What is your main research topic? My work falls into two fields of economics: (applied) Microeconomic Theory and Political Economy. My job market paper is on the topic of Persuasion. Games of Persuasion consider instances in which a decision-maker must make a decision in a risky environment. To inform this decision, better-informed but self-interested experts are asked to provide information. Although the fact that experts are biased is a concern, it is typically thought that relying on polarized experts helps reaching a satisfying outcome. I revisit this issue in a model that puts emphasis on the incentives experts have to gather information. What I find is somewhat surprising since I show that when polarized experts have high stakes in the decision, which is being made, it can be the case that there is generally little diversified information being provided. The benefits typically associated to polarization are diminished. I am currently working on an empirical strategy to test the model’s predictions using data on Civil litigation. I am also working on a series of papers, together with fellow TSE student Simone Meraglia, investigating the determinants of political and economic institutions. In these projects, we are particularly interested in the role played by the threat of expropriation by the state (e.g. the military, the bureaucracy) in the shaping of institutions. Our main contention is that market economies are fragile in that the created wealth is easily appropriable. As a result, to foster trade and extract large revenue from taxation, the state has no choice but to grant political institutions to curb its own strength. We make the case that this logic explains particularly well the grant of autonomy to towns involved in trade in Medieval times. Did this visit help you to advance your research project(s)? Absolutely. It allowed me to discuss my work with some of the leading researchers in my fields by giving talks in various universities and U.S. conferences. On that note, I found that coming from Toulouse usually facilitated these interactions: TSE students enjoy a good reputation abroad. This experience also helped me understand better what made a good job market paper. For instance, the great emphasis put on empirical relevance convinced me to test some of the predictions of my model on Persuasion. Finally, I made great use of Harvard’s library to have immediate access to History books relevant for my work on Institutions. Did you like the academic environment there? Is it very different from that of TSE? What are the main differences? I did like the academic environment at Harvard, although I wouldn’t say that it is very different from that of TSE. Several differences between Harvard and TSE do however come to my mind. PhD students are supervised by several Faculty members there, which I think is a good way of fostering student-faculty relations and having students work on both theoretical and empirical analyses of their topics. I also think it is much more common for PhD students to work as research assistants, which is a good way of developing research skills early in the PhD. On the other hand, students in Toulouse seem to cooperate more and better amongst themselves. In terms of teaching, greater emphasis seems to be put on the acquisition of modeling tools in Toulouse. Overall, did you enjoy this experience? Do you recommend to other TSE students to visit another university for some months during their PhD studies? Do you want to add anything else about your experience? My spell at Harvard was a tremendously positive experience and I certainly recommend such experiences to other students in Toulouse. I think it is best to do such a visit in the third year of the program, once a field of research has already been chosen. As a last piece of advice, I recommend to TSE students visiting other departments to present frequently in seminars, as this is the best way of connecting with fellow students and Faculty members. Staying anonymous in big departments is easy!
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What is your main research topic? I am interested in the industrial organization of health insurance and networks. Did this visit help you to advance your research project(s)? Definitely. I was able to meet several students and faculty who were very helpful and who gave me a different perspective on my work. I even started a couple of projects while I was abroad. Did you like the academic environment there? Is it very different from that of TSE? What are the main differences? I visited U Chicago and Stanford for a few months and in both places I found the faculty and the students extremely welcoming and the academic environment great and quite similar to TSE’s in many ways. I will highlight some of the differences I personally found most striking. I visited the University of Chicago to attend a course on “Price Theory” which is Chicago’s approach to micro. The course was taught by Gary Becker and Kevin Murphy (who some people call the Sherlock Holmes of Economics) and it offered an interesting new perspective that takes aggregate market quantities such as demand curves as primitives. The course focused on thinking through difficult economic problems using only creativity and basic concepts such as elasticities and the Slutsky equation, and essentially no mathematics beyond univariate calculus. The thing that surprised me the most was the emphasis on empirical work. It was very surprising to tell people about the generality of the models I had been working on, only to find them asking me about the magnitudes of the effects or about how a much simpler version of my model could be empirically tested. Because TSE has a large share of theorists, it is important for TSE students to be aware of the value placed on empirical research in the current job market. On a similar note, I also felt that the US departments placed a lot of emphasis on preparing students for the job market. For instance, students tend to focus on their job market paper for most of their PhDs. One can debate if this is ideal for the profession, but it does seem to be a fact. Moreover, I got the impression that US students practice presentations and interviews more often than European students. Another important difference was student collaboration. Especially in Stanford, I felt that a majority of students were working on papers in groups, which seemed to make the whole experience faster, more fun and more rewarding. Staring at an equation/regression for days is a lot less frustrating if there is someone else around that is just as invested. Perhaps it should even be a rule that students should co-author one of their dissertation chapters. The last major difference was sandwiches. There were a large number of catered lunch seminars in both universities I visited where students and faculty typically present ongoing work or a recent working paper. While lunch time is a good break from a long day of economics, catered lunch seminars attract lots of participants to come together in an informal environment to discuss each other’s work, create a good sense of community and are a great way of adding an hour of productivity to one’s day with little extra pain. I went for the free food but ended up meeting several people and had a number of ideas while attending. I suspect that investing in sandwiches has a dramatic impact on a department’s research output but I don’t have the data to prove it. Overall, did you enjoy this experience? Do you recommend to other TSE students to visit another university for some months during their PhD studies? Do you want to add anything else about your experience? I enjoyed my experience a great deal and would very strongly recommend it. While most departments are not able to offer money and frequently have little desk space, I found faculty and students extremely welcoming to someone willing to make the effort to visit them. BS-Initiative is a non-lucrative organization gathering PhD students and young professionals that are eager to share their analysis and expertise on economic and financial matters. Created in October 2012, it aims at promoting the contributions of its members, in order to add a scientific dimension to the public debate on economics issues. BS- Initiative’s editorial and organizational pillars are informing, understanding, analyzing, proposing and sharing ideas. The diversity of our members’ backgrounds and the high number of contributions and ideas makes the BS-Initiative a source of high-quality economic thoughts, analyses and facts. The association follows two goals: to build up a dynamic network of economists and to propose valuable analysis that contributes to the public debate in an effective and lasting way. An international network The BS-Initiative is structured around an editorial committee responsible of guaranteeing the accuracy and coherence of the propositions published by our contributors. Economists following (or have followed) a doctoral formation form this editorial committee. At the beginning of 2013, BS-Initiative consisted of 16 contributors from French universities (Toulouse School of Economics, Paris School of Economics; HEC, Dauphine; Sciences Po Paris) and international universities: Italy (Univeristy of Venise), Belgium (Université de Louvain), Germany (University of Mannheim), and Australia (University of Sydney). Most of the contributors studied at the Toulouse School of Economics and have contributed to the development of the student network at the school (especially through their involvement in the TSE Junior Etudes). In addition, economists from the domains of Banking, Finance and Insurance have joined us. They usually work on country risk analysis on and economic and financial forecasting in their respective organization. By sharing their analyses on bs-initiative.org they are allowing young graduates to enter a privileged network of economists as well as developing a platform where information is exchanged and discussed. A wide distribution of our contributions In less than six months, a user-friendly website has been developed and regularly updated. It supports the long term strategy of organisation. In addition, multiple partnerships have been developed especially with the ‘Cercle les Echos’, first economic daily newspaper in France, and the ‘Economie Matin’, a former journal nowadays published exclusively online. In « Economie Matin », BS Initiative publishes in the « Experts » rubric, along with other important contributors such as Jean-Paul Betbèze, previous chief economist at Crédit Agricole. BS Initiative is highly supported by a network of professionals, graduating mainly with a master of finance from « Université Paris 1 Panthéon Sorbonne », which allows it to have a large access to the professional sphere as well as to the university. Our contributors also have been asked to participate in radio programs linked to economic news as well as publishing reports (like the one coming out in march 2013 « L’Ecole une utopie à reconstruire » edited by La Découverte). An opportunity open to every economist As it develops, BS Initiative continues to recruit a large number of people with a PhD in Economics, professionals in Finance, as well we young PhD students, eager to share their research and their knowledge at the service of public debate. We highly encourage you to read and share our contributions at www.bs-initiative.org!
What was your mission during your internship? I carried out a three-month internship at UNIDO where I worked in a research branch. During the first part of my internship, I had to compile a data set from several different sources. I was in charge of undertaking a literature review, which was carried out in order to select the papers they should use to complete the upcoming annual industrial report. Finally, I had to help perform an econometric analysis of a working paper they wanted to improve. How did you use what your learnt at the TSE? What I learned at TSE helped me in many ways. First of all, the theoretical skills we develop at TSE turned out to be invaluable when undertaking the literature review. Indeed, being able to understand what is at stake in a paper requires some specific math and econometric skills that we acquire at TSE. The classes we have on the software R could have been useful for the data management work they asked me to perform, but unfortunately they used another software. Finally, the official language was English, so the fact that our classes are in English did help me in this matter. How did you get the internship, any advice for students wanting to find one in that field? First of all, as trivial as it seems, applying early does increase your chances of getting in, as you have to compete with hundreds of applicants. Moreover, I would advise students to write quite specific cover letters in order not to make it seem that you wrote a general cover letter that you reused many times. In addition, I think recruiters in this field do care a lot about your language skills and also about your experience in international environments. So, do not forget to highlight them in your CV! Despite the rigid appearance of the application procedures, it may help you to contact people directly to show your interest on top of sending in the application. What was your mission during your internship? I worked as a junior consultant for France Telecom – Orange in the strategy and regulatory affairs in Paris. My job was to study the current model of private copying levies and to create a new one to respond to the forthcoming change in regulation. In a nutshell, a private copying levy is a “tax” that you pay when you buy a device where you can burn or store music or movies on it; it allows you to make private copies of the songs/movies from the original support to device such as CDs, USB, IPod... This tax is redistributed to rights holders (songwriters, singers...) who fight for a high tax against people like France Telecom, Apple or Samsung who want as low a tax as possible. The questions were: Who should pay (consumers, industries...) ? How much per song/ movie? Can we consider copies in the cloud (Dropbox, Google Drive) as private copies and thus relevant to the Levy? This last question is in debate at the European level as consumers are more and more using these services to store their data (and thus their music, movies, etc.). In addition to this, I worked on the economic aspects of net neutrality (Do content providers have to pay for network facilities?) and cloud computing development. How did you use what you learnt at TSE? During this internship I mainly used the incentive and taxation theory that I learnt in TSE. As I was working in the economists’ team, my background in game theory and industrial organization was obviously helpful to interact with my co-workers on other concerns. The part on private copy levy was mainly applied strategy, as a matter of time, we had to go straight to the point and I didn’t use clean economic theory. However, I had to go through many papers on network theory to tackle the issue of net neutrality and cloud computing. How did you get the internship? Do you have any advice for students wanting to find one in that field? I found my internship on the TSE website, in fact, the school has a strong network, so I advise you to use it! Search everywhere and don’t hesitate to send dozens of CVs. Seeing the many things we study at TSE, we sometimes tend to forget that one of these subjects might be very relevant to the internship you’re applying for. If addressed and illustrated in a simple way during your interview, you can demonstrate to the interviewer your knowledge of economic theory as well as your ability to put it into practice in empirical situations, which might be just what you need to get the internship! What was your mission? RBB is a consulting firm that provides expert economic advice on all aspects of competition law. During my stay at RBB, I worked on one cartel case, a merger case and a follow-up damage claims case, at both the European and French levels. More specifically, my work focused mainly on the empirical aspects of the case, handling a lot of data: I helped to analyse data provided by the clients to support our theoretical arguments. How did you use what you learnt in TSE? Competition law is rooted in economic theory and more specifically in the theory of industrial organization. As such, for each case I worked on, I have been asked to apply theoretical concepts and quantitative techniques I learnt in different classes at TSE, obviously in Competition Economics but also in Microeconomics, in Industrial Organization and in Econometrics. As a consultant, you have to work hard and be able to deliver under pressure, two skills I’m sure you have developed while studying successfully in TSE! I think that a school like TSE is the best place to be well prepared to work at RBB. How did you get this internship? Any advice for students wanting to find one in this field? To get my internship, after attending a presentation from one RBB partner at TSE, I simply sent the company my CV along with a cover letter. I then attended one interview in Brussels, completed a short written test, and had the pleasure to learn one month later that I had been selected to be part of RBB for a 6 months internship. My advice to anyone highly motivated in working in that field: be ready for challenges, and go for it! What is your main research topic? I am interested in macro and finance and, more precisely, I am working on a topical subject: sovereign debt. A recent argument for explaining why countries honor their debt is the presence of internal costs of default: debt is usually in the form of bonds partially held by domestic residents. Thus, when defaulting, a sovereign inflicts damage to its own country. My research tends to explain why the government cannot perfectly make up for such internal costs, using, for example, bailouts or any other forms of compensation. This has some implications for domestic financial development and its degree of complexity or opacity, through, for example, credit derivatives or interbank markets. Because of these markets, governments have difficulties to assess precisely domestic exposures, and so they are unable to make up for internal cost of default. It is not ex post desirable, but ex ante, this allows the government to credibly commit. Now, I am considering other forms of bailouts: why does a country want to bail out another country? In concrete terms, why do European countries want to (at least partially) save Greece or Portugal? Did this visit help you to advance your research project(s)? Yes! It did help me a lot and it is still helping me for my research. First of all, visiting another department, wherever it may be, forces to present to other faculties or students ideas or projects that have had already been presented. That helped me to ask once again some questions and to reformulate some results in a new and, sometimes, more interesting way. It was also useful because after one year of full-time research, I had the feeling that I had accumulated a lot of questions or ideas without having sufficiently ordered them. For sure, no need to say that I have also received a lot of new advices and comments on my research, and, on top of that, I had the opportunity to work on new topics leading to new research projects. Did you like the academic environment there? Is it very different from that of TSE? What are the main differences? The academic environment is exceptional at MIT, even though, in general it might seem not fundamentally different compared with TSE. There are a lot of high-quality seminars and workshops. Possibilities of interactions with faculties or other students are numerous. However, at MIT as in Toulouse, these interactions arise only because I created them. In overall, did you enjoy this experience? Do you recommend to other TSE students to visit another university for some months during their PhD studies? Do you want to add anything else about your experience? I really enjoy my visit at MIT and I do recommend to TSE students to make visits during their PhD. I really think that this is a necessary experience for doing research, especially in economic sciences where it is usually about presenting and sharing ideas. Alexander Michaelides is Professor of Finance at the Department of Public and Business Administration of University of Cyprus. He holds a B.A. in Economics from Harvard University and a PhD in Economics from Princeton University in 1997. He worked as Foreign Exchange Economist at Lehman Brothers International in London before joining University of Cyprus as a reader and assistant professor in 1998. In 2001 he moved at the Department of Economics of London School of Economics initially as a lecturer and then as a reader. He rejoined University of Cyprus at 2010. He is specialized in Macro-finance with noticeable contributions in heterogeneous agent models, portfolio choice and asset pricing. I will attempt to analyse the crisis faced by a small open economy (Cyprus) in the Eurozone, and argue that there are interesting questions for both policymakers and academics that arise from this case study. At this point in time, Cyprus is in the process of negotiating the terms of a memorandum of understanding with the Troika (the European Commission, the European Central Bank and the International Monetary Fund). Cyprus is expected to receive a credit line of approximately 17.5 billion euros (small in absolute amounts but large relative to Cyprus’ GDP (100%)). Around 10 billion euros (57%) will be earmarked for the recapitalisation of the banking system and 7.5 billion (43%) will be earmarked for the rollover of expiring debt and budget deficits until 2016. In exchange Cyprus is implementing austerity measures to be able to repay the additional government debt that could exceed 140% (relative to GDP) by the end of 2016. This end result generates a number of questions. How did Cyprus reach this point? Could the current crisis have been avoided? What measures could have been taken to avoid this eventual outcome? Is entry to the Eurozone on 01/01/2008 responsible for this eventual outcome? Is exit from the Eurozone a possible solution? These are some of the questions that are being discussed openly in Cyprus. I will not attempt to answer these here but will discuss chronologically how economic events unfolded and ask the questions policy makers and academics should be interested in from this case study. Cyprus entered the Eurozone on January 1st 2008 and the European Union on May 1st 2004. As in other southern European countries, the combination of lower interest rates through Eurozone entry and better guarantees of property rights through EU entry generated a rapid increase in external demand (first from the United Kingdom, then from Russia) for holiday residences. Locals also started borrowing more due to lower interest rates and a relaxation of down payment constraints locally. By 2010 the combination of household and corporate debt to GDP was, within the Eurozone, second only to Ireland: household debt to GDP was 159.2% and corporate debt to GDP was 144.5% (Lane, 2012 and author’s calculations). An interesting (academic and policy) question arises from this development. What level of private debt to GDP is “dangerous” for financial stability in a country? When land restrictions are tight, either due to stringent planning permission laws or simply the lack of space, tangible assets to GDP tend to have high values. Kiyotaki, Michaelides and Nikolov (2011) make the point that, in a calibrated general equilibrium model, a fall in interest rates leads to higher house price changes in countries with tighter land constraints. We expect Japan and the UK to have a higher ratio of tangible asset value to GDP, and we expect housing prices to be higher in coastal cities relative to cities where land is plentiful (for example, Glaeser, Gyourko and Saks (2005)). Along with high values come also high debts. Given this natural variation in debt levels across countries, at which point does private debt to GDP become dangerous for financial stability? There was also a change in government in Cyprus in February 2008. A more leftist government took over, with a much stronger preference for redistributive policies. Just as external demand for tourism and holiday residences was dropping due to the world economic crisis, the government expanded social transfers dramatically. The government debt to GDP was 48% in the end of 2008 and finished the third quarter of 2012 at 84% (including a 10% increase due to a bank bailout in 2012). A 3% budget to GDP surplus in 2008 became approximately a 6% deficit every year from 2009 to 2012, driven mostly by higher social transfers. At the same time, Cyprus had over time attracted substantial foreign deposits due to its low tax regime and relatively good value-for-money professional services. The banking sector had grown as a result and this trend became more pronounced after EU entry as foreign firms could enjoy a low tax rate within an EU jurisdiction. A natural place for banks to expand for diversification reasons was the Greek economy due to the common language and the substantial number of Cypriots living and working there. Banking sector assets managed to grow to the level of eight times GDP, since encouragement towards “financial integration” in a common currency area meant expanding heavily in Greece. As of September 2012, the three largest Cypriot banks had given out 132% gross loans to GDP and had a 77% deposit to GDP ratio. Thus, the expansion in Greece was financed partly through Cypriot deposits illustrating how global banks make decisions that can affect the host or originator country (Cetorelli and Goldberg, 2012 and Houston, Chen and Yue (2012)). As the probability of Greece exiting the euro rose after 2009, the bank exposure that had been built over the previous 15 years started to negatively affect the state of the Cypriot banking sector. Downgrades of the Cypriot sovereign debt started in 2010 citing repeatedly bad public finances, low competitiveness and the large size of the banking sector (with the implied contingent liabilities for the sovereign). Short term, foreign debt became more important in 2009-2010 as the lure of lower foreign interest rates was a temptation too big to resist in the face of falling tax revenues and higher government expenditures. Once Cyprus was shut out of the international debt markets after May 2011, rollover risk of existing short term debt became an additional, major source of headache for the Cypriot minister of finance. On July 11th 2011 the economy took an unexpected turn for the worse. A cargo of ammunition, that had been confiscated in 2009 under the international arms embargo against Syria, exploded killing 13 people. The cargo was being stored in between a nautical base and the main electricity-producing plant of the country. Immediately, power cuts started affecting negatively the economy and the mood of the country, and full power generation was not restored until 18 months later. In the midst of public anger, the government had to also deal with the worsening situation in Greece that was negatively impacting the local economy through trade links and the banking system. In October 2011 another fatal blow took place, and it emanated from the unintended consequences of the Greek PSI. Through the 79% haircut in net present value of Greek government bonds, 4 billion euros (the equivalent of 25% of Cypriot GDP) in bank capital was wiped out. An interesting policy question with regards to regulation arises here as some banks could be criticized more than others in how they accumulated this position. On one hand, according to Basel requirements government bonds get a zero risk weight. On the other, could banks have been taking on “zero risk” investments with substantial yield differentials relative to German Bunds as the “greatest” carry trade ever? (Acharya and Steffen, 2012). The continuous downgrades of sovereign debt from the three main rating agencies further exacerbated the problems of the banking sector, and by implication, the real economy. Higher funding costs were passed on to businesses and consumers, whereas there was more pressure on banks to increase their capital buffers, a manifestation of what Goodhart (2009) calls “procyclical regulation”. During a boom, any improvement in the credit grades of assets held by a bank, given the constant capital ratio requirements, implies that banks can increase lending. The reverse happens in a recession, so that an economy enters a vicious circle between a credit crunch and further sovereign debt downgrades due to the recession. This argument would surface again in October 2012 (definitely a recession period in Cyprus) when the Troika would require that banks increase their core tier I capital ratio from 8% to 10% within one year. I imagine that the motivation behind this requirement was that it would make banks more careful, attract private investors and reduce the uncertainty arising from evaluating uncertain loan portfolios. But then the question naturally arises: is that requirement the correct policy response during a crisis? Should these capital buffers not vary over the cycle, so that they rise in booms and fall in recessions? And if that should be the case, what should those capital requirements be? The issues are discussed in Kashyap and Stein (2004), Hanson, Kashyap and Stein (2011) and Repullo and Saurina (2011) but quantitative models providing answers to these questions are still not available. As the Cypriot economic crisis is on-going, and the agreement with the Troika has not been signed, all the questions above become important topics of research and discussion, both for European policy makers and academics. What levels of private and government debt are dangerous for financial stability? How should public debt be forgiven to limit collateral damage? Should all government bonds get a zero risk weight when computing capital needs? How does one regulate/ monitor cross-border banking activities? How can banking regulation become less procyclical? How does one alleviate the sovereign debt – bank balance sheet vicious circle? What are the appropriate monetary policy instruments in such an environment? What are the government’s policy options in such an environment? All these questions need further research to be addressed in an intellectually satisfying and policy-relevant way. References Acharya, Viral and Sascha Steffen, 2012, “The “Greatest” Carry Trade Ever? Understanding Eurozone Bank Risks”, working paper Cetorelli, Nicola and Linda Goldberg, 2012, “Banking Globalization and Monetary Transmission,” Journal of Finance, 67, 5, pp. 1811- 1843 Glaeser, Edward, joseph Gyourko and Raven Saks, 2005, “Why is Manhattan So Expensive? Regulation and the Rise in House Prices,” The Journal of Law and Economics, 48, 331-369. Goodhart, Charles, 2009, “Procyclicality and Financial Regulation” Estabilidad Financiera, (16), Bank of Spain. Hanson, Samuel, Anil Kashyap and Jeremy Stein, 2011, “A Macroprudential Approach to Financial Regulation,” Journal of Economic Perspectives, 25 (1), pp. 3-28. Houston, Joel, Chen Lin and Yue Ma, 2012, “Regulatory Arbitrage and International Bank Flows”, Journal of Finance, 67, 5, pp. 1845-1893. Kashyap, A., and J. Stein, 2004: “Cyclical Implications of Basel II Capital Standards,” Federal Reserve Bank of Chicago, Economic Perspectives, 1st Quarter, 18-31. Kiyotaki, Nobuhiro, Alexander Michaelides and Kalin Nikolov, 2011, “Winners and Losers in Housing Markets,” Journal of Money, Credit and Banking, Vol. 43, 2-3, pp. 255-296. Lane, Philip. 2012. “The European Sovereign Debt Crisis,” Journal of Economic Perspectives, 26(3), pp. 49-68. Repullo, Rafael and Jesus Saurina. 2011 “The Countercyclical Capital Buffer of Basel III: A Critical Assessment” CEMFI Working Paper No. 1102. Repullo, R., J. Saurina, and C. Trucharte, 2010, “Mitigating the Pro-cyclicality of Basel II,” Economic Policy, 64, 659-702. Frank Smets is Director General of the Directorate General Research of the European Central Bank. He is a Research Fellow of the Centre for Economic Policy Research in London and a managing editor of the International Journal of Central Banking. He has written and published extensively on monetary, macroeconomic, financial and international issues mostly related to central banking. Before joining the European Central Bank in 1998, he was a research economist at the Bank for International Settlements in Basel, Switzerland. He holds a PhD in Economics from Yale University. Questions by TSE students • Questions about research at a policy institution How different is it for a researcher to be employed by an institution like the European Central Bank (ECB) instead of being a full time faculty member at an economic department of a university? Does the lack of teaching obligations give you more time to focus on your research activities? I have never been a full-time faculty member myself so it is difficult to compare. One of the great things about working in the research department of a policy institution like the ECB is the direct contact with policy makers and the almost daily confrontation with new topical policy questions. When I started working for the Bank for International Settlements after graduating from Yale University in 1992, I found this the most rewarding aspect of becoming a researcher in a policy institution. At Yale, one of my frustrations was to come up with interesting, policy-relevant research questions. At the BIS the problem was the reverse: I did not know which policy question to address first. As a researcher at the ECB one does not have teaching obligations (although many of my colleagues do teach on the side). However, one does have other non-research obligations such as writing and presenting policy notes, preparing a speech, participating in the projection process, being involved in the organization of seminars and conferences, etc. One of the challenges is that compared to teaching and particularly in crisis times these activities are a bit less predictable and may therefore interfere with one’s research commitments. As with teaching, the opportunity is to explore the synergies between one’s research activities and one’s policy contributions. What if your research findings contradict some of the implemented policies supported by ECB? Do you feel restricted by the political nature of this institution? An important objective of the research department is to provide input in the policy process. In management jargon, we want to be a “trusted source of research-based policy advice”. The ECB’s policies therefore partly build on research findings. In this context, it is also the research department’s role to “think out of the box” and to potentially challenge prevailing policies. It is therefore natural that different views are sometimes expressed. The failure of mainstream economists to foresee the crisis shows that more than ever it is important to avoid groupthink. Research plays an important role. At the same time, it is of course important that the publication of research findings do not interfere with the ECB’s communication and policy of a “single voice”. That is why we have an ECB working paper series where most of our research is published under the responsibility of the individual authors. The editorial process focuses on ensuring sufficient quality and appropriate drafting, but is not there to stop the publication of policy sensitive research papers. • Questions about DSGE modeling and policy in the context of the crisis The Smets-Wouters model is part of the standard repertoire of the ECB, being the medium scale DSGE model that the ECB uses. The applications of DSGE (dynamic stochastic general equilibrium) style models have been widespread ranging from pure story-telling and computational illustration, to policy evaluations and forecasting.Wheredoyouseethefutureof DSGE modeling? Which particular trends and extensions would you emphasize? What applications might be more/less feasible in the future than they are now? Medium-scale DSGE models such as the ECB’s New Area-Wide Model (NAWM), the New Multi-Country Model (NMCM) or the Christiano-Motto-Rostagno (CMR) model have over the past decade become standard tools at central banks and other policy institutions. In spite of all the criticism that these models have received following the financial crisis, I think that these tools are here to stay. Every model is only an imperfect and very partial description of reality and is usually designed for specific purposes and to analyze specific questions. It is therefore natural that models evolve as new questions come up. Most policy institutions use a suite of models not only to be able to address different questions, but also to robustify the policy implications. I would emphasize two particular extensions. First, since the financial crisis a lot of research has focused on introducing financial intermediation in macroeconomic models. We have learned that the banking sector is not always a veil and we need to better understand how the financial system and the real economy interact. Under what circumstances does financial instability arise? How does it impair the monetary transmission mechanism? What does it mean for regulatory and non-standard monetary policies? Another direction for on-going research is a better modeling of how expectations are formed and how diverse views by economic actors develop and interact. Both of these developments are challenging because they introduce much more heterogeneity (they move away from the so-called representative agent paradigm) and non-linearity in the DSGE models. This makes solving the models more complicated and time- consuming, but as computer speed and solution algorithms advance new frontiers continue to be explored. Yet these models and their use in policy making are also heavily criticized. What are the methodological shortcomings of this type of approach in your opinion? And what would you respond to the critics who think that such models when taken too literally may give a false sense of scientific sophistication? As I mentioned before, any model is an abstraction of reality and, unfortunately, it takes a model to beat a model. The role of formal models in policy making is generally exaggerated: policy makers do not only use a suite of models, but also a lot of judgment, simple rules of thumb, intuition, etc. when making policy decisions. The standard New Keynesian linearized DSGE models with their emphasis on price and wage stickiness have and will continue to play a useful role, but they were not designed to address some of the new questions that came up in the financial crisis. Some of those questions such as the impact of financial fragility on the transmission process may be addressed in extensions of those models. For other questions, radically different models with different forms of expectation formation and heterogeneity may have to be developed. This makes macroeconomics so exciting in the current context. • Questions about Macroeconomics and Central Banking in the wake of the financial crisis There appears to be a sharp divide in the analysis of what caused the current European debt crisis, and how it should be resolved. For example, how do you view the German-French debate between austerity and growth? And what do you think of the contributions macroeconomists and central bankers have made to this debate? Characterizing the current debate as one between austerity and growth is misleading and too simple in my view. The sources of the euro area sovereign debt crisis are multiple and not just the result of excessive sovereign debt accumulation or excessive consolidation. In Ireland and Spain the proximate source of the problems is the bust of the excessive credit and housing boom and the fall out in terms of a fragile banking sector, weak economic activity and falling government revenues. In Portugal and Italy the most important fundamental factor is the very low productivity growth over the past decade and a half. Only in Greece the underlying problem was excessive government debt accumulation. A common symptom in each of these countries has been a persistently large current account deficit and a large and increasing external debt of close to 100 percent of GDP. When the financial crisis led to a freezing of the interbank market and a sudden stop in capital flows from the core to those countries, this set in motion a number of “diabolic” negative spirals between the banking and the sovereign risks and between those risks and the real economy. Throwing more debt after debt cannot stop these negative spirals. Instead a combination of policies needed to be put in place. This includes i) fiscal consolidation in particular in those countries where the sustainability of government debt is put into questions; ii) structural reforms aiming at improving competitiveness to turn around the current account deficit, stop the accumulation of external debt and regain the trust of international investors; iii) a restructuring and recapitalization of the financial sector to allow it to provide credit to new projects; and iv) a credible backstop mechanism like the ESM and the ECB’s OMT to avoid that self-fulfilling fears of a break-up of EMU undermine government finances. At the same time, institutional reforms need to be undertaken in order to mend the design flaws in EMU and break the link between sovereign and banking risks. The most important reform in this respect is the establishment of a financial market union, comprising of unified banking supervision, a common bank resolution mechanism and a joint deposit insurance system. The fiscal consolidation debate is not about austerity versus growth, but it is about how can governments ensure the sustainability of their debt and improve the efficiency of the government with the view of promoting growth. Fiscal consolidation needs to be done in a smart way and this may differ from country to country. Fiscal consolidation has long-run positive output effects. The question is how these medium-term positive effects can be brought to the present. The answer is by ensuring credibility of the program. In countries in which confidence is low this will require front- loading with possibly negative short- term output effects. Research on fiscal multipliers is important to calibrate those fiscal consolidation policies. What lessons do you draw from the financial crisis? What are the important questions that you feel we (economists) need to work on to avoid similar events in the future? For me one of the most important lessons is that we need to increase the buffers both in policy making and in financial markets. In what direction do you think Macroeconomics will evolve? Will we see a shift of paradigms, much like we saw in the 70s? If so, what will the new macroeconomics look like? Difficult question! There will be more focus on expectation formation and behavioral phenomena such as herding, groupthink and cognitive biases. This will require thinking about new dynamic equilibrium concepts. Macroeconomics will have to pay more attention to the financial system and its interaction with the real economy. This means that rather than one interest rate; macro models will have a multiple of interest rates. It also means that more emphasis will be put on stock and flow interactions and monetary and credit quantities. One of the stylized facts of financial crises across the globe is that credit booms almost always precede them. The interaction between monetary and fiscal policies will also come more and more to the forefront as central banks exit from crisis management. Last but not least: What advice would you give graduate students who wish to start their own research careers in the area of business cycles and monetary policy? It is an exciting time to be studying business cycles and monetary policy. The great recession and the euro area sovereign debt crisis will provide inspiration for many decades to come. I would advice students to look at European data and issues and not only to follow the American research agenda. Introduction to the interview with Eric Maskin by Jean Tirole I’m very pleased that The TSEconomist chose to interview Eric Maskin, who in turn kindly accepted to participate. Eric Maskin is a role model for scholarship. There is no point reviewing here his breakthrough contributions to the economics of incentives; they are well-known and have been deservedly recognized by the Economics Nobel Prize Committee. Let me just say a few words about a slightly less well-known side of Eric. As all those who have met him will confirm, he is a very modest person; he is also a very good citizen and generous with his time. A superb advisor, he has mentored generations of students at MIT, Harvard and Princeton and has changed the path of their careers. I had the great opportunity to be one of his first students- along with my MIT classmate Drew Fudenberg. Extrapolating on our own experience, I can conjecture that his extraordinary track record with students is due to three factors. First, he never insists on his students embarking on his own research topics. He is intellectually curious and will get interested even in subjects lying clearly outside his area of expertise (at least when the student starts working on them- quickly Eric becomes an expert...). If a research path will in his opinion lead to a dead-end or to an unambitious outcome, he will say so. But otherwise he will be strongly supportive, regardless of the topic. As he rightly argues in his TSEconomist interview: “I think the most important element in producing a successful Ph.D. dissertation is being really interested in the questions you are trying to answer. If you truly care about the subject, you have the incentive to immerse yourself in it – and that’s what leads to a good dissertation. In fact, this is probably the most important element in producing good research more generally.” By being supportive of the student’s own interests, Eric makes it more likely that the student succeeds in his/her dissertation and start of career. I should mention two other factors, both related to the personal traits mentioned above. First, he is very generous with his time. I still fondly remember the tutorials Drew Fudenberg and I had with Eric Maskin in his MIT office. He would discuss with us the yet unpublished papers of now classic work by for instance Myerson, Myerson-Satterthwaite, Green-Laffont, Milgrom-Roberts, Kreps- Wilson and (as we asked him) his own work by himself or with Jean-Jacques Laffont, John Riley, Peter Diamond or Partha Dasgupta. This was just extraordinary; we just saw the field of economics change in real time and were getting insights as to what the shortages of the new approaches (game theory, information economics) and areas for future research were. This is what my TSE colleagues try to emulate today by covering recent developments in an enthusiastic manner. Eric’s second trait that makes the PhD process under his supervision both enjoyable and productive is his graciousness. Working on a PhD thesis generates anxiety; regardless of previously demonstrated talent, performing research is for most PhD students a jump into the unknown and there are always many moments of doubt, when one wonders if one is able to fulfill expectations. Self-confidence is with passion a key to delivering good research; but unlike passion, self-confidence is fragile and does not come by easily. Eric has always been a gentle supervisor. While he clearly indicates to the student unpromising research paths or wrong reasoning, he always does so in a soft, constructive manner. Let me give you an anecdote, which probably Eric does not recall (and that I almost successfully repressed myself). In my second year of the PhD program, I had the great opportunity to work on a joint paper with him on Keynesian equilibria – this was the beginning of a long collaboration (indeed in the following year, while I was still an MIT student, we started working on the various papers on Markov perfect equilibria – the pure game – theory piece as well as the three IO applications). One day, while he was away at a conference, I added a proposition to the paper. Alas, this proof of the proposition contained a fateful mistake. When returning, Eric quickly figured out the mistake, but very graciously and in a soft-spoken way tried to find redeeming features (honestly, there were none, the mistake was rather stupid), and went on to provide an alternative proof. While embarrassing for me, this episode certainly taught me a lesson. Research is a complex alchemy, in which sheer analytical power is just one of many ingredients. Another ingredient is the ability to alternate between two opposite advocacy roles: wishful thinking- hoping that a proof or idea will work, sometimes against all odds, and not hesitating to take shortcuts before writing things more carefully – and critical examination – submitting the outcome to the toughest refereeing process possible. Yet another absolutely key factor is passion, as described in the interview. And finally there is a large payoff to being in the right place with the right people. Eric Maskin is certainly one of these scholars who always make the investigation intellectually challenging and at the same time much fun, as it should! Interview with Eric S. Maskin: Questions by TSE students Eric Maskin is Adams University Professor at Harvard. He received the 2007 Nobel Memorial Prize in Economics (with L. Hurwicz and R. Myerson) for laying the foundations of mechanism design theory. He also has made contributions to game theory, contract theory, social choice theory, political economy, and other areas of economics. He received his B.A. and Ph.D from Harvard and was a postdoctoral fellow at Jesus College, Cambridge University. He was a faculty member at MIT from 1977-1984, Harvard from 1985-2000, and the Institute for Advanced Study from 2000-2011. He rejoined the Harvard faculty in 2012. • Life and the Nobel Prize Why did you decide to become an economist given that you were trained as a mathematician? How much investment in math would you recommend to Ph.D. students interested in economic theory in general but without any math background? It’s true that my initial training was in mathematics. However, almost by accident, I happened to take a course from Kenneth Arrow on “Information Economics,” which was so inspiring that I decided to change direction. It seemed to me that economics combined the best of both worlds: the rigor of mathematics with the immediate relevance of a social science. As for how much math I would recommend, I’d say that basic analysis, including measure theory, is certainly very useful. Also, linear algebra and stochastic processes always helps. But beyond that, I don’t think a huge mathematical investment is necessary to do economic theory unless you are planning to work in an extremely technical area. What were your immediate reactions and thoughts when you were informed that you won the Nobel Prize? How did being a Nobel laureate affect your life? My first reaction was great surprise and a sense of unreality – but also pleasure, especially from the fact that Leo Hurwicz and Roger Myerson were being recognized too. For the most part, the prize hasn’t changed my life a great deal, but it has given me the opportunity to visit some places I wouldn’t have otherwise seen and meet some people I wouldn’t have otherwise come across. It has also given me the chance to speak to a much broader audience. What was the feeling of living in the Princeton house in which Albert Einstein spent the last 19 years of his life? What do you think is the most remarkable element of his work and his legacy? It was certainly a thrill to live in Einstein’s old house; he has always been one of my heroes. For me, his most remarkable accomplishment is to show how far we can go in understanding the world through pure thought alone. You come from a musical family: your mother taught at Juilliard and your brother is a professional oboist. As a matter of fact, you turn out to be a first-rate musician yourself. You play the piano as well as the clarinet, and perform regularly in concerts, mainly classical music, but also jazz. Did your involvement with music affect your research life? Did you ever regret that you did not follow the family tradition in the choice of your profession? Music has helped provide some balance to my life. I love doing research, but must acknowledge that writing an economics paper does not allow me to express my emotions very much. Playing music, by contrast, gives me a rich emotional outlet, which is very satisfying. I don’t regret not becoming a professional musician. As it is, I have the best of both worlds – I can do economics and play music on the side (perhaps not as often as I’d like, but still quite a bit). It would be very hard for a professional musician to do economics on the side. • About Crises and Economic Theory The recent financial crisis revealed that markets do not work so perfectly as some policy makers had thought. What were the main reasons for which policy makers and politicians were so confident about the performance of financial markets and rejected the call for more stringent regulation? Can such behavior be justified by realistic economic theoretical models? What do you think are the main lessons that we should keep in mind for the future? I don’t really understand why politicians and policy makers had such faith in the self-regulation of financial markets – perhaps ideology had something to do with it. Certainly, such faith was not based on a good understanding of economic theory, which shows very clearly how financial markets can fail because of serious externalities. I hope that we remember going forward that financial stability depends on correcting these externalities, and that a good way of doing so is regulation – especially, regulation of leverage. How do you comment on the recent policy decisions of the EU, like the outright monetary transactions of the ECB, the austerity packages implemented in many European countries and the intensive discussions around the issue of Eurobonds? Do you believe that the currently applied rescue plans in these countries are incentive compatible or they leave room for misbehavior? I think the ECB’s accommodating monetary policy has been helpful, but I’m afraid that austerity programs have largely proved to be counterproductive; they were implemented at time when economies were still fragile, and have tended to make things worse. I applaud the idea of Eurobonds and other moves to integrate Europe’s fiscal side. Of course, rescue plans create a moral hazard problem, which is why the fiscal consolidation of Europe (including the power of a central authority to constrain member countries’ domestic spending) is so important. Do you think that the Euro as currency can survive the exit of one of the small and peripheral countries from the Eurozone (say Greece for example)? Could it survive the exit of Germany? Can the consequences of such events be really predicted? I’m no expert on European politics, but I’d guess that the Euro might survive the exit of Greece, but not the exit of France or Germany. The honest answer, though, is that these are just wild guesses. I suspect that even experts on the subject can’t do much better than guess. • Patent Protection and Innovation Your opinion that patents can inhibit innovation in particular in industries like the software industry seems at first sight to contradict the conventional wisdom that patent protection leads to more innovations. Do you think that we should weaken the patent protection in particular industries in order to improve social welfare? There are indeed industries in which relaxing patent protection might be good for innovation and society. This is true especially of industries – like software – in which invention is highly sequential; where instead of there being one big discovery, there are lots of little discoveries, each building on what has been done before. In such industries, patents can block critical follow-on innovation. You may want to build on a discovery I’ve made. But if I hold a patent on that discovery, I am apt – as a monopolist – to set a high license fee, which may well deter you from innovating. • Our final question: You have contented yourself with your research, but have been a fantastic advisor as well. What do you think are the main ingredients of a successful Ph.D. dissertation? I think the most important element in producing a successful Ph.D. dissertation is being really interested in the questions you are trying to answer. If you truly care about the subject, you have the incentive to immerse yourself in it – and that’s what leads to a good dissertation. In fact, this is probably the most important element in producing good research more generally. |
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