Friday, October 10, 2008

Khaki Economist: Bank of Sweden Prize in Economics--a Roundup of the Horses

With the financial world falling apart, crisis inspiring suicides, and the Great Abyss of collapse more or less dependent on next Monday's stock-market reaction to today's Washington crisis talks, now is a great time to be thinking about the Nobel Prize in Economics. The prize, for those unaware, is handed out on Monday, to the economist considered most good-looking.

For the punters amongst us, there are precious few form-guides available in this betting market. This is a great failure. Below, then, is my round-up of the favourites.

Martin Feldstein Odds-on favourite at $8, but not mine.

An American economist, Feldstein is a good macroeconomist and public finance theorist. His close association with the Reagan and Bush administrations earned him the early short odds in this race, though recent events may have changed all this. His eating trough was poisoned earlier in the month, diminishing his prospects for the prize, when the financial products division of AIG, of which he is the chief director, lost a couple of bets. This has cost the US government (so far) around US$115B, which is quite a sum.

His association with Bush, Reagan, and AIG lead me to not recommend your putting money on him.

Thomas J. Sargent paying $12

Sargent is another American macroeconomist, who played an important role in theorising `rational expectations'. Rational expectations allow economists to make a (quite realistic) assumption that people form expectations over the future based on rationality, and vary their behaviour accordingly. Non-economists would be quite shocked to learn economists have not always done this--once upon a time, expectations were assumed to be formed by present conditions, or yesterday's--which is why rational expectations, and the theory's founders, are favoured to win a gong sooner or later.

While I have no doubt of the depth and influence of this theory, I'd not think it fitting to give this years' award to someone in this field, simply due to the Crisis. On the other hand, the voters may want to award a pure theorist, and not a crisis economist.

Robert Barro paying $13--my tip

The second most influential economist not to have won a Nobel already, Barro is a hero of mine. He is, predictably, another American macroeconomist, though specialises in public finance during economic crises--quite a good thing to have specialised in, this week.

His notable papers have included one on `Ricardian equivalence'*, which is when people perceive government debt as personal wealth. Equivalently, this is like people increasing their savings to pay off government debt in the future. I have always had a problem with the Ricardian equivalence argument, as it sounds to me like another endogeniety problem (when one thing looks to have caused another, but it may be the other way around). That is, it would require very foresighted savers to plan to pay off government debt in the future; it is more likely, as governments borrow off the private sector (or foreigners), the savings must be a precondition for government borrowing to occur in the first place.

Another paper, of use today, "On Determination of Public Debt" (1979), presents a situation of a large crisis, during which the government optimally increases debt and the money supply, inflating away some debt, smoothing the crisis, and maintaining tax rates. While this paper is not his most influential, I reckon a lot of policy advisers will be trawling through it and those it influenced over the coming weeks.

*Barro, R., "Are Government Bonds Net Wealth?", Journal of Political Economy, 1974, vol. 82, no. 6

Paul Romer Paying $13

An American growth economist, Romer has been named amongst the 25 most influential Americans by Time (1997), though only makes IDEAS' top 100 economists. His contribution has been to take exogenous growth theory, and look at technological and environmental constraints. This can best be summed up by a quote:

"Economic growth occurs whenever people take resources and rearrange them in ways that are more valuable. A useful metaphor for production in an economy comes from the kitchen. To create valuable final products, we mix inexpensive ingredients together according to a recipe. The cooking one can do is limited by the supply of ingredients, and most cooking in the economy produces undesirable side effects. If economic growth could be achieved only by doing more and more of the same kind of cooking, we would eventually run out of raw materials and suffer from unacceptable levels of pollution and nuisance. History teaches us, however, that economic growth springs from better recipes, not just from more cooking. New recipes generally produce fewer unpleasant side effects and generate more economic value per unit of raw material."

Paul Krugman--Paying $16

Rounding up my guide is Paul Krugman, a Princeton professor and New York Times columnist. A favourite among liberals and Democrats, he is equally hated by conservatives and libertarians. This is partly because, as such an industrious economist (and commentator), he provides a large target. Daniel Klein, an economist, wrote "The principle reason I scrutinize Krugman is that he is brilliant, outspoken, relatively candid, industrious, and highly visible and influential. Investigating him is a way of investigating a larger cultural phenomenon" which "is ready to sacrifice poor people's interests for the sake of social-democratic values".

So if he is just a shit-stirrer, why would he be paying these (relatively) short odds? Apart from penning one of my favourite columns, which mainly deals with political economy, he also has been a loud voice on trade theory and international monetary economics. In the early 90s, he savaged the (doomed) fixed exchange-rates of Asia, earning (maybe undeservedly) something of a prophetic reputation--though he denies having called the Asian Financial Crisis. He also recently predicted housing price drops in the US would be between 25 and 50%--rates individual suburbs in New Mexico, Arizona, and Florida are already experiencing.

Despite being so well known, and having so much clout, he is unlikely to pick up the cup this year. The Bank of Sweden prize tends to go to those who've made great contributions to theory, not analysis. Krugman is probably the best analyst around, but enjoys popular influence more than academic.

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