...against fictions and other tall tales

Wednesday, 31 July 2013

Bankers as public servants

An insightful anecdote by a reader of the American Scholar on how banking has changed during his lifetime:
Good Fences Make Good Bankers” by William J. Quirk (Spring 2013) reminds me of an experience I had in the 1950s. A final-year law student interviewing for a position with a major bank in Ohio, I had the temerity to ask the interviewer what kind of financial future I might expect in a legal career with a bank. He paused and in measured tones told me that if I was concerned with financial success, I should not go into banking. Banking, he said earnestly, was a quasi-public-service industry, and its primary mission was to protect the funds of its depositors and assist its borrowing customers
Can you picture a bank interviewer, with a straight face, uttering these same words to a young job applicant today? (italics added)


Shapiro, Fred., "Bankers as public servants", American Scholar, Summer 2013.

Tuesday, 30 July 2013

Janet Yellen most prescient among colleagues

Economist James Tobin once wrote that every policymaker thinks and makes decisions based a model of the economy. Tobin explained that the model need not be a complicated one; it just needs to provide a useful framework for understanding the economy and how it evolves, as well as assist the policymaker in decision-making:
There is really no substitute for making policy backwards, from the desired feasible paths of the objective variables that really matter to the mixture of policy instruments that can bring them about. [...]  
The procedure requires a model -- there is no getting away from that. Models are highly imperfect , but they are indispensable. The model used for policymaking need not be any of the well-known forecasting models. It should represent the policymaker's beliefs about the way the world works...Any policymaker or advisor who think he is not using a model is kidding both himself and us...
This week, the Wall Street Journal published the results of an interesting study examining the statements of 14 policymakers made during the course of the recovery concerning the economy and its outlook. According to the WSJ, the statements of Janet Yellen have been the most prescient (see this clip). In other words, her model of the economy has been very effective at helping her anticipate the economy's prospects during the last few years. According to Jan Hilsenrath of the WSJ, one of the authors of the study, Yellen
...had a model of the economy that worked in this case. She has a model that says when there's a lot of slack in the economy, when there is a lot of unemployment, when there is a lot of idle factories, you don't get a lot of inflation. And that model worked this time around. [...] 
Her fans who want her to become the next Fed chair would argue she's been right before. She was issuing some warnings in 2006 about the housing bubble. She was talking in the 1990s -- you know, when you go to transcripts of Fed meetings -- about froth in the financial markets.
One interesting fact is that Janet Yellen was a student of Tobin (and a good one too).
When Janet L. Yellen was a graduate student in economics at Yale University, classmates quickly figured out that the best way to decipher Professor James Tobin's lectures was to borrow her notes. And long after Yellen received her PhD in 1971, the Yellen Notes--as they became known--served as the unofficial textbook for generations of graduate students. ''She has a genius for expressing complicated arguments simply and clearly,'' says Nobel winner Tobin.

Thursday, 18 July 2013

"You want to make sure you have sustainable economic growth? Invest in your kids"

Those words are from Art Rolnick, former senior VP of the Federal Reserve of Minneapolis. They're from a recently released video entitled The Raising of America - Are we Crazy about our Kids?

The basic message of the video is that investing in early childhood pays off in the long run. Here's what economist James Heckman has to say about one of the studies that concluded high-quality early childhood learning is beneficial to a child's performance later in life:
"What did we learn? Many things. It's very successful in terms of the economic performance of the children. For each dollar invested you get back somewhere between 7 and 10 percent rate of return per year over the lifetime of the child. Which is a huge rate of return."
Behind this impressive rate of return are large amount of statistics showing that the children who were enrolled in a high-quality early childhood program performed significantly better in school (and later in life) than those who weren't:
"They found that the children that were in the high-quality program were less likely to be retained in the first grade, were less likely to need "special ed", were more likely to be literate by the sixth grade, graduate high school, get a job, pay taxes and start a family. And the crime rate between the two groups -- the randomized group and the control group -- the crime rate goes down by 50 percent. So those look like pretty good outcomes."
A very smart production.

Tuesday, 9 July 2013

Does the concentration of finance matter?

It may sound like a strange question in light of all the talk about "too big to fail" during the last few years. But, believe or not, the idea that bank concentration has an impact on real economic activity isn't the standard view. Here's from a recent blog post by NY Fed economists Mary Amiti and David Weinstein:
The notion that financial institutions are large relative to the size of economies is not something that plays a prominent role in traditional economic theory. Macroeconomic textbooks tend to treat economies as composed of representative firms that are infinitesimal in size compared to any given market. As a result, positive and negative idiosyncratic shocks [movement in bank loan supply net of borrower characteristics and general credit conditions] to financial institutions cancel out due to the law of large numbers. 
However, this representation stands in stark contrast with the reality of concentration in financial markets. A striking regularity is that a few banks account for a substantial share of an economy’s loans.
Starting from this basis, Amiti and Weinstein have examined Japanese aggregate bank lending data and other aggregates and were able to demonstrate the following: banks matter, bank concentration matters, bank lending matters. No small feat.

On the issue of bank concentration and aggregate lending, they found that
...if markets are dominated by a few financial institutions, cuts in lending due to some change in financial conditions in just a small number of banks have the potential to substantially affect aggregate lending. Moreover, if firms find it hard to find good substitutes for loans like issuing equity or debt, then it is possible for their investment rates to fall as well. 
As for their take on banks' impact on the real economy, the conclusion to their paper (on which their blog post in based) gives a good summary:
Our paper contributes to this literature by providing the first evidence that shocks to the supply of credit affect firm investment rates. We find that even after controlling for firm credit shocks, loan supply shocks are a significant determinant of firm-level investment of loan-dependent firms. This result is particularly surprising because our sample is comprised of listed companies that have, by definition, access to equity markets. Moreover, the fact that so much lending is intermediated through a few financial institutions means that idiosyncratic shocks hitting large financial institutions can move aggregate lending and investment. We show that about 40 percent of the movement in these variables can be attributed to these granular bank shocks. This means that the idiosyncratic fates of large financial institutions are an important determinant of investment and real economic activity.
And the implication for policy, according to Amiti and Weinstein, is significant. Here is the relevant excerpt of their blog post on this point:
...[P]olicymakers without detailed information on the major financial institutions are likely to have a difficult time understanding the causes of lending and investment fluctuations. A large portion of Japan’s aggregate economic fluctuations can be traced to the country’s banking problems. 
While many researchers have focused on the implications of banks being “too big to fail,” we show that even if large banks do not fail, granular bank shocks can have substantial impacts on aggregate investment. 
For example, reductions in bank capital at large financial institutions can cause investment declines by firms that would like to borrow, while recapitalization of the right institutions can stimulate investment. In sum, this study shows that what happens to large financial institutions is important for understanding aggregate investment behavior. 
While their paper looks specifically at Japanese data, the authors suggest that the overall conclusions are relevant to the situation in the US given that it too has a very concentrated banking sector.

Amiti, Mary and David Weinstein, How much do banks shocks affect investment: Evidence from matched bank-firm loan data, NY Fed staff paper 604, March 2013