Could the Shadow Open Market Committee have outperfomed the Fed?

Decisions of the Open Market Committee of the US Federal Reserve bank have long been scrutinized, both by market for obvious reasons and by academics. Some of the latter have even formed a Shadow Open Market Committee in reaction to the decision by President Nixon to impose price and wage controls in 1971, with the support of the Fed president. This committee has evaluated Fed policy and criticize Fed actions when due. But would it have done a better job?

William Poole, Robert Rasche and David Wheelock, who are all Fed employees, study how the policies advocated by the SOMC during the period of high inflation in the 1970s would have performed. Those policies where at odds with what the Fed was doing and even with what many academics were proposing. The policy rule was rather simple: reduce the target money growth rate by one percent every year, down to 4%. To evaluate this rule, you need a model, so they take the New-Keynesian model of Clarida, Gali, and Gertler (1999) off the shelf and run various experiments: one with the SOMC rule, one with the historic data (the Fed's action: a one time drop in money growth). While both policies eventually achieve their goal of reducing inflation, the SOMC one does so with less cost in output.

Now things are not that easy. To be fair to the Fed, it had at the time had rather little credibility, and it is not clear it could have gained any more credibility by adopting the SOMC's policy, as it requires some long-term commitment. Also, the Fed had to fight against attempts by Congress to take over monetary policy, and thus its policy choices were limited. And had the SOMC known that it policy would have been actually implemented, I am not convinced it would have taken the same choice. Indeed, it was rather risky, as it was at odds with what most other people were advocating. And markets may have reacted with incredulity to such an odd move.

Who gains from public higher education?

The answer to this question seems rather obvious: those who get such education. Who loses? That is less obvious, and education has positive externalities on others.

Ana Balcão Reis says things are not that simple. First, we have to keep in mind that only few people are credit constrained when it comes to college tuition. Indeed, most of those who are do not make it that far in the first place. Second, those who benefit from public higher education are also those who pay the most taxes, thus the welfare benefit for them is ambiguous. To sort this out, the paper builds a model with different levels of education and agents differing by ability, human capital and the capacity of their parents to pay (which depends on their own human capital).

First think about the marginal agents, those who are the last one to go to public university. They would prefer not to have this option, that is, have only private universities and not pay the associated taxes. But because they have to pay them and college is now cheaper, they choose to get educated with little benefit. Those who do not go to college do not to pay taxes and would thus vote against public higher education. And the richest pay more in taxes than what they would pay in tuition. So all those left in favor of public universities are the not too rich who would go to college anyway. The question is whether they are a majority.

There is one important aspect missing in this analysis, though. Higher education has a positive externality on others: a more educated workforce raises everyone's productivity, and it makes it also easier to accumulate more human capital. This is only partially prices into wages, thus higher education needs some subsidies to reach efficient outcomes. Thus, a microeconomics analysis as performed here misses potentially important macroeconomic effects.

Information with negative value

We all have regretted some decisions we have made. But different individuals respond differently to this. Some would say "oh well, I would have done differently had I known, but this is best I could do at the time." Others are more like "OMG this is horrible, you should not have told me." An individual of the second kind finds negative value in any ex-post information and thus wants to live in a world with a different information structure from the first.

Emmanuelle Gabillon formalizes this idea and studies structure where information is available before ("flexible") or only after ("non-flexible") decisions are taken. The paper also derives the characteristics a regret utility function should have (in particular, it cannot have "rejoicing"). Information can only have negative value in the non-flexible case if preferences exhibit concavity with respect to the ex post best outcome. Interestingly, information can also have negative value in the flexible case for a regretful person. Indeed, while information is useful for all people in revising the expected utility of strategies, for a regretful person it also is useful to revise expected regret. One can thus become even more conservative and this can lead to outcomes that are inferior in expectation to those where one would not have had the information.

As expected, lottery players are not rational

There is no mystery that under normal circumstances, homo oeconomicus does not play the lottery. Exceptions arise when there is enjoyment in playing the lottery (is this why slot machines a so popular in the US?) or when there are particular reasons. But casual observation indicates people play the lottery, and a lot. Maybe these circumstances mentioned above are met, maybe they are not rational economic agents.

Claus Bjørn Jørgensen, Sigrid Suetens and Jean-Robert Tyran would say lottery players, at least some of them, have a peculiar sense of probabilities. While many change their numbers, among those who change, many avoid numbers that have recently been drawn, as if the lottery were a drawing without replacement. But if a number is on a streak (drawn a few times in a row), then they choose it. If margins were not so high in lotteries, one could possibly make money by arbitraging against these people trying to predict the lottery numbers. But you can actually getting a positive return from lotteries by only buying tickets when large jackpots are at stake. The International Lottery Fund based in Australia is there to prove it.

Does hosting Olympic Games matter after all?

Is seems to be common knowledge that attracting big sports events is good for business and especially tourism. I have never found this argument particularly compelling, after all it is mostly local residents who attend such events. And previous research I reported on gives me right: in the case of the Atlanta Olympics, the impact was very short-lived and limited to the tourism industry. But maybe there is more and better evidence.

Markus Brückner and Evi Pappa take a different approach form the traditional impact study: they look at macroeconomic aggregates and focus on the anticipatory effect during the bidding process for the Olympic Games. The fact that a country is bidding gives people an indication that aggregate demand may increase in the future, especially if the country is selected into the last set of candidates. This anticipation can increase economic activity right now. Brückner and Pappa study a panel of 184 countries over 57 years. They find higher GDP growth during the five years before hosting, peaking at four years when the next host is announced. As expected, the impact fades quickly for unsuccessful bidders. And results are robust for World Exhibitions, but strangely reversed for Football World Cups. In all that, I wonder whether bidding for such large events is in fact exogenous. Indeed, you only want to bid if you have a healthy economy, especially if the event is large like the Olympic Games.

Cross-border banking and financial stability

Should banks be allowed to do business across borders? The answer is not obvious. For one, it is beneficial that they have the opportunity to better diversify their risks, but they can do this without having to open branches in other states or countries. The counterpart is that doing business elsewhere increases opportunities for adverse shocks. Finally, regulatory competition in an international banking market leads to a large systemic risk.

Dirk Schoenmark and Wolf Wagner try to sort this out in the case of Europe and come to the conclusion that it depends. They argue that Germany and the UK are well diversified and thus can sustain cross-border banking, even though there appears to be overexposure to the US, as exemplified by the large negative consequences in Europe of the recent crisis in the US. For the countries on the fringes of Europe, though, there seems to be very poor diversification. Indeed, these economies seem to be very dependent on a few large foreign banks, and consequences could be dire if they run into difficulties or decide to pull out.

This analysis is entirely based on asset shares and thus diversification. This neglects a major advantage of foreign banks: they bring lending capital that would otherwise not be available. The case for cross-border banking is thus understated in this paper.

Should there be international trade in pollution rights?

A basic principle in Economics is that of comparative advantage: a country will produce the goods that it is relatively better at producing, even it is bad at it. The traditional story usually includes relative endowments in capital and labor, and the capital intensity of goods matters. Now add environmental externalities. Comparative advantage would say that polluting production should take place were pollution is the "cheapest," that is. where it would have fewer consequences. This is the principle being the introduction of an international market for pollution rights. Such markets are already active within countries, with the idea that firms that can best control pollution will produce the polluting goods, as they need fewer pollution rights. Would this basic principle also hold across countries?

Jota Ishikawa, the late Morihiro Yomogida and Kazuharu Kiyono claim that it is not necessarily beneficial to have an international market. Indeed they point out that rich countries could import pollution rights from the poor countries, thereby further deteriorating the environment in the developed economies. So instead of relocating production, pollution is imported. It all depends on comparative advantage.