly found herself fighting the Europeans, the Japanese and Wall Street to prevent bank capital from shrinking under the new Basel II accord—a war that would last for years. As an author, Ms Bair quickly turns to the government’s response to the housing bust. She explains how securitisation had created a web of interests that was causing millions of unnecessary foreclosures, depressing home prices and harming investors. Had it tried, the government could have solved this “co-ordination problem”—especially since Fannie Mae and Freddie Mac, two government-sponsored agencies that were created to support the growth of the American housing market, owned one-third of the toxic assets. But few cared.

Both books show that the Obama administration devoted much more energy and attention to helping Wall Street than to stemming the foreclosure crisis, despite having been given TARP money to do so. Ms Bair recounts how the methodology used to calculate the “stress tests” was cleverly altered so that Citi would keep its tax breaks. This resourcefulness was not applied to help keep people in their homes, however. Whereas incompetence was common—the rules determining which mortgages would be modified were changed nine times in the first year alone—a bigger problem was that these schemes were not designed with ordinary people in mind. When asked how the government’s efforts were supposed to help homeowners, Timothy Geithner, the treasury secretary, responded by explaining that they would aid the banks by slowing down the pace of foreclosures.

For all the books’ virtues, they also contain some flaws. Oddly for a financial expert, Ms Bair repeatedly writes that banks “hold” equity when they actually sell it to investors. She also believes that Mr Geithner, an appointed official, acted against the president’s wishes for years. This seems unlikely. Mr Barofsky’s “Bailout” is also more confusing than it need be, going back and forth chronologically without any obvious reason. Both books, however, do something essential: they show the paths not taken. The financial crisis did not have to be so unfair.

Crying over nearly spilt milk

Dec 8th 2012 | WASHINGTON, DC | from the print edition

THE fiscal cliff may get all the attention along Pennsylvania Avenue these days but, almost unheeded, America’s agriculture is facing a cliff of its own. For the dairy business, it will arrive at the same time as the more famous version, at the end of the year.

Support for agriculture in America derives from farm bills that usually last several years at a time. Unfortunately, the last one expired on September 30th this year, with two different replacement versions, one in the House and one in the Senate, still unreconciled. Both aimed to cut farm spending a bit: over ten years, by $35 billion and $23 billion respectively. The bills also differ in the mechanisms they propose to support farmers. Southern peanut and rice farmers complain the Senate’s bill would make them lose out relative to Midwestern wheat and soya growers.

At the moment negotiations over the fiscal cliff are consuming all the political air. From soil conservation to price supports to trade, American farm policies are all on hold. The expiry of the latest bill means several conservation programmes have been frozen, as have export loan guarantees.

This year’s harvest is long in, so the effects so far have been muted. But if there is no farm bill by the start of the next agricultural year, the government’s price-support scheme will automatically revert to what it was in 1949. Most crops have until the spring or summer, but the deadline for milk and other dairy products comes at the end of December. Applying the old formulas today would require the federal government to buy up enough milk to establish a minimum wholesale price more than double its current level, and, later on, enough wheat to raise its price by 67%.

No one really expects Congress to plunge taxpayers into this “agriculture abyss”. When the previous farm bill was about to expire in 2007 the first of several temporary extensions was passed just days before the government would have had to intervene in the dairy market. Frank Lucas, the Republican chairman of the House agriculture committee, says that “reverting back to an antiquated system…is not responsible,” while Debbie Stabenow, the Democratic chairman of the Senate agriculture committee, is confident that a deal will be reached before the end of the year. But as with the rest of the fiscal cliff, the mere fact that both sides want a solution is no guarantee it will happen.


Jan 12th 2013 | WASHINGTON, DC | From the print edition

ASK most Americans about pay disputes at great institutions, and they will probably think of the management lockout imposed by the National Football League last year, which led to the temporary replacement of professional referees with amateurs.

That, however, ended relatively quickly, without serious damage to anyone’s pay or to the prestige of the franchise. Some of America’s best symphony orchestras may not be so lucky. To see why, look no further than the Minnesota Orchestra, one of the best in the country.

Thanks to the recession, ticket sales and donations have fallen about 10% over the past six years. So far, the shortfall has been covered by withdrawals from the orchestra’s endowment. This, combined with poor investment returns over the past few years, has produced a sizeable gap between what the orchestra’s board was expecting to have when it agreed to the last round of contracts with musicians in 2007, and what it actually has in hand today.

Desperate to close the gap, the orchestra’s board proposed pay and benefit cuts for the musicians that would lower their compensation by 50%. The musicians rejected the offer back in September. Management responded by cancelling concerts. There will be no more until the middle of February at the earliest.

The board argues that the musicians have refused to make any counter-offer besides a wage freeze. The musicians say that their tone-deaf management is over-reacting to a temporary downturn. Things cannot be too dire if the orchestra’s “Building for the Future” campaign could raise nearly $100m during a recession, they say. Some of that money, however, came directly from the state of Minnesota, which will soon hold hearings on whether it was misled about the health of the orchestra’s finances.

The turmoil in Minneapolis is, sadly, far from unique. Many other orchestras, including those of Philadelphia, Chicago, Indianapolis, Atlanta, St Paul, Detroit, Spokane and Richmond, have also endured contentious pay disputes and even strikes. Drew McManus, an arts consultant, believes this is because the sagging economy “uncovered institutional problems more than anything else”. According to him, musicians in certain orchestras are being forced to pay for managers’ past mistakes, including aggressive empire-building and insufficient provision for bad times.

New model army

Jan 19th 2013 | WASHINGTON, DC | From the print edition

THE models that dismal scientists use to represent the way the economy works are sometimes found wanting. The Depression of the 1930s and the “stagflation” of the 1970s both forced rethinks. The financial crisis has sparked another.

The crisis showed that the standard macroeconomic models used by central bankers and other policymakers, which go by the catchy name of “dynamic stochastic general equilibrium” (DSGE) models, neither represent the financial system accurately nor allow for the booms and busts observed in the real world. A number of academics are trying to fix these failings.

Their first task is to put banks into the models. Today’s mainstream macro models contain a small number of “representative agents”, such as a household, a non-financial business and the government, but no banks. They were omitted because macroeconomists thought of them as a simple “veil” between savers and borrowers, rather than profit-seeking firms that make loans opportunistically and may themselves affect the economy.

This perspective has changed, to put it mildly. Hyun Song Shin of Princeton University has shown that banks’ internal risk models make them take more and more risk as asset prices rise, for instance. Yale’s John Geanakoplos has long argued that small changes in the willingness of creditors to lend against a given asset can have large effects on that asset’s price. Easy lending terms allow speculators with little cash to bid up prices far above their fundamental value. If lenders become more conservative, these marginal buyers are forced out of the market, causing prices to tumble.

Realistically representing the financial sector would help solve the other big problem with mainstream macro models: that they are inherently stable unless disturbed from the outside. This feature is helpful when studying how an economy in “equilibrium” responds to things like a spike in the price of petrol, but it limits economists’ understanding of why economies expand and contract in the absence of such external shocks. Highly leveraged financial firms with portfolios of risky assets are bound to upend an economy every so often. Having banks in models would generate shocks from within the system.

The world’s big central banks are interested in these new ideas, although staff economists are reluctant to abandon existing “industry-standard” models. If any central bank is likely to experiment, however, it is the European Central Bank, thanks to its “two-pillar approach” to assessing the risks of price stability. The ECB pays as much attention to “monetary analysis”, which includes things like bank lending and money creation, as to “economic analysis”, which is more concerned with things like inflation and joblessness.

Improving DSGE models is the obvious way to take the lessons of the crisis on board. But others exist too. “Agent-based modelling” tries to depict the transactions that might occur in an actual economy. These models are populated by millions of agents that gradually alter the economy as they interact with each other. The idea was developed in the 1990s when biologists wanted to study the behaviour of ant colonies and the flocking of birds. But modelling an entire economy did not become practical until recently because of the sheer number of calculations needed.

The evolutionary structure of agent-based models allows economists to study how bubbles and crises occur over time. For example, an increase in bank lending means more spending and therefore higher returns on existing investment, which in turn encourages further lending. But too much lending can prompt the central bank to raise rates if inflation starts to accelerate. Higher borrowing costs could lead to a wave of defaults and even to a crisis if too much debt was taken on during the boom.

The EURACE project, an initiative by a consortium of European research bodies, has produced a sophisticated agent-based model of the EU’s economy that scholars have used to model everything from labour-market liberalisation to the effects of quantitative easing. In Australia Steve Keen, an economist, and Russell Standish, a computational scientist, are developing a software package that would allow anyone to create and play with models of the economy that incorporate some of these new ideas. Called “Minsky”—after Hyman Minsky, an American economist celebrated for his work on boom-and-bust financial cycles—it places the banking system at the centre of the economy.

A long road lies ahead, however. “Nobody has got something so convincing that the mainstream has to put up its hands and surrender,” says Paul Ormerod, a British economist. No model yet produces the frequent small recessions, punctuated by rare depressions, seen in reality. But “ultimately,” Mr Shin says, “macro is an empirical subject.” It cannot forever remain “impervious to the facts”.


Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google+ photo

You are commenting using your Google+ account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )


Connecting to %s