While my 3S-RULE ([s]tudy, [s]ports, [s]leep) is in effect and I spend most of my day at the local library, I also try to catch up on some university-independent articles that have been piling up on my desk. Sadly, my original goal – to read one article per day – proved to be (much) too optimistic. I only manage(d) to read about 2-3 articles per week. I hope to improve the count to 4-5/week in the future, when I’m not so pressed on meeting deadlines. So here’s a short overview including a summary, a comment, and further links. TO SCIENCE AND KNOWLEDGE!
1. “The True Lessons of the Recession – The West Can’t Borrow and Spend Its Way to Recovery” by Raghuram Rajan (2012).
Short Summary: Rajan criticizes the “standard Keynesian line’s”  response to the crisis: deficit-spending will not solve the crisis! Saving later will not be enough! The article tries to lay out how our long-term economic perspectives should be and how growth could return to the Western democracies. He thinks the West has far too long ‘stimulated’ itself via deficit-spending and false promises to postpone ‘hard decisions’, which in time turned to inflated GDP-numbers. His solution for America/the West? Investing in education/retraining, re-regulate the financial sector, encourage entrepreneurship and investment.
Comment: Hardly anything he mentions is controversial – in fact I know of nobody who wouldn’t support his policy suggestions. Still, education is the first to fall prey to spending cuts, re-regulating the financial sector to do good seems to be a very complex issue and there is no clear line in how to “encourage entrepreneurship and investment”. Despite the majority of people supporting these policy goals there are not implemented. Now why is that? I think the essay doesn’t tackle ANY important question. It reads like any ‘sensible’ political position, which already shows how superficial its content is.
2. “The World Our Grandchildren Will Inherit: The Rights Revolution And Beyond” by Daron Acemoglu (2012).
Short Summary: Daron Acemoglu starts by formulating 10 trends “that have defined our economic, social, and political lives over the last 100 years” . He wants to use these to extrapolate the future development of humanity. The most important trend for him has been the rights revolution at the start of the 20th century. All other trends have been strongly influenced by – what Robert A. Dahl might call political equality – the development of nondiscriminatory rights. The negative predictions of anti-democrats have (so far) not come true. Democracies have perhaps proved themselves surprisingly stable. The nine other trends are listed under the titles: (2) the sweep of technology, (3) unrelenting growth, (4) uneven growth, (5) the transformation of work and wages, (6) the health revolution, (7) technology without borders, (8) century of war, century of peace, (9) counter-enlightenment in politics, and (10) the population explosion, resources and the environment.
Will these trends continue in the future? At the heart of his interpretation “is the idea that technological change is at the root of economic growth – but that political institutions shape the nature, pace, and spread of technological change” . Prof. Acemoglu doesn’t support the modernization theory and instead opts for an institutional approach. He bases his approach on the development on inclusive institutions (economic as well as political), that “provide incentives and opportunities for innovation and economic activity for a broad cross-section of society” [ibid.]. On the opposite end of the spectrum lie extractive institutions that “are characterized by insecure property rights for the majority, coercion, and lack of freedom directed at extracting resources from the majority for the benefit of a narrow elite” (ibid.). Based on the future developments of these two institutional ‘settings’
the our future will be bleak or bright.
Comment: To illustrate his points Acemoglu makes smart use of graphs and data without overburdening the reader. He’s very aware of the fact that it’s not particularly scientific to just draw the trend lines further into the future. You need a model. While he does provide a short glimpse of what he has in mind (inclusive vs. extractive institutions) he doesn’t quite go into detail in this paper. Institutional explanations have recently – partly due to the release of his book (see Further Reading) – gained some importance (maybe again?). They lie at the heart of social interaction, indeed make them possible, and shape them substantially. The usage, however, might be too broad for my taste. Further, I’d say that it’s already very hard to show macro-effects when you have very good data, but for many countries you don’t have any reliable data at all. But I have not read any of his papers (and he writes a lot), so maybe he found a way around this problem. In any case one should be wary of the causality of macro-effects, when there’s no usable micro-foundation.
Further Reading: Interview with Daron Acemoglu about his most recent book: “Why Nations Fail”.
3. “Making Macroprudential Policy Operational” by Houben, van der Molen & Wierts (2012).
Short Summary: This is a paper on the regulation of financial/systemic risk caused by financial crisis to achieve financial stability. The authors concentrate on six main questions:
(1) What are the objectives of macroprudential policy? – A financial system that allows to effectively allocate resources, manages risks and absorbs shocks [see Fig. 1.1: 16].
(2) How can this be achieved? – Depending on the time horizon/objective (leverage and credit, liquidity and funding and the resilience of the market structure) different instruments are available: “countercyclical capital buffers, time-varying leverage ratios, changes in sectoral risk weights, limits to loan-to-value (LTV) and loan-to-income (LTI) ratios, a capital surcharge for systemically important financial institutions, recovery and resolution plans” . They all have to be assessed for their effectiveness (cross-border leakages, spill-over effects, and efficiency (trade-off between resilience and growth). Furthermore it is necessary to address maturity mismatches and funding risks, limit the shadow banking sector and to introduce minimum margins and haircuts to counter procyclicality. It is, however, difficult to tackle these problems at the moment.
(3, 4, 5, 6) How should these instruments be applied? What indicators should be used and how the institutions designed? Who should be accountable?
Here the authors argue that one should be very transparent what conditions warrant which instrument to be used and in what way. This should counter inaction and lets market participants form ‘rational expectations’ resulting in credible commitment and therefore increase macroprudential policy effectiveness (see Fig. 1.3 for examples: 20). This effectiveness can be further enhanced when anchored in a well-defined mandate, stating its responsibilities, powers and accountability. If possible the institution should be independent from the government and the authors prefer a ‘Twin Peak’ model: both central banking and prudential supervision in a single institution (21). They summarize all their points in Figure 1.4 on page 23.
Comment: The financial crisis has shown that the central bank’s conventional approach might lack some analytical tools and ‘firepower’. The fault partly lies within the ill-designed framework the ECB abides to – but also in the lack of showing spontaneous flexibility.
The authors don’t talk about the normative aspect of having yet another influential independent institution. It would also be hard to introduce it on European level without parliaments frowning, and rightly so. The paper does nonetheless show how future regulation might look like, what indicators to use, how to apply them and under what framework. It is up to the politicians to find a common ground – which will be hard enough – and a way to introduce them. The central banks are one of the most trusted institutions, why shouldn’t a macroprudential supervision unit attain the same legitimacy through ‘good work’ and ‘solid results’? It might in fact be the only way to get any legitimacy as a international institution.
Further Reading: Macroprudential Policy #2.pdf by Wierts.