Report from Lindau: Day 3

I am writing from St Gallen University in Switzerland, where the closing ceremony of the Lindau meetings is taking place. The ceremony includes a panel of economists who will discuss the origins of the financial crisis. Similarly ambitious topics were covered yesterday in the third day of the meetings.

Roger Myerson provided a model of moral hazard in the banking sector where bankers have career concerns and used it to explain financial bubbles. This way of integrating micro and macro considerations is much needed if better models of the economy are to be build. Daniel McFadden also tackled the important issue of government intervention in the health insurance markets when there exist frail consumers. Unfortunately, both talks were not well constructed, were technical and much of their message was lost.

Ed Phelps gave a more descriptive talk and denounced the rise of "corporatism", a way of conducting economic policy that goes back to Mussolini and that consists on a strong intervention of the state in favor of the interests of private enterprises. Phelps argued that corporatism was prevalent in Tunisia and Egypt, and led to corruption, nepotism and inefficiencies, but also in the US where corporatism has precluded the less well off from enjoying the benefits from the last episode of economic growth.

The lectures by Eric Maskin and George Akerloff were much better structured and clear. Maskin gave a talk on Condorcet and Borda voting rules that was almost identical to the one he gave in Edinburgh four years ago. Akerloff gave an introduction to the use of the concept of identity in Economics and its explanatory power. The talk, that was also a way of publicizing his recent book with Rachel Kranton, said nothing new to those have been reading his work with attention but it was of interest to those unfamiliar with his ideas. It is quite remarkable that when Akerloff first mentioned these concepts around fifteen years ago the profession received them with profound skepticism. Fortunately, thanks partially to the behavioral revolution, his work has received the appreciation it deserves.

But the big star of the day was, unsurprisingly, Joseph Stiglitz. It was amazing how Stiglitz managed to compress so many ideas in just 30 minutes. He started with his by saying that macroeconomics has failed as a science because it failed to predict the crisis and as an example mentioned the facts that the models used by central banks do not actually include a banking sector. But his two main ideas where that globalization has made the system less stable rather than in the other way: Financial integration helps contagion and exacerbate risks. The other idea was that the recent crisis, provoked by staggering inequality according to him, was a manifestation of a structural change . In the same way as the crash in 29 represented the transition from an economy based on agriculture to one based in manufacturing, the 08 crisis has marked the transition from a manufacturing based economy to a service based economy. Given this structural change, models and data from the previous "era" are of little use in the new one.

In the afternoon, I attended the parallel discussion session in which Stiglitz answered questions from a big crowd of young economists. He elaborated on some of these ideas and discussed how also with globalization the Pareto optimality of free trade gets severely undermined: With international prices of agricultural products, bad harvests mean that local farmers receive lower revenues for sure. He insisted in blaming, quite rightly, Alan Greenspan for the dire situation of the US economy who thanks to the Iraq war and the tax cuts transformed a superavit into a unmanageable debt.

Now is time to go on a boat trip at Lake Konstanz. So that's all from Lindau, folks!

Report from Lindau: Day 2

Disappointing. This is probably the word that best describes the second day of the Lindau Nobel Meetings, where panel and discussions revolved mostly around two issues, the reasons behind the financial crisis in 2008 and the foundations of economic behavior.

The morning did not start well. In a rather uninspiring lecture, William Sharpe did a very bad service to the profession when he showed a graph depicting the utility of financial traders in his model and said "I do not know whether traders have these utility functions, but does not this graph look really beautiful?". With this he gave more arguments to those who say that economists are completely detached from reality.

Sharpe was followed by John Nash who proved once again that he should not participate in scientific conferences. Sir John Mirrlees raised standards a bit with his talk on poverty and food markets. His most provokative idea was that rising food prices may actually help people in developing food-producing countries to leave poverty rather than actually impoverishing them even more.

After the break, Ed Prescott took the stage to shake the audience once more. He explicitly associated tax cuts and tax increases with booms and recessions respectively. He further argued that the financial crisis of 2008 did not lead to the subsequent economic crisis we are still in, the so-called Great Recession that, he said, after checking the newly revised economic data does not look like a big recession any more. Robert Mundell provided his own explanation to the crisis. For him it was big swing in exchange rates what precipitated the last crisis, as in many other cases in the past. He also argued in favor of a world currency, the eurodollar. This proposal was a big surprise, to say the least, coming from someone who received the Nobel prize for pointing out that single currency areas may not be a very good idea.

The set of lectures finished with Robert Aumann (in the photo), surely the most passionate and enthusiastic of all the laureates who spoke during the day. In his talk, Aumann discussed under which conditions strategic behavior can be analyzed as one-person decisions problems. Unfortunately, the lecture was not well pitched the audience got lost about half way.

Aumann played also an active role in the plenary session in the afternoon, a panel on "behavioral economics", in which he heatedly debated with Reinhard Selten. Aumann argued that the deviations from standard economic predictions uncovered in experiments are due to the unfamiliar nature of the decisions and that these deviations are much less frequent in decisions that are important or often repeated. He mentioned the concept of "rule-based rationality" by which people are not necessarily rational in their decisions but choose to use rules that usually lead them to take rational choices. Selten argued against the existence of such rules or, at least, against the idea that these rules are chosen or adjusted. He even suggested that utility functions not even exist and promised to elaborate more on his lecture in day 3. This comment acted as an ironic echo to Sharpe´s remark on utility functions in his morning lecture.

Unfortunately, apart from this debate, the panel on behavioral economics was rather confusing and basic. The discussions left out many aspects like reciprocity or social preferences. Let´s hope that tomorrow will be better.

Report from Lindau: Day 1

The opening ceremony of the Lindau Meetings started with an address by the German Federal President Mr Christian Wulff. His address covered many of the issues raised after the financial crisis in Europe and tried to be quite consensual. He mentioned the unfairness of taxpayers funding rescue packages whilst CEOs still enjoy milliionaire bonuses. He acknowledged that financial markets are very important drivers of economic policy these days and that politicians are often too eager and not toughtful enough when respondind to them. But he also insisted in the German official rethoric where irresponsible spending by the Southern European countries is deemed as the main culprit of the situation. The response, Mr Wulff said, is that spending cuts and austerity must be enforced if the crisis is to be overcome.

The panel on "sustainability" that followed started with Roger Myerson thanking macroeconomic theories for improving standards of living since 1929. It continued with the rather inane interventions of two young economists. Then McFadden put his farming cap on and used agricultural methapors to describe the world economy. The last turn was for Joseph Stiglitz's. His words were probably the highlight of the day. He started by contradicting both Mr Wulff and Myerson by saying that spending cuts are leading countries to disaster as Medieval doctors' use of leeches were drove weak patients to death. Then he continued arguing that precisely macroeconomic theories led us to the crisis in the first place. Finally, he talked about the euro, doomed for disaster from the outset according to him, but still worth saving.

After the break Peter Diamond reminded central bankers that there is no clear reason why an inflation target of 2% is better than 3% and that price control, although important, should not become an obsession. On the other hand, Chris Pissarides addressed the gap in work hours between the US and Europe and highlighted two reasons: First, that activities such us health care, cooking or cleaning that in the US are "marketized" in Europe are performed by families, mostly because taxes are higher. And second, and more worrisome for Europeans, because public employment in education and health have increased considerably in the US compared to Europe.

Finally, the panel discussion on democgraphic change generetaed a very interesting debate between Prescott and Peter Diamond, especially regarding taxation of savings. Predictably, Prescott (in the phote) argued for no taxation on savings and actually went further and advocated the abolition of income taxation, that should be replaced by consumption taxation. Diamond on the contrary argued that no taxation of capital was not a good idea, as suggested by the negligible effect on savings after they were partially declared tax-free by Mrs Thatcher.

What has become evident after this first day of sessions is that there is a heated and healthy debate within the discipline. Huge names in Economics hugely disagree on huge issues. So let's keep on discussing.

Report from Lindau: Day 0

I am right now at Lindau, Germany, where the 4^th Lindau Meeting on Economic Sciences will take place during this week. Since 2004, Nobel Laureates and selected young researchers from all over the world meet in this beautiful island in the middle of Lake Konstanz to discuss their ideas and interact. In this edition, the Lindau Foundation has gathered 18 laureates and more than 370 young economists from more than 60 countries (although from my first impressions I would say that more than Germans dominate over all other nationalities).

Given the scientific potential of the meeting and the interesting discussions and plenary sessions in the programme I thought it would be a good idea to act as an improvised reporter for the Edinburgh Economics Blog and write a daily report on what will be going on here in Lindau.

Today we will have Nobel Laureates McFadden, Myerson and Stiglitz talking about sustainability and growth whereas Peter Diamond, Chris Pissarides and Dale Mortensen will talk about the future of employment in Europe (grim, I guess) and demographic change. I will report on the highlights of these discussions tomorrow.

For the time being let me tell you about the first thing related to meetings that I encountered at my arrival to Lindau: the banners you can see in the photo above. They were hung in front of the Conference Centre by ATTAC, Real Democracy Now and other organizations whose German names I cannot translate. As you can see, they ask economists to drop “neoliberal” ideas and to introduce ethics in Economics. The “Heterodox” economic views endorsed by these banners deserve more than one post, so let me just mention that they made me think about two ideas related to the Lindau meetings. First, how wrong these views are. They portrait Economics as a monolithic discipline, populated by Machiavellian and perverse scientists who are leading the world to chaos. To the very least, that vision is wrong because participants in the Lindau meetings include Nobel Laureates with such disparate thoughts as Akerlof and Stiglitz on the one side, and Scholes and Prescott on the other. If there is something absent in Economics at this moment is consensus (and that is a good thing).

Second, these protests highlight how badly we as economists have managed public perceptions of Economics (or how little we have cared about them), and also the extent to which this is due to the fact that for too long the discipline has been rowing in the direction of interested parties (as Nick Stern pointed out already two years ago). I will never get tired of repeating that the rational model of behaviour that we economists handle is descriptive rather than prescriptive and that it does not rule out other motivations. But I am not naïf enough to ignore that Economics has often treated selfishness (which is not equal to self-interest) as an all-encompassing view of human beings. Still, if anything, one of the causes of the present crisis is that the relentless force of selfishness has been underestimated.

Nobel Laureates and young economists will see these banners every day at the start and end of the sessions. I hope they will not ignore them. These banners represent both a reminder of our failures and a challenge for the future.

World without the risk-free bench mark…

Last week’s S&P’s downgrade of US debt undoubtedly marked a new chapter in the history of the recent crisis. Double-dip recession is no longer a mere possibility, but a sad reality. Extensive use of fiscal and monetary policies, otherwise known as Quantitative Easing, was implemented by the Fed and ECB to battle against the meltdown of the financial system in 2008. But, by driving the interest rates to near to zero levels, the developed world locked itself in the liquidity trap, while soaring debt levels stripped the governments of the ability to use fiscal policy if the recession returned. The Debt crisis became a new malaise in the developed world, which caused a fall of investors’ confidence in the strength of political institutions and their ability to deliver quick and much needed anti-recession solutions. S&P used weakening of political leadership as their main reason for the US downgrade, an event which caused massive market sell offs last week.

So what effect might the US downgrade have on the economy, other than from the need to rewrite hundreds of thousands of economic text books to correct for the absence of the risk-free bench mark? Market uncertainty and increased volatility had already been reflected in recent panics which caused share sell offs all around the world. As for the average consumer, a cut in debt rating usually results in higher interest rates paid on mortgages, car loans etc, as they are linked in the short term. However, some suggest that a mistake in S&P calculations by almost $2 trillion(!), and their worries about the US political strength and not the country’s creditworthiness will make investors even more unsure who to believe. Thus the most immediate effect is the increase in the uncertainty premium needed to compensate investors for holding US Treasuries. We should really start getting worried if the other two major rating agencies (Moody’s and Fitch) follow the steps of S&P, which will only make the panic worse. But for now, what S&P did goes against vital economic assumption- they deprived investors of beloved ‘risk-free’ assets, leaving them hanging without a safety net.

Written by Daria Rusanova - 4th year MA (Hons) Economics and Economic History