Yield Curves

The yield curve shows us the interest rate of bonds maturing at different dates. We might generally expect – in normal times – that the yield curve would be upward sloping, which would imply that short term yields are lower than long-term yields. This would reflect the fact that investors expect interest rates to be higher in the future which would occur if they expect monetary policy to be tight, in order to fight inflationary pressures caused by an expanding economy. Hence we might think that an upward sloping yield curve is a positive reflection on the future of the economy, as investors believe that it will be overheating and will require contractionary monetary policy. However this analysis is only true if we focus on the long end of the yield curve: that long-term interest rates will be fairly high. It might be the case that we have an upward sloping yield curve because the current short term yield is low (and the long-term yield is at an average level); this will obviously imply that expectations are such that future activity will improve, but may not be particularly reassuring about the magnitude of such activity.

Big Push Model

A coordination problem is a situation where agents are unable to coordinate their behaviour, such that they end up in an equilibrium that leaves all agents worse off than in an alternative Pareto efficient equilibrium. This exists because complementarities between several conditions are necessary for successful development and the externalities arising from these complementarities are often not considered by decision making agents. Rosenstein-Rodan developed the big push theory which suggests that a government, or coalition of firms/organisations/individuals, needs to overcome these preconditions before growth can occur. Ellis describes this Big Push theory as a "minimum level of resources that must be devoted to... a development programme if it is to have any chance of success. Launching a country into self-sustaining growth is a little like getting an airplane off the ground. There is a critical ground speed which must be passed before the craft can become airborne....".

Political Commitment Theory of Trade Agreements

The political commitment theory of trade agreements argues that trade agreements arise due to the desire of the government to signal to private investors that they wish to pursue pro-growth policies. If announced unilaterally, this signal is not binding and so may not induce investors to invest, as they may not be confident that the government will stick to its announcement. However, when signalled via the signing of an international treaty, this may increase confidence that the government will stick to its promise, because the punishment from breaking its international commitments is much higher than if it broke a unilaterally declared promise. This theory therefore complements are understanding of why governments sign-up to trade agreements, and more importantly, explains why small countries enact tariff reductions when they don’t benefit from reductions in the terms of trade externality, due to their economic size.

Should changes in consumption be predictable?

The classical consumption models (Modigliani’s Life-Cycle hypothesis and Friedman’s Permanent Income hypothesis) tell us that consumption is dependent on life-time income. This is based on the assumptions of credit market access (so we don’t have liquidity constrained individuals) and certainty. In short this means that consumption will only change if income changes, and a temporary income change will cause consumption to rise by less (i.e. MPC is low) than a permanent income change (i.e. MPC is close to 1).

Due to the theory of consumption smoothing – whereby individuals prefer to have similar incomes over two periods (or a lifetime) than extremities in either period – we would expect change in consumption to be low over a lifetime. [...]

Behavioural Economics – Some notes

The advent of the neoclassical approach to establish economics as a science, led to the disappearance of many psychological insights already made by economists, for example Smith says “we suffer more… when we fall from a better to a worse situation, than we ever enjoy when we rise from a worse to a better.” And Edgeworth points out that one agent’s utility can be affected by another agent’s payoff. One development of neoclassical economics was the formulation of the expected utility framework which makes precise assumptions that can be falsified, it assumes stable and consistent preferences, the ability to perform complex computations, and an ability to memorise a large amount of information. [...]

Neoclassical Business Cycles

According to Prescott the reason for business cycles is due to technology shocks which manifest itself as changes in the TFP productivity term (or Solow residual) A. Summers criticises this explanation believing that Prescott doesn’t provide evidence for where these technology shocks come to. Furthermore he cites Berndt who shows that the oil shock crisis – recessionary periods in the 1970s for both the US and the UK – had little effect on labour productivity which would cast doubt on Prescott’s story. Summers also points out that US GNP declined by 50% between 1929 and 1933, and questions whether it is really plausible that such an output shock could be caused by a productivity shock which lead to inter-temporal substitution on such a scale, as Prescott’s model would predict.

Measuring Inequality

Inequality is the difference between the incomes of the rich and the poor and there are a number of different measures to see how inequality has been changing over time and between countries. National accounts do not provide any data on how income, consumption or wealth is distributed across households [OECD] instead they provide overall income for the country, and dividing this by the population gives us the average income of the nation. Instead we need to use household survey data to give us a measure of inequality. Such surveys are not consistent across countries and therefore make international comparisons of inequality difficult. To overcome these issues, and allow more precise measures of international inequality, we might consider aggregating the national accounts data with the survey data. Unfortunately, this is a very difficult task, and may cause more issues than it solves. One such issue is that in survey data, households who own their home when asked their income may not include an imputed value of their rent, but this is done when we construct the national accounts. Deaton believes that this factor alone is responsible for explaining a large majority in the difference between national income as given by the national accounts versus the household surveys.

Search Markets

Economic theory may initially have us believe that firms shouldn’t offer a higher wage than the reservation wage of workers. If they did so then another firm could enter the market, charge below the reservation wage, have lower costs, sell output at a lower price and capture the market. Yet the theory of efficiency wage provides another story, that higher productivity can offset the cost of higher wages (so that a firm offering w>w* isn’t competed out of the market), and more importantly that a firm must offer a wage greater than the reservation wage in order to operate.

Was there a Victorian Failure in Manufacturing?

Comparisons of Britain’s labour productivity in manufacturing with that of other industrialised countries, such as the USA and Germany, from 1850-1914 suggest no dramatic decline in this sector during the period. However, labour productivity performance at the whole economy level was poor in comparison to other countries. (a) How can this be explained (b) Does it suggest a failure occurring in the UK economy?

Over the period 1850-1914 there was a decline in Britain’s overall labour productivity comparative to its competitors – against the US Britain was more productive in 1870 but was overtaken during the 1890s – in 1870 US/UK labour productivity in the aggregate economy was 89.8 [...]

Standards of Living during the Industrial Revolution

The debate about living standards in the Industrial Revolution has recently focused on anthropometric measures, such as height and mortality, and linked these to the ability to work more intensively. Describe how these factors may be related. Discuss what the anthropometric evidence reveals about living standards in this period.

Anthropometric measures add a new light on the debate and show whether people were healthier as a result of the industrial revolution. If they were then they would have been able to work more intensively because they would need fewer days off work due to fatigue or illness. Schultz believes that there is a positive relationship between height and productivity because height is a measure of nutritional status and better fed, healthier people could work harder. [...]