Q1: What do we mean by the following statement, " the key source of uncertainty is the fact that workers cannot always discern whether they are experiencing a relative price change or a general price change"?
Both Friedman and Lucas agree that, in the world of completely flexible prices, the only reason that any individual firm will produce more or less than the 'normal' or 'natural' level is if it thinks there is really a greater or lesser demand for its goods, relative to other goods in the economy. As the analogy I used in the lecture went, the firm's entrepreneur may expand output if he believes he has become the new Steve Job, whose product is relatively more popular than others. In terms of prices, this means there is a relative price change: the price of my product may now increase, while prices of other goods are unchanged, because there's more demand for my good only.
However the price of my good can rise for 2 reasons. (1) There can be a relative price change, in the sense that my good really becomes more popular and there's more demand for it. If I knew that was really the case, I would quite rightly expand my output (the same way Steve Job expands his company in response to greater demand). Or (2), there's simply an increase in aggregate demand stemming from expansionary monetary policy for example. Here, everyone's prices will tend to increase, and there's a change in general prices rather than relative prices. If I knew that this was the case, my reaction would be to produce the same amount I did before, but simply readjust my price in line with the new general price level.
In practice, firms cannot always differentiate between the two. So even if there is purely an aggregate demand shock, which affects general prices only, some firms may mistakenly (given their imperfect information about both the relative price and general price shocks) think that there have been some relative price changes and hence they will respond by changing the output produced. When all firms respond to aggregate demand in the same way, the result is a huge macro level change in output, GDP if you like. This is the mechanism, according to Friedman and Lucas, how changes in aggregate demand can bring about changes in total output, i.e. 'money matters'.
3 Letters from Economists
Fiscal sustainability is no doubt the next looming concern, not least for those advanced economies that have stretched their budgets in dealing with the 2007 financial crisis.
On the Valentines day, Besley, Goodhart, Pissarides, Vickers, Muellbauer, Rogoff , Sargent and others, cosigned a letter stating:
Then on Feb 18th, followed 2 more letters.
Layard, Allsopp, Blinder, Hendry, Solow and Vines argued:
The last letter signed by Skidelsky, Marcus Miller, Blanchflower, De Grauwe, DeLong, Freeman, Hammond, Kirman, Manning, Richard Smith, Stiglitz and others also disagreed with Tim Besley and co.:
Lord Keynes certainly won't be disappointed by sons of the land.
On the Valentines day, Besley, Goodhart, Pissarides, Vickers, Muellbauer, Rogoff , Sargent and others, cosigned a letter stating:
In order to minimise this risk and support a sustainable recovery, the next [British] government should set out a detailed plan to reduce the structural budget deficit more quickly than set out in the 2009 pre-budget report.
The exact timing of measures should be sensitive to developments in the economy, particularly the fragility of the recovery. However, in order to be credible, the government’s goal should be to eliminate the structural current budget deficit over the course of a parliament, and there is a compelling case, all else being equal, for the first measures beginning to take effect in the 2010-11 fiscal year.
Then on Feb 18th, followed 2 more letters.
Layard, Allsopp, Blinder, Hendry, Solow and Vines argued:
We disagree.
First, while unemployment is still high, it would be dangerous to reduce the government’s contribution to aggregate demand beyond the cuts already planned for 2010-11 (which amount to 1 per cent of gross domestic product). History is littered with examples of premature withdrawal of the government stimulus, from the US in 1937 to Japan in 1997. With people’s livelihoods at stake, a responsible government should avoid reckless actions.
Second, Britain’s level of government debt is not out of control. The net debt relative to GDP is lower than the Group of Seven average, and on present government plans it will peak at 78 per cent of annual GDP in 2014-15, and then fall. Moreover British debt has a longer maturity than most other countries, and current interest rates on government debt at 4 per cent are also low by recent standards.
Third, since the crisis began, private households and businesses have had to increase their saving in order to reduce their debts. It is this saving that finances the government deficit. If the government did not take up the slack, there would be a deeper recession.
Of course there needs to be a clear plan for reducing the government deficit. But the existing one for next year appears sensible. What is needed then is much more detail for the following years, and a radical plan for the medium term. That is what the debate should be about.
The last letter signed by Skidelsky, Marcus Miller, Blanchflower, De Grauwe, DeLong, Freeman, Hammond, Kirman, Manning, Richard Smith, Stiglitz and others also disagreed with Tim Besley and co.:
We believe they are wrong.
What they fail to point out is that the current deficit reflects the deepest and longest global recession since the war, with extraordinary public sector fiscal and financial support needed to prevent the UK economy falling off a cliff.
There is no disagreement that fiscal consolidation will be necessary to put UK public finances back on a sustainable basis. But the timing of the measures should depend on the strength of the recovery. The Treasury has committed itself to more than halving the budget deficit by 2013-14, with most of the consolidation taking place when recovery is firmly established. In urging a faster pace of deficit reduction to reassure the financial markets, the signatories of the Sunday Times letter implicitly accept as binding the views of the same financial markets whose mistakes precipitated the crisis in the first place!
They seek to frighten us with the present level of the deficit but mention neither the automatic reduction that will be achieved as and when growth is resumed nor the effects of growth on investor confidence. How do the letter’s signatories imagine foreign creditors will react if implementing fierce spending cuts tips the economy back into recession? To ask – as they do – for independent appraisal of fiscal policy forecasts is sensible. But for the good of the British people – and for fiscal sustainability – the first priority must be to restore robust economic growth. The wealth of the nation lies in what its citizens can produce.
Lord Keynes certainly won't be disappointed by sons of the land.
EE432 2010: Topic 3 Materials and Problem set 2
The reading pack for topic 3 is now available for download
The following problem set is due on Friday 19th next week.
The following problem set is due on Friday 19th next week.
Friedman's Interviews
To follow up on our discussion of the natural rate hypothesis, here are some Milton Friedman's thoughts on more general topics. Admire the brilliance but keep an open mind and retain your critical thinking!
Where does a pencil come from?
The Great Depression and monetary policy
Policies must be judged by their results, not their intentions (reposted; this is a 30-min full interview)
On greed...
Where does a pencil come from?
The Great Depression and monetary policy
What about market failures?
Policies must be judged by their results, not their intentions (reposted; this is a 30-min full interview)
Discrimination? Market solution vs affirmative actions.
Why drugs should be legalized
EE432 2010: Topic 2 Materials and Problem Set 1
Here are the materials for topic 2, New Classical Macroeconomics, including the lecture notes.
And here is problem set 1, to be handed in on Wednesday 10th February, i.e. next week.
As you know, we are some way behind our schedule, and there are a lot to catch up. It's important to concentrate in the weeks ahead, as the mid-term is coming up in a month time. Make-up classes are being arranged, and I'll let you know once that's confirmed.
Myths vs Reality
FT has just posted this piece, 'Ten myths of Indian economy' by Shankar Acharya, a very prominent economist in India. Quite a lot of these apply equally well to Thailand. Reasonable thoughts on economics is surprisingly something of a rarity in policy circle...we should have more people like him over here.
Economic policy in India, and perhaps in other countries, is constrained by powerful prevailing myths and prejudices. Sometimes these myths simply reflect lazy thinking or an apparent immunity to facts. Sometimes they are shored up by strong vested interests. Sometimes all three. Whatever the reason it is hard to dispute the potency of myths in economic policy making. Here are my 10 favourites, some old, some new.
1. Higher minimum support prices for food grains are good for farmers. Not so. Yes, they are good for a powerful minority of farmers who have sizable marketable surpluses and ready access to government procurement programmes. But the majority of Indian farmers (especially poorer marginal farmers) are hurt by higher food prices for the simple reason that they are net buyers of food grains. And when you add in tens of millions of landless labour, it is quite clear that inexorably higher MSPs for wheat and rice are often quite damaging for rural households.2. The move to a Goods and Services Tax will reduce the burden of taxation. I hope not! Or the already enormous fiscal deficit will soar higher. The more thoughtful government pronouncements do speak of a reform which is revenue-neutral or even revenue-enhancing. But there are many who tout the illusory prospect of a lower tax burden. The underlying logic of this reform is not tax relief but rather relief from distorted economic incentives and avoidable hassles and uncertainties, which are embedded in the current system of multiple indirect taxes.
3. There is no role for monetary policy when inflation is driven by supply shortfalls. Not quite. The truth is that the extent and duration of an inflationary bout triggered by a supply shock (such as a drought) does depend on the degree of accommodation offered by monetary policy. If liquidity is excessive, the inflationary consequences will be greater; if liquidity is tighter, price increases will be less. Of course, the act of tightening monetary policy can reduce output expansion. Hence the short term trade-off between inflation and growth is a live issue even when the initial shock is from the supply side. And then there is the problem of expectations: if monetary policy stands pat in the face of supply-induced inflation, then inflationary expectations can fuel the fire.
4. Our labour laws protect labour. Quite the opposite. Present laws over-protect a tiny minority (about 5 per cent of India’s 450m plus labour force, not counting government employees) at the expense of the vast majority of workers. By making it extremely difficult to retrench workers in the organised sector our existing laws massively discourage the employment of new workers in organized enterprises. In effect, these laws are very anti-employment and lead to huge under utilisation and “casualisation”of our most abundant resource, low-skill labour.
5. The exchange rate only matters to exporters. This is a common misperception, even among trained economists. Actually, the exchange rate is the single most important price in the economy, which powerfully influences the relative profitability of all tradable goods and services versus non-tradables (like haircuts in Delhi or restaurant meals in Mumbai). Thus, an appreciation of the rupee (versus foreign currencies) not only makes exports less profitable but also hurts an even greater range of import substitutes, that is goods and services produced for our home market in competition with imports from abroad.
6. Reducing fiscal deficits hurts growth. In the present “fiscally stimulated” environment there is much anxiety that a reduction in the current record high fiscal deficits (over 10 per cent of gross domestic product) will hurt growth. The massive deficits of 2008/9 and 2009/10 were perhaps justifiable in the face of contractionary effects of the global crisis. But these deficits are neither sustainable nor desirable. Actually, the Indian economy has grown fastest during periods when deficits were being reduced (1992-1997 and 2003-2008) and slower when deficits were expanding (1997-2002). This is because less government borrowing usually facilitates more productive private investment.
7. Subsidies on food, fuel and electricity help mainly the poor. Not so. The food subsidy mainly helps better off farmers and consumers in only four or five states where the public distribution system has effective coverage. The great majority of India’s poor do not have effective access to subsidized food grains. Many studies have shown that the huge subsidies on petrol, diesel, LPG cylinders and kerosene mainly accrue to better-off urban households (all those fuel-guzzling cars and SUVs). The large state government subsidies on electricity for agriculture have helped to thoroughly undermine the development of a viable electricity distribution network and kept our villages in darkness. In contrast, note how the rapid spread of mobile telephony did not need subsidies.
8. Foreign capital inflows are always good for our economy. Twenty years ago most Indians believed the opposite, that all private foreign capital inflows were bad and somehow designed to impoverish us. In the last two decades the conventional “wisdom” has swung to the opposite extreme. In fact, as both the Asian crisis of 1997-8 and the Global Financial Crisis of 2008-9 has amply demonstrated, foreign capital inflows into a developing country can be a mixed blessing. Specifically, for India, the capital inflow surge of 2005-8 posed serious problems of an overly appreciated exchange rate, excess domestic liquidity and an asset price boom. The more thoughtful of our policy-makers, including then Reserve Bank governor Reddy, grasped the need for capital account management in such situations.
9. Private provision of infrastructure can effectively substitute for government. Private public partnerships are the ruling mantra of the day. Since government has failed badly in providing adequate power, roads, ports, water, sanitation and so forth, we must turn to PPPs for our deliverance. Or so runs the new myth. Of course, there is a big and useful part that the private sector can play in building up our infrastructure. But the experience from all over the world suggests that the government must continue to play the major role in this area. In particular, PPPs cannot substitute for effective governance in infrastructure provision. Indeed, there is a growing body of experience which suggests that the governance requirements of PPPs are pretty high, if we are not to fall prey to the rip-offs of crony capitalism.
10. The trader (or middle man) is at the root of many of our economic problems. This is one of our really hoary and hairy myths. Whenever the rate of inflation rises, governments blame rapacious traders and deploy regulations to control their stocking and other activities. The truth is traders are essential to the efficient functioning of an economy. Commerce is the lifeblood of economic activity. Of course, individual traders exploit whatever monopoly power circumstances grant them to maximize their profits. But the problem does not lie with traders. It rests with the circumstances and policies which nurture national or local monopolies and oligopolies. The best antidote to monopolistic exploitation is competition. And that is best nurtured through better connectivity (transport and communication) and reduction of regulations and levies which fragment markets and raise barriers to competition, whether from abroad or at home.
EE432 2010: Course Description and Topic 1 Materials
Welcome to EE432 2010! I hope you all will have a good and enjoyable semester.
I have uploaded the following for your downloading pleasure.
The key reading for topic 1 will be Blanchard and Fischer's chapter on money (find precise pages in the course description). All readings included in the pack are optional.
In terms of the lecture note, we will only cover materials up to the toy version of Kiyotaki-Wright model (i.e. up to page 6). The latter part will not be covered and will not be assessed in exams, but I include them in case you wish to see the formal model in full.
Don't forget the Wednesday class is cancelled. A makeup class will take place as early as possible once the registration for the course is finalized.
I have uploaded the following for your downloading pleasure.
The key reading for topic 1 will be Blanchard and Fischer's chapter on money (find precise pages in the course description). All readings included in the pack are optional.
In terms of the lecture note, we will only cover materials up to the toy version of Kiyotaki-Wright model (i.e. up to page 6). The latter part will not be covered and will not be assessed in exams, but I include them in case you wish to see the formal model in full.
Don't forget the Wednesday class is cancelled. A makeup class will take place as early as possible once the registration for the course is finalized.
"The Way of the General"
by Zhuge Liang
Types of Generals
There are nine types of generals.
Those who guide with virtue, who treat all equally with courtesy, who know when the troops are cold and hungry, and who notice when they are weary and pained, are called humanistic generals.
Those who do not try to avoid any task, who are not influenced by profit, who would die with honor before living in disgrace, are called dutiful generals.
Those who are not arrogant because of their high status, who do not make much of their victories, who are wise but can humble themselves, who are strong but can be tolerant, are called courteous generals.
Those whose extraordinary shifts are unfathomable, whose movements and responses are multifaceted, who turn disaster into fortune and seize victory from the jaws of danger, are called clever generals.
Those who give rich rewards for going ahead and have strict penalties for retreating, whose rewards are given right away and whose penalties are the same for all ranks, even the highest, are called trustworthy generals.
Those who go on foot or on a warhorse, with the mettle to take on a hundred men, who are skilled in the use of close-range weapons, swords, and spears are called infantry generals.
Those who face the dizzying heights and cross the dangerous defiles, who can shoot at a gallop as if in flight, who are in the vanguard when advancing and in the rear guard when withdrawing, are called cavalry generals.
Those who mettle makes the armies tremble and whose determination makes light of powerful enemies, who are hesitant to engage in petty fights while courageous in the midst of major battles, are called fierce generals.
Those who consider themselves lacking when they see the wise, who go along with good advice like following a current, who are magnanimous yet able to be firm, who are uncomplicated yet have many strategies, are called great generals.
Capacities of Commanders
The capacities of commanders are not the same; some are greater, some are lesser.
One who spies out treachery and disaster, who wins the allegiance of others, is the leader of ten men.
One who rises early in the morning and retires late at night, and whose words are discreet yet perceptive, is the leader of a hundred men.
One who is direct yet circumspect, who is brave and can fight, is the leader of a thousand men.
One of martial bearing and fierceness of heart, who knows the hardships of others and spares people from hunger and cold, is the leader of ten thousand men.
One who associates with the wise and promotes the able, who is careful of how he spends each day, who is sincere, trustworthy, and magnanimous, and who is guarded in times of order as well as times of disturbance, is the leader of a hundred thousand men.
One whose humanitarian care extends to all under his command, whose trustworthiness and justice win the allegiance of neighboring nations, who understands the signs of the sky above, the patterns of the earth below, and the affairs of humanity in between, and who regards all people as his family, is a world-class leader, one who cannot be opposed.
Types of Generals
There are nine types of generals.
Those who guide with virtue, who treat all equally with courtesy, who know when the troops are cold and hungry, and who notice when they are weary and pained, are called humanistic generals.
Those who do not try to avoid any task, who are not influenced by profit, who would die with honor before living in disgrace, are called dutiful generals.
Those who are not arrogant because of their high status, who do not make much of their victories, who are wise but can humble themselves, who are strong but can be tolerant, are called courteous generals.
Those whose extraordinary shifts are unfathomable, whose movements and responses are multifaceted, who turn disaster into fortune and seize victory from the jaws of danger, are called clever generals.
Those who give rich rewards for going ahead and have strict penalties for retreating, whose rewards are given right away and whose penalties are the same for all ranks, even the highest, are called trustworthy generals.
Those who go on foot or on a warhorse, with the mettle to take on a hundred men, who are skilled in the use of close-range weapons, swords, and spears are called infantry generals.
Those who face the dizzying heights and cross the dangerous defiles, who can shoot at a gallop as if in flight, who are in the vanguard when advancing and in the rear guard when withdrawing, are called cavalry generals.
Those who mettle makes the armies tremble and whose determination makes light of powerful enemies, who are hesitant to engage in petty fights while courageous in the midst of major battles, are called fierce generals.
Those who consider themselves lacking when they see the wise, who go along with good advice like following a current, who are magnanimous yet able to be firm, who are uncomplicated yet have many strategies, are called great generals.
Capacities of Commanders
The capacities of commanders are not the same; some are greater, some are lesser.
One who spies out treachery and disaster, who wins the allegiance of others, is the leader of ten men.
One who rises early in the morning and retires late at night, and whose words are discreet yet perceptive, is the leader of a hundred men.
One who is direct yet circumspect, who is brave and can fight, is the leader of a thousand men.
One of martial bearing and fierceness of heart, who knows the hardships of others and spares people from hunger and cold, is the leader of ten thousand men.
One who associates with the wise and promotes the able, who is careful of how he spends each day, who is sincere, trustworthy, and magnanimous, and who is guarded in times of order as well as times of disturbance, is the leader of a hundred thousand men.
One whose humanitarian care extends to all under his command, whose trustworthiness and justice win the allegiance of neighboring nations, who understands the signs of the sky above, the patterns of the earth below, and the affairs of humanity in between, and who regards all people as his family, is a world-class leader, one who cannot be opposed.
In Memory of Eva Cassidy
This month marked the 13th year since Eva Cassidy passed away.
Here are the rare video recordings of Eva Cassidy live at the Blues Alley in 1996.
The Blues Alley, present day.
The interior still looks pretty much the same.
Eva Marie Cassidy (February 2, 1963 – November 2, 1996) was an American vocalist known for her interpretations of jazz, blues, folk, gospel, country and pop classics. In 1992 she released her first album, The Other Side, a set of duets with go-go musician Chuck Brown, followed by a live solo album, Live at Blues Alley in 1996. Although she had been honored by the Washington Area Music Association, she was virtually unknown outside her native Washington, DC when she died of melanoma in 1996.
Four years later, Cassidy's music was brought to the attention of British audiences when her version of "Over the Rainbow" was played by Terry Wogan on BBC Radio 2. Following the overwhelming response, a camcorder recording of "Over the Rainbow", taken at the Blues Alley, was shown on BBC Two's Top of the Pops 2. Shortly afterwards, the compilation album Songbird climbed to the top of the UK Albums Charts, almost three years after its initial release. The chart success in the United Kingdom led to increased recognition worldwide; as of 2008 her posthumously released recordings, including three UK #1s, have sold around eight million copies. Her music has also charted top 10 positions in Australia, Germany, Sweden, Norway and Switzerland.
from wikipedia
Here are the rare video recordings of Eva Cassidy live at the Blues Alley in 1996.
What a Wonderful World
Somewhere Over the Rainbow
The Blues Alley, present day.
The interior still looks pretty much the same.
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