June 29, 2003
Notes: Sticky Information...

Yet another thing for me to add to the "must read" pile... Disagreement about Inflation Expectations N. Gregory Mankiw, Ricardo Reis, Justin Wolfers | NBER Working Paper No. w9796 | June 2003: Abstract: Analyzing 50 years of inflation expectations data from several sources, we document substantial disagreement among both consumers and professional economists about expected future inflation. Moreover, this disagreement shows substantial variation through time, moving with inflation, the absolute value of the change in inflation, and relative price variability. We argue that a satisfactory model of economic dynamics must speak to these important business cycle moments. Noting that most macroeconomic models do not endogenously generate disagreement, we show that a simple sticky-information' model broadly matches many of these facts. Moreover, the sticky-information model is consistent with other observed departures of inflation expectations from full rationality, including autocorrelated forecast errors and insufficient sensitivity to recent macroeconomic news....

Posted by DeLong at 07:46 PM

June 05, 2003
Gains From International Trade and Investment

An Irish-Arizonian-Australian cross-disciplinary alliance of Kieran Healy and John Quiggin is thinking about Pierre-Olivier Gourinchas and Olivier Jeanne's brand-new "The Elusive Benefits of International Financial Integration"--the conclusion of which is that in standard neoclassical models freeing up capital flows across nations has the capability to boost economic welfare by an amount on the order of magnitude of one percent: John Quiggin: (Small) gains from trade: (Small) gains from trade: Kieran Healy links to a paper by Pierre-Olivier Gourinchas and the missing-from-the-web Olivier Jeanne in which a calibrated growth accounting model is used to show that the gains from unrestricted capital mobility are likely to be of the order of 1 per cent of GDP. Gains from risk sharing aren't mentioned but other papers are cited to say that these are of a similar magnitude. Those who listen to the general pronouncements of economists might be surprised by the modest size of the estimated gains. But for those who have looked at similar exercises in the past there is no surprise here. One of the better-kept secrets of economics is the fact that most studies suggest that the replacement of a typical high-tariff regime (say Australia's in the 1960s) will yield...

Posted by DeLong at 07:09 AM

May 28, 2003
Daniel Davies Recommends Donald Mackenzie

Daniel Davies recommends the work of Edinburgh sociologist Donald Mackenzie......

Posted by DeLong at 08:30 AM

May 09, 2003
A Bizarre Piece from the Economist

A very strange piece indeed from the Economist: Economist.com: ...The most striking development has been a move at Harvard, which has one of America's biggest and most influential economics faculties, to offer an alternative to the basic undergraduate economics course.... The new course is being proposed by Stephen Marglin, a tenured professor who earned his chair largely for research that attempted to square a Marxian approach with Keynesian demand theory. One basis of the proposed course and others like it, however, is the rapid uptake of the ideas of behavioural economics. This uses lessons from psychology to undercut the idea of Homo economicus as a rational being. Many of these ideas are based on the work of Daniel Kahneman, a psychologist and winner of last year's Nobel prize in economics, and his collaborator, Amos Tversky, who died in 1996. They highlighted, through a number of experiments, the various ways that people perceive and misperceive risks. Behavioural economics is a fascinating field. On its face, moreover, it seems to undermine the neoclassical orthodoxy. It suggests that people, contrary to the basic assumptions of the standard approach, do not always behave rationally. They may avoid slight risks, and yet take wild gambles....

Posted by DeLong at 01:44 PM

April 10, 2003
Notes: More Finance Demand Curves Sloping the Wrong Way

Notes: Teaching: Econ 236: Behavioral: Finance: Yet More Demand Curves That Slope the Wrong Way This time it's due to performance-based arbitrage: PBA: circumstances in which the fact that prices move against fundamentals leads investors to think that their smart-money managers aren't so smart, and so withdraw funds: From Andrei Shleifer and Robert Vishny (1995), "The Limits of Arbitrage" (Cambridge: NBER Working Paper 5167). One model of risky arbitrage is that of a large number of investors taking small positions against the mispricing. Fama's (1965) classic analysis of efficient markets and Ross's (1976) Arbitrage Pricing Theory are based on this model. An alternative, and in many cases more realistic view, is that arbitrage is conducted by a few professional, highly-specialized investors who combine their knowledge with resources of outside investors to take large positions. They operate in markets where fundamentals are difficult to ascertain and correct hedging strategies are hard to implement, such as the currency and derivative markets. The fundamental feature of such arbitrage is that brains and resources are separated by an agency relationship. the money comes from wealthy individuals, banks, endowments, and other investors with only a limited knowledge of individual markets, and is invested by arbitrageurs...

Posted by DeLong at 03:49 PM

Notes: Risk Aversion

Teaching Notes for Econ 236: April 9: What do different risk aversion parameters imply about gambles? Kocherlakota (1995) [Narayana R Kocherlakota (1995), "The Equity Premium: It’s Still a Puzzle," Journal of Economic Literature, 1996-1, pp. 42-72.] reports that the raw "equity premium puzzle" implies a coefficient of relative risk aversion of 18... (and then there is the risk-free rate puzzle: at a crra of 18, you need a raw time preference factor of -8% per year to fit average per-capita consumption growth to the average real risk-free rate of interest. What does such a high risk aversion parameter mean? Well... ...At a coefficient of relative risk aversion of 1... you are indifferent between a this year's consumption level of $30,000 for certain and a 58% chance of $40,000 coupled with a 42% chance of $20,000. ...At a coefficient of relative risk aversion of 5... you are indifferent between a this year's consumption level of $30,000 for certain and a 86% chance of $40,000 coupled with a 14% chance of $20,000. ...At a coefficient of relative risk aversion of 10... you are indifferent between a this year's consumption level of $30,000 for certain and a 97.6% chance of $40,000 coupled with...

Posted by DeLong at 03:44 PM

March 17, 2003
How to Be Happy

Richard Layard of the LSE tells us how to be happy in his Public Lectures and Seminars " href="http://cep.lse.ac.uk/events/lectures/">Lionel Robbins lectures......

Posted by DeLong at 03:13 PM

March 08, 2003
A Brief Dialogue on Behavioral Economics

The Importance of Framing the Issue Properly... (Even though I was a major participant in this dialogue, it was several years ago. So I have followed the historical methodology of Thucydides: I have written as if each participant said what was appropriate and fitting for the situation, all the while staying as close as possible to the words actually said.) Time: A warm spring evening at the height of the tech boom. Place: A chi-chi downtown Palo Alto restaurant. Stanford Professor and Hoover Institution Fellow Robert Hall: And now for the wine? Berkeley Professor Brad DeLong: (Looks at wine list.) I'd rather not. They look too expensive for what they are. Hall: But I'm paying. The Stanford macro seminar is paying. DeLong: So? Hall: I'm the one who should be worrying about that, not you. Go ahread and order. DeLong: Why can't I worry about it? Hall: Because you're not paying. The price is irrelevant as far as you're concerned. It's all free to you. DeLong: It's free to me in the sense that buying it doesn't diminish my future opportunities to buy other things. But there's another sense in which it is not free. Hall: And that would be?...

Posted by DeLong at 08:45 AM

February 28, 2003
O Brave New World!

I wrote: I don't know about you, but in the future I'm only making contracts with people with elevated oxytocin levels... Virginia Postrel writes about those who are beginning to found the subdiscipline of Neuroeconomics: Looking Inside the Brains of the Stingy. Kieran Healy Responded: Brad DeLong points to an article by Virginia Postrel about the nascent science of neuroeconomics. There's a lot of experimental work showing that people typically trust each other much more than homo economicus would. In standard bargaining games, where it's rational to stiff the other guy but better (in terms of your prize money) if you both trust each other for a bit, people tend to trust each other. This holds even where experimenters create exchange conditions that positively encourage you to be an asshole -- by removing face-to-face interaction, ensuring anonymity, making the games one-shot deals, and so on. The new studies look at what happens to the brain chemistry of people playing the game. They find that people who trust show higher levels of the hormone oxytocin. In a different set of studies, the article says researchers, 'receiving low-ball offers stimulates the part of the brain associated with disgust. "They can predict with...

Posted by DeLong at 09:17 AM

February 27, 2003
Excuse Me, What's Your Oxytocin Level Today?

I don't know about you, but in the future I'm only making contracts with people with elevated oxytocin levels... Virginia Postrel writes about those who are beginning to found the subdiscipline of Neuroeconomics: Looking Inside the Brains of the Stingy: ...Professor Zak and his colleagues study trust with a variation of the ultimatum game. Each player receives $10. Player 1 gets an additional $10. Players interact anonymously over computers. Player 1 can send any whole-dollar amount to Player 2. Whatever he sends is tripled, so a $5 gift turns into $15. Finally, Player 2 can return some of the money to Player 1. If Player 1 expects Player 2 not to send any money in return, Player 1 will keep the initial stake. That's the game's standard equilibrium. "In fact," Professor Zak said, "most people send about half of their stake to Player 2. They're signaling that they want to trust them." In response, about 75 percent of the Player 2's return some money, making both better off. "Even though we can't see each other and we don't know each other, we understand the other person as a human being," Professor Zak said. Extrapolating from animal results, he hypothesized that...

Posted by DeLong at 08:09 PM