Consumption Smoothing

A topic that perhaps deserves more discussion is whether/how households are actually smoothing consumption throughout this recession, particularly where one or more household member has been laid off or had substantial reductions in salary and hours. There are many dozens of papers that one could cite in developing some ideas in this area. Two papers below have particularly interested me as I have been thinking about this. The first looks at the extent to which increased debt payments interfere with consumption smoothing. The second looks at the extent to which consumers can maintain welfare by cutting back on durable expenditure while maintaining non-durable consumption. In an optimistic version of the Irish economy, people who have been made unemployed may be able to smooth through the current period by (i) using savings (ii) using redundancy payments (iii) delaying durable expenditure (iv) using extra time available to seek lower prices (v) taking advantage of generally lower prices economy wide (vi) working with financial institutions to restructure their debt payments (vii) switching more to domestic production e.g. making sandwiches rather than buying lunch in a cafe (viii) using informal bartering as a method of acquiring services (ix) borrowing from relatives (x) social welfare (xi) income insurance (xii) charity. I am sure readers can think of many other ways in which people who have been laid off are trying to smooth consumption. We have never had high unemployment in Ireland coinciding with very high levels of personal debt and, as such, relying on previous Irish research is not likely to be very informative as to the welfare issues at stake here. The previous discussion on price indices is clearly relevant but a wider discussion of the role of formal and informal institutions in consumption smoothing in this new environment would be interesting.

Do High Debts Hinder Consumption Smoothing?

Shocks, Stocks and Socks

George Lee

I do not have any links with either Fine Gael or George Lee. I do think he merits special consideration from Economists as he is likely to be a key player in the shape of the economic policy of the current main opposition party. His maiden speech to the Dail is available on the link below. As one might expect, he seemed in command of economics in a way that will make him an interesting, though now partisan, figure in the national economic policy debate. A lot of his speech focused on the psychological and social cost of unemployment. In terms of economic policy, he argued that unemployment and private sector debt have been neglected from the debate and that he was going to contribute to correcting this. I will be watching with very strong interest as to how he follows up on this.

Link here (scroll about half way down)

Unemployment and Negative Equity

Ronan Lyon’s final post on this thread is available at this link

By necessity, there is a lot of educated guess-work in the post. For example, the working assumption in Ronan’s analysis is that recent layoffs are as likely to be homeowners as not. Nevertheless, the effects of the double-whammy of unemployment and negative equity affecting Dublin’s commuter belt is an issue that Ronan’s post usefully highlights.

Bryan Caplan’s Unemployment Wager

In response to a recent paper that was somewhat bullish about the benefits of the European employment model, Bryan Caplan proposes the following bet. It has since been taken up by John Quiggin.

“I’m going to offer the following bet to the authors of the CEPR report:

The average European unemployment rate for 2009-2018 (i.e., the next decade) will be at least 1% higher than U.S. unemployment rate. The bet will be resolved when Eurostat releases its final numbers for 2018.

I’m happy to bet each of the three authors $100 at even odds. Will they accept?

P.S. By 1% I of course meant 1 percentage-point.”

Teaching or Research?

A new NBER paper asks why universities reward faculty on the basis of research productivity despite making most of their money from teaching. One theory is that top researchers being located in an institution increases the signalling value of the degrees awarded in the Institution. Another is that screening faculty on the basis of good teaching is very difficult and that screening them on the basis of research is more feasible and that good researchers are likely to be good teachers and to transmit knowledge at a much higher level than faculty who are not research active. A question that the paper leaves open but is an important one is what is best for students and society in terms of the allocation of university budgets. Should we be focusing on getting more teaching staff and having them spend more time in the lecture hall and classroom or more on attracting top research staff to improve the prestige of institutions and facilitate students being influenced by top researchers?

link here

A Default Solution to Pension Problems

I mentioned before that John McHale wrote a paper a few years summarising the behavioural economics solutions to pension underfunding.
McHale Article

The literature has progressed a lot even since then. The IFS in London are holding an event on June 15th to discuss, among other things, mass “opt-out” pension schemes being rolled out over the next five years in the UK where having a pension is the default position for new employees rather than not having a pension. Such pensions are designed based on simple psychological insights about how people make future decisions, the insights being mostly that we overweight current pain and have a tendency to procrastinate. This sounds pretty simple but incorporating these insights does make a big difference to policy design.

This literature is the most advanced, in my view, application of behavioural economics to real-world policy problems and it will be very interesting to see how this evolves. A link to their report is also available on the link below. I have constructed reading lists and so on for students and they are available below. They might be useful if people are interested in the general area of applying behavioural economics to policy.

Link to IFS

http://geary.ucd.ie/econpsych/

Writing off a generation? – Blanchflower

Snippets of Blanchflower’s newsnight interview are available below. He is quite adamant that omitting graduate unemployment from the policy response is a big mistake. He is talking about the UK but it may not have escaped the notice of readers of the blog finishing exams that things are tight here also.

http://news.bbc.co.uk/2/hi/programmes/newsnight/8062464.stm

I posted previously on his paper with Bell which offers some solutions to young unemployment.

Unemployment and Homeownership

Ronan Lyons updates his ongoing discussion of this issue on the following link

As Ronan states himself, these are round numbers being constructed from extrapolations from the Census and various property data sites. Ronan is moving toward estimates of the number of people who are both unemployed and in negative equity. I will make his life more difficult by noting that while this would be a really interesting statistic (particular its regional distribution), it does not take into account people who have retained some form of employment but whose income has fallen substantially.

Boston Fed Paper on Foreclosures

A recent Boston Fed working paper examines the rationale for government intervention to subsidise mortgage mitigation. The paper is sceptical about the benefits of this approach and they conclude the following:

An important implication of our analysis is that policies designed to reduce foreclosures should focus on ameliorating the immediate effects of job loss and other adverse life events, rather than modifying loans to make them more “affordable” on a long-term basis”.

http://www.bos.frb.org/economic/ppdp/2009/ppdp0902.pdf

I would respectfully call on our own Central Bank to start producing and publishing this type of research and my apologies to them if they already have and I am not aware of it. I am basing my belief that this research is not in circulation from looking in detail at the publications section of the Central Bank website. In general, I cannot find any good publications written in the Irish context on the implications of falling house prices on household financial positions and the policy issues associated with this. These policy issues are clearly different in Ireland than in the United States due to very different legal methods for dealing with mortgage default. We need a document though that spells out the different options available if a sizeable proportion of mortgage holders in areas where values have plummeted (and may never recover) start being unable to make their repayments. I am aware that all sorts of arrangements are currently being used in individual cases but this is hardly a substitute for a fully outlined statement of policy options that could be debated on forums like this and by smaller groups of experts.

To date, Ronan Lyon’s two blog posts seem to be the most sophisticated data analyses of negative equity and related issues in the Irish context. I cannot see how the monetary economists working in Ireland can claim to have a full grasp of the current situation without an understanding of these micro-features. I have absolutely no axe to grind here and I look forward to being shown the error of my ways.

Central Bank Publications Page

ICTU Employment Document

ICTU’s employment document is an interesting addition to the debate. However, it is not fully clear where the one billion figure comes from and, in general, it would be worth thinking further about costing. The overall thrust of the document is important though, in particular their correct emphasis on the urgent need to address full unemployment.

linked here

Emmanuel Saez – Bates Clarke

This years Bates Clarke medal was awarded to Emmanuel Saez. Details of the award are below. Below that is  his IDEAS page. The work that Saez is doing across areas like tax, social interactions, information provision and so on provides many good ideas that have relevance to policy. The award committee cite his contributions to areas of public economics like optimal tax theory, measurement of income distributions, field experiments in financial behaviour among other areas.

http://www.vanderbilt.edu/AEA/clark_medal.htm

http://ideas.repec.org/e/psa117.html

Unemployment among the Young

Unemployment among the young is something that has been under-discussed in the debate so far. For example, in about a month from now, the first of this year’s college students will start finishing up in Ireland. Last year the numbers read approximately 20,000 undergraduates each from the Universities and IT’s, 13,000 postgraduates from the Universities and approximately 2,000 from the IT’s. Thus, with the assumption that this year is the same as last year, there will be about 40,000 undergraduates and 15,000 postgraduates coming out of college and its past time to start a debate about policy for this group. Given that there is currently a public sector embargo on hiring and private sector hiring is so weak, the options for a lot of this year’s graduates do not look good. My guess is that over half the undergraduate students will go on to postgraduate but the insustainability of this as an employment response should be obvious if the labour market is not set to recover for the next few years.

HEA Stats

The recent budget packages are essentially a combination of back-to-work incentives, training schemes, incentives for training, extra third level places and so on. The total budget allocated for these measures is 128 million and they look like a very partial response at best, albeit a start.

Budget Jobs Response

Bell and Blanchflower released a paper earlier in the year that is a must-read for any policy-maker who reads this blog and is interested in developing policy to immediately rectify unemployment among young people. The article stresses the importance of not allowing young people to enter into early periods of unemployment and the potential long-run economic and psychological costs of not acting. It offers proposals such as job-sharing, mandatory training/schooling until age 18, development of “shovel-ready” labour intensive projects and so on. I think that we urgently need a policy document from a selection of government departments on how a package of such proposals could be rolled out, given the current budgetary constraints. I know many on this blog may argue that pricing ourselves back into international competitiveness is the only sustainable employment response, but in an environment with such low global demand it would be foolish not to think of urgent active responses for both graduates and non-graduates.

Bell and Blanchflower Article

Behavioural Economics: Should Policymakers Care?

Behavioural Economics is one of the main drivers of modern economics but we have not spoken about how ideas from this field are relevant to current Irish economic conditions. This is not a blog just for specialists so I am going to try to give some jargon-free sentences on what behavioural economics is and why policy-makers should care. This is purely my own view having researched the area since 2001 and having lectured courses in TCD and UCD on the topic and they do not reflect any attempt at capturing the consensus opinion in this field. I feel very strongly of the view that the absence of an understanding of both psychology and of policy evaluation has damaged Irish policy and that a continued cynicism about the capacities of the Irish public sector to deliver innovative policy is leading many to stop trying to think of innovation. Behavioural Economics combined with rigorous policy design is a partial corrective to these tendencies.

Basically, behavioural economics focuses on the application of psychology to economic behaviour. Increasingly, it is focused on why people make decisions in key domains relevant to economic policy. A trend has been the development of the view that policies need to be designed rigorously with respect both to potential evaluation and with respect to actual psychological principles and that such policies should stand or fall on the basis of whether they work. A recent Economist article put this at the heart of the next ten years of economics arguing that the union of behavioural economics and policy evaluation represents the most dynamic tendency in economics. Just because the Economist says it, doesnt make it so, but we should give this work credence in thinking about a potential Irish recovery.
The most developed literature that can be applied in Ireland is the one on pensions. John McHale wrote a great piece a few years ago summarising some of the literature up to then on behavioural economics and pensions and its relevance to the Irish situation. It did not seem to have much of an influence on the debate, which is a shame. In general, financial decision making is the first area that really should be looked at if policy makers want to take behavioural economics seriously. Tax codes, legal codes, social welfare entitlements and so on are need to be gone through not just from the point of view of accounting waste. We need to look in depth at what financial incentives exist for people and how people interpret these financial incentives and whether people are disincentivised by the framing of these processes. Several experiments in the US are starting to show that simple questions of how instruments are framed, the cognitive complexity of application forms, the nature of the default setting can all have dramatic effects on behaviour. As pointed out by Akerlof and Shiller, the interaction of the psychology of financial decisions with the regulatory structure generates a lot of the negative effects seen on financial markets.
McHale Article

Secondly, behavioural economics is also focused on the outcomes of people’s decisions and, in general, is not wedded to the view that consumption is a good measure of people’s well-being. Focusing on well-being directly is increasingly a concern in behavioural economics.  In particular, looking directly about how factors such as health, unemployment, aging and so on determine well-being is increasingly a guide to developing policy. The UK have taken seriously the idea that things like home foreclosure and unemployment are not just economic events but are also psychologically distressing and have been provided psychological therapy on a more wide ranging basis than before, based on recommendations from this literature. Several other policy ideas derive from looking closely at well-being and these should not be dismissed lightly and certainly not without some debate.
Thirdly, behavioural economics is increasingly focusing on actual policy experiments in real world contexts. My own opinion is that this is the prime way in which economics can positively impact recovery in Ireland. In particular, well-designed micro-policy experiments in areas such as health, financial decisions, based on sound principles about how people actually behave is the main thing we can take from this new literature. This does not necessarily mean more government intervention (it may mean less). However, it does mean far more active discussion of specific micro-level policies in areas such as education, training, innovation and so on. A focus purely on expenditure to the absence of actual outcomes and process is characterising a lot of the current debate and this is damaging.
Some recent popular works written by leaders in the field that people might be interested in if they want to understand the potential relevance of behavioural economics to current policy are linked below.