November 2007 Archives

Every so often, you see a paper that just reaches out and grabs your attention by its sheer size and comprehensiveness. This is one of those papers.

"A Quantitative Theory of Unsecured Consumer Credit with Risk of Default" by Satyajit Chatterjee, Dean Corbae, Makoto Nakajima, and Jose-Victor Rios-Rull (Econometrica vol. 75 no. 6, Nov. 2007 pages 1525-1589.)

Non-gated version here. Homework assignment (!) based on the paper here.

I was Dean's TA for the graduate macro class at Iowa back in the day. I think he was already working on the seeds of this paper at that time (a dozen years ago or so). According to the note at the end of the paper, almost 5 years elapsed during the review process. This paper has a theoretical model with all of the requisite proofs befitting a lead article in Econometrica as well as a computer simulation of the calibrated model. They conduct a policy experiment similar to the recent change in bankruptcy laws. Their model predicts a significant increase in average consumption.

At first glance, the welfare gains they find are surprisingly large. I wonder how sensitive the welfare effects are to the parameters. This is a difficult question in any model with a complicated simulation (this I know from experience in my own papers), and their paper is already 65 pages long. So that question will probably need to be explored further in another paper. This paper will be of most interest to specialists who deal with quantitative macro models of heterogeneous agents. It's probably not destined for first year reading lists. But if you do any kind of work with these models or have an interest in the frontier of macro research on bankruptcy issues, then you should look at this impressive paper.

Final sales, especially for durable goods, appear to be stalling out. That's not a good sign. If we weren't waiting for the other shoe to drop on housing and the financial markets, this might be regarded as a decent GDP report. But consumption is likely to contract in the current quarter. The question is, how much?

Chairman Bernanke spoke last night. Here's the full text. Here's the part that made everyone take notice.

With respect to household spending, the data received over the past month have been on the soft side. The Committee will have considerable additional information on consumer purchases and sentiment to digest before its next meeting. I expect household income and spending to continue to grow, but the combination of higher gas prices, the weak housing market, tighter credit conditions, and declines in stock prices seem likely to create some headwinds for the consumer in the months ahead.

This is one you'll want to bookmark and assign to your students.

Frederic Mishkin: The Federal Reserve’s Enhanced Communication Strategy and the Science of Monetary Policy

Given to the Undergraduate Economics Association at MIT. Lucky folks.

It's been a while since we have looked at the fed binary options from the Chicago Board of Trade. And there was some significant movement today too.

Implied probability of at least a 25 bp cut is now at around 87% (call option with 95500 strike price closed at 87, up 9 from yesterday's close).

Implied probability of at least a 50 bp cut is now at around 30% (call option with 95750 strike price closed at 30, up 10 from yesterday's close).

Payoffs are based on the target fed funds rate at the end of December. Hence these take into account the possibility of an intermeeting cut.

It's impossible to point to one factor as being the prime mover here. There's Donald Kohn's speech where he says,

Another consequence of operating under a high degree of uncertainty is that, more than usually, the potential actions the Federal Reserve discusses have the character of "buying insurance" or managing risk--that is, weighing the possibility of especially adverse outcomes. The nature of financial market upsets is that they substantially increase the risk of such especially adverse outcomes while possibly having limited effects on the most likely path for the economy.

See also, Frederic Mishkin from earlier this month.

We also have the steady drum beat of negative housing news along with a jump in jobless claims. Not even a GDP revision can overcome that. (Of course, the GDP revision is not fooling anyone into revising their forward looking forecast. Barry Ritholtz calls the revision "fanciful".)

But two Fed officials have expressed a clear preference to hold rates where they are. One votes at the next meeting. The other will be a voting member next year. (Reuters)

CHICAGO (Reuters) - Two Federal Reserve Bank officials hinted strongly on Tuesday that they would not support an interest rate cut in December, contending that the Fed has provided enough insurance against financial turmoil and would risk opening the door to higher inflation.

The comments from Chicago Fed President Charles Evans and Philadelphia Fed President Charles Plosser put the central bank at odds with financial markets that are anticipating a series of rate cuts over the next few months.

...

But Evans and Plosser, while acknowledging risks to the economy, suggested that further cuts to the federal funds rate, the bank's most powerful policy tool, might not be the right solution to the credit market's problems.

...

"In some circumstances, lowering interest rates may prolong the painful process of price discovery," he said in a speech to the Rochester University Simon Graduate School of Business.

I think I may use that quote in my classes next week.

The beat goes on.

Happy birthday to the classic video game. Here's the article from Wired, which cites Wikipedia as a source.

In that Wikipedia entry, we learn the following. Pong wasn't really the first game.

The earliest electronic ping-pong game was played on an oscilloscope, and was developed by William A. Higinbotham at the Brookhaven National Laboratory in 1958. His game was called Tennis for Two.

That had to be fun. If you can visualize playing ping-pong on an oscilloscope, you do qualify for official geek status. (Welcome to the club.)

And of course everyone knows this part of the story (if you are a computer history buff)...

The makers of the Magnavox Odyssey insisted that they held a patent on the concept of a tennis video game, and in 1974 Sanders/Magnavox filed a lawsuit against Atari. This was the first lawsuit relating to intellectual property rights in the video game industry. Lawyers for Magnavox found witnesses who recalled seeing Nolan Bushnell playing the Odyssey's table tennis game at the trade show in Burlingame, California in 1972, and obtained a guestbook from the event that he had signed. Atari settled out of court by agreeing to pay $700,000 to license the patents that Magnavox held on the Odyssey. On January 10, 1977, Judge John Grady of the Federal District Court in Chicago ruled in favor of Sanders/Magnavox on all counts relating to the lawsuit. The ruling upheld the claim that US patent #3,728,480 entitled Television Gaming and Training Apparatus was the pioneering design for a video game. (See original for footnotes)

So like just about everything, the actual date the idea was conceived is lost in the mists of history. But today, we raise a glass to that little white ball of pixels that started a revolution.

From the NY Times Opinionator Blog:

Open primaries ­ in which voters don’t have to be a member of a party to vote for its candidates ­ have long been a thorn in the sides of national Democrats and Republicans. Now, according to the Associated Press, Virginia’s G.O.P. is going to do something about it: “If you’re planning to vote in Virginia’s February Republican presidential primary, be prepared to sign an oath swearing your Republican loyalty. The State Board of Elections on Monday approved a state Republican Party request to require all who apply for a G.O.P. primary ballot first vow in writing that they’ll vote for the party’s presidential nominee next fall.”

Oh, the joys of our system. This would be one reason I favor the caucus approach. These candidates are seeking the nomination of their parties. There's nothing wrong with requiring people to publicly declare their support for a candidate in an open forum like a caucus at this stage. Open primaries do leave open the possibility for interlopers to distort the nomination process. That said, if you don't like the law... change the law. But if you're going to have open primaries, then they should be subject to the same rules as any election. And this tactic would arguably seem to violate those rules. Sure it's unenforceable. But they are asking people to promise a future vote as a condition for voting in the present.

I'm sure the Virginia Republicans will argue that they have the right to restrict access to their primary ballot. After all, it's their party and their nomination process. But I think they're trying to have it both ways. If you don't like open primaries, change the law. Don't impose a loyalty oath. That just makes you look silly.

The last week or so before the break here was a race against time to get some things done for classes and so forth. More regular blogging will resume after the weekend. Enjoy the day.

And enjoy this link to the Wall Street Journal's Thanksgiving tradition. They have been running this editorial on the day before Thanksgiving since 1961. It applies just as much now as then.

And the Fair Land

(I believe this link goes to a free version.)

This interview was conducted in October 2005 but not released until now. Hat tip to Greg Mankiw.

Today is a teaching day for me, so I don't have much time. But I am currently listening to Bernanke answering questions from the Joint Economic Committee. Here is a link to his testimony. Not much about inflation in there.

As I write this and listen to the Q and A, Ron Paul is apoplectic, as you might imagine.

In other news, the ECB and the Bank of England leave interest rates where they are.

I'm giving a test in a couple hours. One of the concepts we have been discussing is the relationship of the value of the dollar to the interest rates at home and abroad. Nothing like being able to pull a question right out of the headlines.

From the NY Times

In an unusually blunt interview, the president of the Federal Reserve Bank of Philadelphia said he already expected growth to slow to an annual pace of 1.5 percent or less. But he said he would not support another rate cut unless the slowdown appeared to be even sharper than that.

Read the whole thing.

I figure I've logged about 1600 miles of driving in the last 11 days. That cuts into the time available for blogging. Things should improve now for a while at least.

Yesterday, I was in Chicago with my students competing in the 7th District College Fed Challenge. Three time defending national champion Northwestern University won again. Although the University of Chicago certainly gave them a run for their money. We faced U of C in the first round and thus didn't advance. Even so, the value of the program as a learning experience for our students is tremendous.

Fredric Mishkin spoke yesterday about the risk management approach to monetary policy decisions. This was the basis for the lead off question in the final round Q and A session at the Fed Challenge. By the way, all of the final round teams (in addition to our team), were unanimously in favor of holding rates constant at this point in time. The competition is real-time. Therefore having it so soon after the last meeting does sort of predispose one to holding steady. However, there was a lot of discussion and debate by all the teams about what the outlook is going forward.

As for that outlook, Tim Duy is concerned.

...One has to imagine that the Fed must be feeling a little uneasy about pulling the trigger on another 25bp last Wednesday given Friday’s employment report. Still, they likely take comfort in the belief that they drew a line in the sand with the statement, declaring a balanced risk outlook.

But can they stick to that line during a scary four months? Can they look through to that period of “moderate growth” that they keep predicting? I would like to believe they are ready to stick to their guns, but recent history is not on my side.

...

Can the Fed resist that pressure to keep cutting even if they are confident that the medium term risks are really balanced? If the “risk management” faction at the Fed continues to hold power, it seems like more rates cuts are likely, especially if there is any hint of further softening in employment or investment. That is what recent history tells us.

Standing in the way of additional cuts, however, is these new-found inflation concerns that appeared in the last statement. Declining core-inflation has been cited as a justification for Fed easing based upon decreasing estimates of the neutral Fed funds rate. I would only like to suggest that the recent history of core-PCE is not all that comforting. Looking a three-month inflation trends on an annualized basis:

I detect something of an upward trend in the past four months, on the order of 50bp – perhaps it is too early to be lowering estimates of the neutral rate? Personally, I wouldn’t break out the champagne on the inflation story just yet. It appears, however, that Fed Chairman Ben Bernanke and Governor Frederick Mishkin – the power couple in the “risk management” regime – already popped the cork.

The chart is from Duy's post at Economist's View.

This is precisely a point that was made by my students as well as most of the other teams at the Fed Challenge yesterday. This is a concern going forward. There is a very real risk that any further easing could have nasty repercussions for intermediate to long term inflation expectations. And if the Fed is going to be facing a real inflation problem in a year or two, when the economy is still trying to right itself from the subprime debacle, that's not going to be good for growth either.

See also this article by Bloomberg's John Berry.