Seasonality in house prices

There is a marked seasonal cycle in many housing markets. Sale volumes and house prices are significantly higher in the Summer and lower in the Winter. Evidently there should be some arbitrage, by selling high and buying low and renting in between for those who are genuinely moving or simply holding on to real estate for speculators. Possibly, the transaction costs are too high for this to happen. Or maybe the market for houses is not fluid enough for price not to cycle in a predictable way.

Cemil Selcuk picks up on this second idea and builds a search model where the supply is smaller in the Winter in the sense that the probability of finding an appropriate house is lower. As a result, there are fewer successful matches in the Winter, and they happen with a lower price because of the discount cost of waiting for better opportunities in the Summer and because the matches in the Winter are of lower quality. This is a rather trivial theoretical result, and it would be nice to know whether it approaches quantitatively the seasonal differences that are observed.

Are multipliers larger than we thought?

In the last years, much of the debate on fiscal stimulus vs. austerity was centered on the measurement of government spending multipliers. And to a large extend this was a debate between those how used dynamic stochastic general equilibrium (DSGE) models, finding small multipliers, and those using reduced form models, finding large multipliers. Both strategies have pitfalls, the structural one in that the model may be miss-specified as it is always an abstraction of a complex reality, the reduced-form one because of the Lucas Critique.

Patrick Fève, Julien Matheron and Jean-Guillaume Sahuc make the point that there could be a source of downward bias in the estimation of the elasticity in structural models. It arises from ignoring the endogeneity of government expenses combined with complementarity between public and private consumption. With exogenous expenses, the elasticity is 0.97 for the United States, with endogenous ones, it is 1.31. No small potatoes.

Tax capital *and* inheritances

I probably do not surprise anyone if I claim that how much to tax capital income and bequests is controversial. In the United States, it is due a divergent beliefs about the motivation of entrepreneurs and luck of being born in the right environment. In Europe, arguments center on fairness. The literature does not help much, with results being very sensitive to income processes, market features and preferences. Capital income is generally taxed less than labor income, often not at all, and results on bequests vary wildly, again often with zero tax results.

Thomas Piketty and Emmanuel Saez add to this bewildering literature with a tour-de-force, a very rich, yet tractable model that allows to disentangle quite a few effects and illustrate what influences these taxes, in particular parameters that can be estimated. The richness is necessary to relate the model to real world better than the extant literature which yields this unrealistic and unobserved zero tax result. It is impossible for me to summarize over 100 pages in a few paragraphs, so here is a short overview.

The model features a large degree of heterogeneity, in taste for bequests and wealth accumulation, and in labor ability. Hence labor income and inheritance are not highly correlated, allowing for a trade-off between capital and labor income taxes because, as Piketty and Saez put it, two-dimensional inequality requires two tax tools. The tax on bequests is higher if bequests represent a large fraction of output, if the aggregate elasticity of bequests with respect to their tax is high, and if the taste for bequests is low. Tax rates on bequests can go all the way to 80%, and are for most parametrizations much higher than for labor income. This is because in general labor income should be favored, as it is derived from ability, unless people really like leaving bequests a lot.

If markets are imperfect and there is risk in capital return, then tax rates of capital income and bequests start differing. The lifetime equivalent of the capital income tax is then much higher than the bequest tax rate. because return fluctuations have stronger impact on periodic capital income than bequests, which are mostly accumulated capital and labor income. Important in this is also that in all economies, most people receive very little if any at all in terms of inheritance. This makes results remarkably robust with respect to welfare criteria.

Being tall and risk aversion

Are tall people less risk-averse than others? That seems like an odd question to ask. In particular, what would one want to do with the answer? Well, if the answer is no, this can help in establishing better insurance policies. Also, if some policies influence height, it is good to know what taller people entails (besides the known higher income and confidence).

Olaf Hübler finds that, yes, tall people are less risk averse. What is more interesting is that this result disappears once you factor in other variables, like personality, skills, and information about parental behavior. That is particularly interesting because such information is often not readily available, whereas height can be easier to find and used as a proxy. So, not such an odd question after all. Another question is then why would there be such a relationship.

On the difficulty of targeting financial aid to students

With the cost of education continuing to rise, financial aid to student becomes more important to help those with merit but little means (or borrowing constraints). Identifying whether financial aid actually helps bright students go to university is of course the most important question.

Loris Vergolini and Nadir Zanini study this in the case of Italy, where they surveyed students before and after university entrance, in the context of a generous financial aid initiative targeted towards bright low-income students. The results are sobering. it does not appear to have motivated more students to go to university. Those who were going anyway now are willing to move farther, presumably to potentially better programs. But this program was only recently introduced and could not have an impact on the school effort of those about to graduate. One can hope that its existence will motivate younger cohorts to excel in school to be eligible and make it to university.

Universities as catalysts of the commercial revolution in the Middle Ages

Universities can have a profound impact on the economy of a region, Silicon Valley being a prime recent example. But this is usually difficult to see as they are spread pretty much everywhere now. Hence the interest in looking at older data, where universities were less common and economic activity differed a lot more across regions.

Davide Cantoni and Noam Yuchtman go way back, up to the 14th century in Germany. They compare the establishment of new market places to the founding of universities and find a surprisingly strong correlation when looking at the distance from the nearest university. Of course, you may think this is all endogenous. If a city or region develops, new market places emerge and there is critical mass or wealth for an institution of higher learning. But the authors argue there is causation from universities to markets. Indeed, the Papal Schism of 1386 was an exogenous shock that allowed the creation of universities, and they exploit the trend shift in the granting of markets around this date. The intuition of the causation is that universities provided training in law, which facilitated the creation of legal institutions and ultimately the enforcement of contracts. So, once more, institutions matters, but this is also an interesting counterexample to the intuition that lawyers create demand for there services with no economic or social benefit.

The cost of hiring in Germany

How much does it cost to hire someone? This question is surprisingly difficult to answer. It is not sufficient to keep a log of all the recruitment expenses, the time spent and the training costs. Indeed, there are a lot of implicit costs that may, or may not, appear in the future. Indeed, when you commit to employ someone, you also commit to insuring this person in many ways. In the US, health care insurance is a factor. In many jurisdictions, rules regarding firing may also entail substantial costs, for example if they force you to retain an underperforming employee. And you often also commit to provide some insurance against productivity changes by paying a relatively stable wage. Summing up, figuring out the cost of a hire is damn hard.

Samuel Muehlemann and Harald Pfeifer try to figure out some of these costs for skilled workers in Germany. They find a cost worth on average eight weeks of pay, and that is only taking into account time and expenses during the recruitment process as well as the monetary and time costs of training. Strangely, there are no economies of scale, as the elasticity with respect to the number of hires is 1.3. Even worse, the cost doubles from small to large firms. Labor market institutions do not seem to be blamed for this convexity. I am not sure how to rationalize all this. Large firms can hire several workers simultaneously, and this must save some costs. Same for training programs.

Are the Chinese capital controls optimal?

China is currently amassing large foreign reserves while imposing internally capital controls. Does this make sense? Wouldn't an economy that has the ability to create such surpluses want to participate more fully in world markets? One should not forget that these foreign reserves are accumulated thanks to a positive trade balance and a fixed exchange rate, not thanks to a particularly well functioning capital market in China. In fact, the financial sector in quite under-developed in China, and most households have access to nothing more than simple bank accounts.

Philippe Bacchetta, Kenza Benhima and Yannick Kalantzis build a model where the central bank has access to world market, but domestic households not. This enables the central bank to impose a different interest rate than the world interest rate, but it steady-state it is best to replicate an open economy: accumulate reserves and issue domestic debt at the world interest rate. If the economy grows rapidly, though, you want to have a higher interest rate domestically while imposing capital controls, that is, one needs to prevent arbitrage. But then, intertemporal substitution needs to happen through international reserves, as households cannot do it.

What is intriguing here is that we have a situation where open markets are welfare inferior to restricted ones with a reserve accumulation policy. Usually, we think that free markets would work best, especially as here there is no moral hazard, systemic risk, or other distortion. The reason is that borrowing constraints are binding as the economy converges towards steady state, and it cannot provide adequate intertemporal allocation in open markets. The central bank needs to help, and needs to differentiate interest rates to do so. That can only happen with capital controls.

Amy Finkelstein wins MIT Award

This was certainly a busy week for anyone following some of the ethics sagas in our profession. First, there was the non-renewal and temper tantrum of Bruno Frey, then there is the American Economic Association awarding the John Bates Clark Medal to Amy Finkelstein. Following my previous post on this award, this is hardly a surprise. For those keeping score, the last awards were given to:

2012: Amy Finkelstein, PhD MIT, Faculty at MIT
2011: Jonathan Levin, PhD MIT, Faculty at Stanford
2010: Esther Duflo, PhD MIT, Faculty at MIT
2009: Emmanuel Saez, PhD MIT, Faculty Harvard then Berkeley
2007: Susan Athey, PhD Stanford, Faculty at MIT then Stanford and Harvard
2005: Daron Acemoglu, PhD LSE, Faculty at MIT
2003: Steven Levitt, PhD MIT, Fellow at Harvard then faculty at Chicago
2001: Matthew Rabin, PhD MIT, Faculty at Berkeley
1999: Andrei Shleifer, PhD MIT, Faculty at Princeton, Chicago and Harvard

It is somewhat hard to swallow that MIT students and faculty are so much better than the rest, but one cannot discard the possibility that this could happen. What is more suspect is the composition of the committee: of the seven, three have an MIT PhD (Abel, Crawford and Hoxby), and one is faculty at MIT (Banerjee). What is the American Economic Association thinking? If you want to lend any credibility to this award, and you know who the prime candidates are, you put together a committee that does not look like it was constituted at the MIT ASSA cocktail party. It is true that in the past years, MIT PhDs were a majority on the committee, so there is progress, but the longer the streak goes, the more it looks dubious. It is especially annoying that Banerjee was put back in the committee two years after he gave the award to his colleague and lover (not a secret any more now that they have a baby).

The American Economic Association needs a serious overhaul of its committees. They are stacked with people from the same places, losing the representativity of the association. The proposed candidates for office are always coming from the same institutions, and a write-in campaigns cannot be successful. The AEA has already lost its credibility with its main award, and it needs to be very careful that its new journals do not go the same way, as they are again stacked with the usual suspects as editors. No surprise then that they have a really hard time taking off, despite all what people at the suspect institutions will tell you.

I hate quotas, but I think that in the current situation, the AEA needs to institute quotas in all its committees and editorial boards, if only to get out of a potential situation of self-fulfilling group thinking. No more than two PhDs or faculty from the same institution on the same committee or board. Have at least a "professional" economist and an economist from government or Fed on every committee. Same for non-PhD-granting colleges. Have true elections for president and vice-president with multiple candidates. And, why not, let the John Bates Clark medal be awarded by complete outsiders: academic economists not based in the US and not educated in the US (but not Ernst Fehr).

Bruno Frey: the story that keeps giving

A few weeks ago, I had a post entitled Bruno Frey, the epilogue, thinking that now that the University of Zurich made him a gigantic gift by manipulating the investigation into his behavior and keeping mum, Bruno Frey would have learned to finally shut up. But no, he has still not understood a thing a keeps going on, to the point that was getting daily updates in my email about the latest on him. Let me run a few highlights by you.

As was rumored for some time, the University of Zurich decided not to renew the two-year contract he was entitled to as an eminent retiree. There no official announcement, but it was reported by Olaf Storbeck, then by the Tages Anzeiger, a local newspaper. In the latter, Frey's wife, Margit Osterloh, defends his behavior and confirms that "he will continue working in Warwick", so he has indeed been told to leave the University of Zurich.

This firing then explains the bizarre behavior of Bruno Frey in the preceding days. Indeed, he appeared unusually incoherent in a television show, then wrote an outrageous piece in the same Tages Anzeiger newspaper calling for the defunding of his department (which actually got a major gift that was probably waiting for his departure). His reasoning is that the professors try too hard to publish their research, neglecting working with the media. He also mentions his research is essentially the only relevant one. Never mind that his employer tried very hard to protect him, gave a special status to his students who were exempt from exams, and now that was simply to possible to go on, the university did its best to let the situation quietly disappear to avoid embarrassing him. He answers with a slash-and-burn tactic.

That said, I also got a copy of the report commissioned by the University and looking into his self-plagiarism on the Titanic studies. As mentioned earlier, there is nothing about the many previous cases. View a pdf copy here.

So Bruno Frey will now continue his activities at the University of Warwick, which has a long tradition of hiring prominent retirees to boost its academic ranking. He joined in early 2011, that is right before the Titanic case came up, and early enough to qualify for the next research assessment exercise of the UK universities. But for the University of Warwick to keep any credibility, it ought now to take position on the Bruno Frey case, now that it is his sole employer.

Finally, as the story keep going on, I created a tag just for Bruno Frey.

Volunteers are happy

Why do people volunteer? Obviously it must be because they find some satisfaction in it. But they may be forced to do it (say, by peer pressure or because it improves one's CV), yet one can still argue they appreciate the volunteering because they find a benefit in it: without it, there would be adverse consequences. It thus seems unavoidable to find a positive relation between volunteering and happiness, unless one is able to tease out the circumstances of volunteering. Add to this the endogeneity issue that people may be volunteering because they want to spread their happiness, or because they enjoy good circumstances that allow them to work without pay.

Martin Binder and Andreas Freytag use the British Household Panel Survey to study whether volunteering makes happy. I am not sure their reduced-form estimates are able to capture the subtleties I mentioned in my first paragraph with propensity score matching. I find more promising their inclusion of personality traits to take care of selection bias in volunteering, although personality cannot completely be ruled as exogenous. Also, their quantiles regressions can potentially highlight some heterogeneity that can be useful for our understanding of the relationship. In the end, they find that volunteering makes people happy, no surprise here, and more so the longer they volunteer. The quantile regression, however, reveals that the happiest individuals do not derive happiness from volunteering, presumably they are happy for other reasons. The least happy ones do enjoy volunteering much more. I wonder whether this comes from some decreasing marginal utility of volunteering, and whether this ties in with the fact that the poor are more generous, as discussed before.

Econochemistry?

I have highlighted in the past some exceptionally bad examples of forays of physicists into Economics (search for "Econophysics"). Not all are that bad, but they generally have in common that they portray the economy just as exogenous stochastic processes where no economic agents take decisions. That can make sense in some contexts, but these are rare cases. Now it seems chemists are venturing into Economics, what good could that bring?

Yochanan Shachmurove and Reuel Shinnar are an economist and a chemist who managed to get a paper into the working paper series of the department of Economics at the University of Pennsylvania. So it must be a serious piece. Their point is that is Chemistry, they have to deal with chemical reactors that depend on many variables and are very difficult to predict. This is not unlike an economy, where a multitude of factors may matter in ways so complex with some randomness thrown in that forecasting is very difficult as well. The authors suggest to use partial control, which involves identifying a few crucial variables and monitor those for forecasting. That does not look like much of an innovation to economists, as we are used to abstract modeling, factor analysis, econometrics and simple rules like the Phillips Curve or the Taylor Rule.

The methodology of partial control they are trying to push, though, hits a few roadblocks when applied to Economics. The first is that it needs an objective, which is easy to set in a chemical plant (it is the choice of the plant manager) but not so easy for an economy as a whole. The second is that it needs to separate the problem into independent units. They suggest, for example, to treat the United States as independent from the rest of the world. That may work for some questions, but many it does not, especially when the point is to summarize complex interactions. Third, the procedure requires a hierarchy of reactions. Much of our understanding of general equilibrium would not be captured by such constraints. Fourth, the method relies a lot on the ability to manipulate controls. That is easy in a chemical plant, but an entirely different problem in an economy. The authors take the example of the Fed and interest rates. Well, the Fed has a target on one very special interest rate, all others are market driven.

While Shachmurove and Shinnar offer scattered examples of how to apply partial control, there is no sense of how a complete model would look like. I would wait to see a model in operation before calling this an interesting modeling strategy for Economics.

Rational expectations as an optimal approximation

The rational expectations hypothesis has somehow fallen into disrepute because it is viewed as somehow failing to predict or account for the recent crisis. This is of course because of a fundamental misunderstanding of the hypothesis, as it does not imply that markets are efficient, or in equilibrium, or that the equilibrium is unique, or that bubbles cannot happen. But it is a hypothesis, and as any hypothesis it could be rejected by the evidence, for example by experiments showing people are afraid of Knightian uncertainty and yet are optimistic. But the fact that there was a crisis is not empirical evidence in this regard.

Kenneth Kasa actually shows that the rational expectations hypothesis is also a result, up to a close approximation. Indeed, if one is uncertain about the economic environment ("does not know the model"), one adheres to robust rules in the sense that among all possible models, one picks the one with the worst possible outcome. Call this the 'evil' agent. Add to this the assumption that one likes being optimistic. Call this the 'angelic' agent. Now assume that the evil and the angelic agents negotiate what to do in a Nash sense. They will then choose to behave in a way that is very close to rational expectations. This means that optimal expectations are rational, even though the model is not known and one has the documented psychological biases. In other words, rational expectations can be a useful approximation even outside the usual core of assumptions.

Named matching donor are best to elicit more donations

US universities care a lot about donations, as much of their operations are financed by endowment revenue. Foundations also spend considerable resources trying to build this endowment. Hence, it is no surprise that there is a steady stream of research on how to best elicit donations, especially from private universities. One of the big issues they face is to generate the first dollar in donation (which costs several dollars), after that it is usually much easier to get more donations.

Dean Karlan and John List find through experimentation that matching donors are particularly effective in enticing other donations, especially where they are named and recognizable. The latter effect is even stronger for new donors. The challenge now is to find the matching donor. The experiment was performed with the Gates Foundation, I doubt many other potential matching donors can be found to have such high appeal. The experiment may have been too extreme to draw reliable conclusions.

How to best tax by gender and marital status

It is well known that income taxes are distorting in a way that is not welfare improving, as it discourages labor supply. But as we need government revenue to finance public goods and there is support for some redistribution, we have to live with income tax. Of course, one can discuss whether it would be better to crank up sin taxes to provide revenue and provide lump-sum subsidies (or taxes) to provide for redistribution, but let us suppose we have only labor income tax available. Then it is obvious that tax rates need to be differentiated by labor supply elasticity. That is difficult to elicit from individuals, but there are some individual characteristics that can help here.

Let us focus on gender and marital status. Women have a higher labor supply elasticity, especially when married. One has therefore to be careful not to tax them too much, or they drop out of the labor force. The same applies to a much lesser degree to married men. Gender is mostly unalterable, thus it should be easy to tax by gender, but politics get in the way. It is easier to differentiate taxes by marital status, but the latter is unfortunately endogenous. All this is probably why many countries tax differently by marital status, but not by gender.

Spencer Bastani studies the question using a model where, unfortunately, marriage is exogenous and characterized by perfect assortative matching: the most productive men marry the most productive women. When married, spouse bargain over each one's consumption and labor hours. Critical here is the exogenous bargaining power of the husband. Note that it is assumed that marriage always remains viable, there is no divorce, even though divorce is a threat point. In the end, men should be taxed more than women, unless the bargaining power of the husband is high (where lump-sum payments to women are likely to be higher, so they do not lose completely. And remember, this bargaining power is exogenous, and can be changed by law). If household production has a significant public good component, there should be redistribution from couples to singles. Welfare gains from such taxation are important, especially if wage gaps between genders are large. And this is the situation where it is the most feasible: women are then secondary earners, and one can tax secondary incomes differently without causing too much of a commotion.