American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Journal Article Front Matter i vi http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.i 10.1257/jep.24.4.i American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Symposia Why Does the Economy Fall to Pieces after a Financial Crisis? Robert E.HallStanford U 3 20 The worst financial crisis in the history of the United States and many other countries started in 1929. The Great Depression followed. The second-worst struck in the fall of 2008 and the Great Recession followed. Commentators have dwelt endlessly on the causes of these and other deep financial collapses. This article pursues modern answers to a different question: why does output and employment collapse after a financial crisis and remain at low levels for several or many years after the crisis. It focuses on events in the United States since 2008. Existing macroeconomic models account successfully for the immediate effects of a financial crisis on output and employment. I will lay out a simple macro model that captures the most important features of modern models and show that realistic increases in financial frictions that occurred in the crisis of late 2008 will generate declines in real GDP and employment of the magnitude that occurred. But this model cannot explain why GDP and employment failed to recover once the financial crisis subsided—the model implies a recovery as soon as financial frictions return to normal. At the end of the article, I will mention some ideas that are in play to explain the persistent adverse effects of temporary crises, but have yet to be incorporated into the mainstream model. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.3 10.1257/jep.24.4.3 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Symposia Financial Intermediation and Macroeconomic Analysis MichaelWoodfordColumbia U 21 44 Understanding phenomena such as the recent financial crisis, and possible policy responses, requires the use of a macroeconomic framework in which financial intermediation matters for the allocation of resources. Neither standard macroeconomic models that abstract from financial intermediation nor traditional models of the "bank lending channel" are adequate as a basis for understanding the recent crisis. Instead we need models in which intermediation plays a crucial role, but in which intermediation is modeled in a way that better conforms to current institutional realities. In particular, we need models that recognize that a market-based financial system—one in which intermediaries fund themselves by selling securities in competitive markets, rather than collecting deposits subject to reserve requirements—is not the same as a frictionless system. I sketch the basic elements of an approach that allows financial intermediation and credit frictions to be integrated into macroeconomic analysis in a straightforward way. I show how the model can be used to analyze the macroeconomic consequences of the recent financial crisis and conclude with a discussion of some implications of the model for the conduct of monetary policy. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.21 10.1257/jep.24.4.21 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Symposia The Economic Crisis from a Neoclassical Perspective Lee E.OhanianUCLA and Center for the Advanced Study in Economic Efficiency, AZ State U 45 66 This paper assesses the 2007-2009 recession using neoclassical business cycle theory. I find that the 2007-2009 U.S. recession differs substantially from other postwar U.S. recessions, and also from the 2008 recession in other countries, in that lower labor input accounts for virtually all of the decline in income and output in the United States, while lower productivity accounts for much of other U.S. recessions and the 2007-2009 recession in other countries. I also find that existing classes of models, including financial market imperfections models, do not explain the U.S. recession. This is because the 2007-2009 recession is almost exclusively related to what appear to be labor market distortions that drive a wedge between the marginal product of labor and the marginal rate of substitution between consumption and leisure, a topic about which current classes of financial imperfection models are largely silent. I discuss future avenues for developing this class of models, and I consider alternative hypotheses for the recession, including the view of John Taylor and others that economic policies intended to help manage the crisis, actually deepened the recession by increasing uncertainty and distorting incentives. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.45 10.1257/jep.24.4.45 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Symposia Natural Expectations and Macroeconomic Fluctuations AndreasFusterHarvard U DavidLaibsonHarvard U BrockMendelHarvard U 67 84 A large body of empirical evidence suggests that beliefs systematically deviate from perfect rationality. Much of the evidence implies that economic agents tend to form forecasts that are excessively influenced by recent changes. We present a parsimonious quasi-rational model that we call natural expectations, which falls between rational expectations and (naïve) intuitive expectations. (Intuitive expectations are formed by running growth regressions with a limited number of right-hand-side variables, and this leads to excessively extrapolative beliefs in certain classes of environments). Natural expectations overstate the long-run persistence of economic shocks. In other words, agents with natural expectations turn out to form beliefs that don't sufficiently account for the fact that good times (or bad times) won't last forever. We embed natural expectations in a simple dynamic macroeconomic model and compare the simulated properties of the model to the available empirical evidence. The model's predictions match many patterns observed in macroeconomic and financial time series, such as high volatility of asset prices, predictable up-and-down cycles in equity returns, and a negative relationship between current consumption growth and future equity returns. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.67 10.1257/jep.24.4.67 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Symposia Macroeconomics after the Crisis: Time to Deal with the Pretense-of-Knowledge Syndrome Ricardo J.CaballeroMIT 85 102 The recent financial crisis has damaged the reputation of macroeconomics, largely for its inability to predict the impending financial and economic crisis. To be honest, this inability to predict does not concern me much. It is almost tautological that severe crises are essentially unpredictable, for otherwise they would not cause such a high degree of distress. What does concern me about my discipline is that its current core—by which I mainly mean the so-called dynamic stochastic general equilibrium approach—has become so mesmerized with its own internal logic that it has begun to confuse the precision it has achieved about its own world with the precision that it has about the real one. This is dangerous for both methodological and policy reasons. To be fair to our field, an enormous amount of work at the intersection of macroeconomics and corporate finance has been chasing many of the issues that played a central role during the current crisis, including liquidity evaporation, collateral shortages, bubbles, crises, panics, fire sales, risk-shifting, contagion, and the like. However, much of this literature belongs to the periphery of macroeconomics rather than to its core. I will discuss the distinction between the core and the periphery of macroeconomics as well as the futile nature of the integrationist movement—that is, the process of gradually bringing the insights of the periphery into the dynamic stochastic general equilibrium structure. I argue that the complexity of macroeconomic interactions limits the knowledge we can ever attain, and that we need to place this fact at the center of our analysis. We should consider what this complexity does to the actions and reactions of the economic agent, and seek analytical tools and macroeconomic policies that are robust to the enormous uncertainty to which we are confined. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.85 10.1257/jep.24.4.85 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Symposia Treasure Islands James R.HinesU MI 103 26 In movies and novels, tax havens are often settings for shady international deals; in practice, they are rather less flashy. Tax havens, also known as "offshore financial centers" or "international financial centers," are countries and territories that offer low tax rates and favorable regulatory policies to foreign investors. For example, tax havens typically tax inbound investment at zero or very low rates and further encourage investment with telecommunications and transportation facilities, other business infrastructure, favorable legal environments, and limited bureaucratic hurdles to starting new firms. Tax havens are small; most are islands; all but a few have populations below one million; and they have above-average incomes. The United States and other higher-tax countries frequently express concerns over how tax havens may affect their economies. Do they erode domestic tax collections; attract economic activity away from higher-tax countries; facilitate criminal activities; or reduce the transparency of financial accounts and so impede the smooth operation and regulation of legal and financial systems around the world. Do they contribute to excessive international tax competition? These concerns are plausible, albeit often founded on anecdotal rather than systematic evidence. Yet tax haven policies may also benefit other economies and even facilitate the effective operation of the tax systems of other countries. This paper evaluates evidence of the economic effects of tax havens. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.103 10.1257/jep.24.4.103 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Symposia Shopping for Anonymous Shell Companies: An Audit Study of Anonymity and Crime in the International Financial System J. C.SharmanGriffith U 127 40 The last few years have seen an international campaign to ensure that the world's financial and banking systems are "transparent," meaning that every actor and transaction within the system can be traced to a discrete, identifiable individual. I present an audit study of compliance with the prohibitions on anonymous shell companies. In particular, I describe my attempts to found anonymous corporate vehicles without proof of identity and then to establish corporate bank accounts for these vehicles. (Transactions processed through the corporate account of such a "shell company" become effectively untraceable—and thus very useful for those looking to hide criminal profits, pay or receive bribes, finance terrorists, or escape tax obligations.) I solicited offers of anonymous corporate vehicles from 54 different corporate service providers in 22 different countries, and collated the responses to determine whether the existing legal and regulatory prohibitions on anonymous corporate vehicles actually work in practice. To foreshadow the results, it seems that small island offshore centers may have standards for corporate transparency and disclosure that are higher than major OECD economies like the United States and the United Kingdom. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.127 10.1257/jep.24.4.127 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Articles Activist Fiscal Policy Alan J.AuerbachU CA, Berkeley William G.GaleBrookings Institution Benjamin H.HarrisBrookings Institution 141 64 During and after the "Great Recession" that began in December 2007 the U.S. federal government enacted several rounds of activist fiscal policy. In this paper, we review the recent evolution of thinking and evidence regarding the effectiveness of activist fiscal policy. Although fiscal interventions aimed at stimulating and stabilizing the economy have returned to common use, their efficacy remains controversial. We review the debate about the traditional types of fiscal policy interventions, such as broad-based tax cuts and spending increases, as well as more targeted policies. While there have been improvements in estimates of the effects of broad-based policies, much of what has been learned recently concerns how such multipliers might vary with respect to economic conditions, such as the credit market disruptions and very low interest rates that were central features of the Great Recession. The eclectic and innovative interventions by the Federal Reserve and other central banks during this period highlight the imprecise divisions between monetary and fiscal policy and the many channels through which fiscal policies can be implemented. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.141 10.1257/jep.24.4.141 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Articles Catastrophe Economics: The National Flood Insurance Program Erwann O.Michel-KerjanU PA and Ecole Polytechnique, Paris 165 86 Hurricane Betsy, which hit Louisiana September 9, 1965, was one of the most intense, deadly, and costly storms ever to make landfall in the United States: it killed 76 people in Louisiana and caused $1.5 billion in damage—equal to nearly $10 billion in 2010 dollars. In 1965, no flood insurance was available, so victims had to rely on friends and family, charities, or federal relief. After that catastrophe, the U.S. government established a new program in 1968—the National Flood Insurance Program (NFIP)—to make flood insurance widely available. Now, after more than 40 years of operation, the NFIP is today one of the longest standing government-run disaster insurance programs in the world. In this paper, I present an overview of the 40 years of operation of the National Flood Insurance Program, starting with how and why it was created and how it has evolved to now cover $1.23 trillion in assets. I analyze the financial balance of the NFIP between 1969 and 2008. Excluding the 2005 hurricane season (which included Hurricane Katrina) as an outlier, policyholders have paid nearly $11 billion more in premiums than they have received in claim reimbursements over that period. However, the program has spent an average of 40 percent of all collected premiums on administrative expenses, more than three quarters of which were paid to private insurance intermediaries who sell and manage flood insurance policies on behalf of the federal government but do not bear any risk. I present challenges the NFIP faces today and propose ways those challenges might be overcome through innovative modifications. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.165 10.1257/jep.24.4.165 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Articles The Job Market for New Economists: A Market Design Perspective PeterColesHarvard U JohnCawleyCornell U Phillip B.LevineWellesley College MurielNiederleStanford U Alvin E.RothHarvard U John J.SiegfriedVanderbilt U and U Adelaide 187 206 This paper, written by the members of the American Economic Association (AEA) Ad Hoc Committee on the Job Market, provides an overview of the market for new Ph.D. economists. It describes the role of the AEA in the market and focuses in particular on two mechanisms adopted in recent years at the suggestion of our Committee. First, job market applicants now have a signaling service to send an expression of special interest to up to two employers prior to interviews at the January Allied Social Science Associations (ASSA) meetings. Second, the AEA now invites candidates who are still on the market, and employers whose positions are still vacant, to participate in a web-based "scramble" to reduce search costs and thicken the late part of the job market. We present statistics on the activity in these market mechanisms and present survey evidence that both mechanisms have facilitated matches. The paper concludes by discussing the emergence of platforms for transmitting job market information and other design issues that may arise in the market for new economists. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.187 10.1257/jep.24.4.187 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Features Retrospectives: An Early Supply-Side-Demand-Side Controversy: Petty, Law, Cantillon JohnBerdellDePaul U 207 17 Early modern Europe in the late seventeenth and early eighteenth centuries witnessed an unprecedented increase in the rate of economic growth, and governments entertained a wide range of proposals aimed at developing and harnessing foreign trade and emerging financial markets. In his magisterial survey of foreign trade doctrine titled Studies in the Theory of International Trade (1936), Jacob Viner pointed out that enlightened authors of that time were often nonbullionist mercantilists: they favored export promotion and import reduction not on the grounds that it would lead to an accumulation of gold, but on the grounds that it would increase trade and employment. My focus here is on how some key economists of this time period—William Petty, John Law, and Richard Cantillon—adumbrated disputes between supply-side and demand-side macroeconomics that have continued to the present day. http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.207 10.1257/jep.24.4.207 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Features Recommendations for Further Reading TimothyTaylorMacalester College 219 26 http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.219 10.1257/jep.24.4.219 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Features Notes 227 230 http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.227 10.1257/jep.24.4.227 American Economic Association Nashville, TN 0895-3309 Journal of Economic Perspectives http://www.aeaweb.org/jep/ 24 4 Fall 2010 http://www.aeaweb.org/issue.php?journal=JEP&volume=24&issue=4 Features Index 231 233 http://www.aeaweb.org/articles.php?doi=10.1257/jep.24.4.231 10.1257/jep.24.4.231