Dynamic Stochastic General Equilibrium (DSGE) Models

Noah Smith wonders in a blog post why the private sector does not use DSGE models for forecasting purposes if these models are useful. He writes:

As far as I’m aware, private-sector firms don’t hire anyone to make DSGE models, implement DSGE models, or even scan the DSGE literature. There are a lot of firms that make macro bets in the finance industry – investment banks, macro hedge funds, bond funds. To my knowledge, none of these firms spends one thin dime on DSGE. I’ve called and emailed everyone I could think of who knows what financial-industry macroeconomists do, and they’re all unanimous – they’ve never heard of anyone in finance using a DSGE model.

Self-Correcting Research?

The Economist doubts that science is self-correcting as “many more dodgy results are published than are subsequently corrected or withdrawn.”

Referees do a bad job. Publishing pressure leads researchers to publish their (correct and incorrect) results multiple times. Replication studies are hard and thankless. And everyone seems to be getting the statistics wrong.

A researcher suffers from a type I error when she incorrectly rejects an hypothesis although it is true (false positive); and from a type II error when she incorrectly accepts an hypothesis although it is wrong (false negative). A good testing procedure minimises the type II error given a specified type I error that is, it maximises the power of the test. While employing a test with a power of 80% is considered good practice actual hypothesis testing often suffers from much lower power. As a consequence, many or even a majority of apparent “results” identified by a test might be wrong while most of the “non-results” are correctly identified. Quoting from the article:

… consider 1,000 hypotheses being tested of which just 100 are true (see chart). Studies with a power of 0.8 will find 80 of them, missing 20 because of false negatives. Of the 900 hypotheses that are wrong, 5%—that is, 45 of them—will look right because of type I errors. Add the false positives to the 80 true positives and you have 125 positive results, fully a third of which are specious. If you dropped the statistical power from 0.8 to 0.4, which would seem realistic for many fields, you would still have 45 false positives but only 40 true positives. More than half your positive results would be wrong.

The Financial Crisis

The Economist’s “schools briefs” on the financial crisis: Parts 1, 2, 3, 4, 5. Quoting from the first part:

… it is clear the crisis had multiple causes. The most obvious is the financiers themselves—especially the irrationally exuberant Anglo-Saxon sort, who claimed to have found a way to banish risk when in fact they had simply lost track of it. Central bankers and other regulators also bear blame, for it was they who tolerated this folly. The macroeconomic backdrop was important, too. The “Great Moderation”—years of low inflation and stable growth—fostered complacency and risk-taking. A “savings glut” in Asia pushed down global interest rates. Some research also implicates European banks, which borrowed greedily in American money markets before the crisis and used the funds to buy dodgy securities. All these factors came together to foster a surge of debt in what seemed to have become a less risky world.

“Credibility For Sale,” CEPR, 2013

CEPR Discussion Paper 9562, July 2013, with Harris Dellas. PDF.

We develop a sovereign debt model with official and private creditors where default risk depends on both the level and the composition of liabilities. Higher exposure to official lenders improves incentives to repay but carries extra costs, such as reduced ex-post flexibility. The model implies that official lending to sovereigns takes place in times of debt distress; carries a favorable rate; and can displace private funding even under pari passu provisions. Moreover, in the presence of long-term debt overhang, the availability of official funds increases the probability of default on existing debt, although default does not trigger exclusion from private credit markets. These findings help shed light on joint default and debt composition choices of the type observed during the recent sovereign debt crisis in Europe.

“The Swiss Debt Brake—Ten Years On,” SJES, 2013

Swiss Journal of Economics and Statistics 149(2), June 2013, with Christoph Schaltegger. PDF.

In response to the rapid growth of public indebtedness during the 1990s, Switzerland enacted a constitutional budget restriction in 2003: the Swiss Debt Brake. Aimed at balancing the federal budget over the cycle the fiscal rule appears to have left its mark. At the debt brake’s tenth anniversary, Switzerland’s fiscal position has improved considerably. Several other countries have also implemented fiscal rules, but with mixed success. What lessons are there to be learned from these experiences?

IMF Policy Vis-a-vis Greece

Christoph Eisenring reports in the NZZ about a critical internal assessment of the IMF’s recent policy vis-a-vis Greece. The relaxation of the “medium term solvency” requirement for IMF lending in a situation of acute contagion risk should be reconsidered; contagion should be addressed with different instruments; debt should be restructured earlier than happened in the Greek case; and bail-ins should be favoured.

Government Non-Financial Assets

Elva Bova, Robert Dippelsman, Kara Rideout and Andrea Schaechter review the evidence on governments’ non-financial assets in an IMF working paper. An excerpt from the abstract:

… state-owned nonfinancial assets across 32 economies, with particular focus on the advanced G-20 economies. We find that reported nonfinancial assets comprise mostly structures (such as roads and buildings) and,when valued, land. These assets have increased over time, mostly due to higher property and commodity prices, and are, in large part, owned by subnational governments. Many countries have launched reforms with a view to streamlining public administrations, but receipts and savings have been rather small so far. Governments tend to consider relatively small sets of assets to be disposable …

 

Foreign-Law Sovereign Debt

The Economist discusses the consequences of issuing sovereign debt under foreign law. Investors in Greek government debt did better if they owned paper governed by English law—these series escaped the retroactive addition of collective-action clauses that Greece added to its domestic law bonds in 2012 before renegotiating with its creditors. For Argentine debt the situation may be reversed, due to the New York court decision in the case of Elliott Management against the Republic of Argentina. Indeed, default risk might be lower for Argentine domestic-law bonds.

Household Balance Sheets in the Euro Area

The ECB has published the results of the Eurosystem’s first Household Finance and Consumption Survey. Some results:

  • About 60% of households in the euro area own their main residence—with or without a mortgage. About 11% own a business, and 76% own vehicles.
  • 97% of households own sight deposits or savings accounts. Some (33%) hold voluntary private pensions or life insurance and few (15%) own other financial assets. Only a quarter of households in the top income quintile holds mutual funds; also, a quarter of households in the top income quintile holds publicly traded shares.
  • 23% of households have mortgage debt and 29% have non-mortgage debt. Conditional on having debt, the median value is Euro 68400 and Euro 5000, respectively.

Here are the mean and median net wealth statistics by country and socioeconomic characteristic.

Haircut Estimates for 180 Sovereign Debt Restructurings

Juan Cruces and Christoph Trebesch have posted data on 180 sovereign debt restructurings between 1978 and 2010. They analyse this data in a paper forthcoming in the American Economic Journal: Macroeconomics.

Cruces and Trebesch consider distressed restructurings of medium and long-term public or publicly guaranteed debt with foreign private creditors (including commercial banks and bondholders but excluding official creditors organised in the Paris Club) that were ever finalized. Their preferred haircut measure varies between -10% (Brazil, February 1983) and 97% (Republic of Yemen, February 2001).