economics: all about human behaviors and expectations

Another interesting theory is the notion of self-fulfilling currency crisis (Obsfeld 1996)

•this notion asserts that whether a currency crisis occurs or not depends on how market participants view the future exchange rate.

•If the market participants expect that a sharp devaluation is impending, devaluation REALLY occurs. If they expect that the exchange rate stable, however, devaluation will not happen.

• Therefore, a currency crisis is self-fulfilling and multiple equilibria are possible: A currency crisis may or may not take place depending on the expectation of market participants.

case in point:

•hypothetical situation:

3 economic agents, a CB and investors A and B.

Ø The central bank is assumed to have a certain level of foreign reserves, R, which can be used for stabilization of the foreign exchange rate.

Ø Two players, A and B, are assumed to play a one shot non-cooperative game.

•Now suppose that two players have each 6 units of (domestic currencies), making use of two different strategies, keeping domestic currencies or selling domestic currencies and buy foreign ones.

•The payoff of this game depends on the amount of foreign reserves of the central bank.

(i) Case 1

•The central bank has 20 units of foreign reserves (denominated in domestic currency), i.e., R=20. Suppose that the transaction cost is 1 unit of domestic currency. Then the Nash equilibrium will be situation where both investors do not sell domestic currency .

(ii) Case 2
•R=6. In this case, if either one of the two investors sell domestic currency to buy foreign exchange, its foreign reserves will be soon depleted.
Ø The central bank is forced to devalue the domestic currency or let the exchange rate float.
Ø Assume that the central bank devalues the domestic currency by 50% when it cannot defend the fixed exchange rate with its foreign reserves.
Ø Because the investor who bought foreign reserves will have 3 units of capital gain and have to pay 1 units of transaction cost, he will have only 2 units of capital gain in his hand. If both investors A and B sell 3 units each to buy foreign exchange, then each investor will have only 1/2 (3/2-1).
Ø The Nash equilibrium is the case where both parties sell

(iii) Case 3

•assume R=10. Neither investor alone can deplete the central bank resources, although both can if they sell in concert. That is, devaluation cannot occur when only one investor attacks and the other does not because the central bank can defend the attack fully with its foreign reserves in hand.
•In this case the investor incurs only one unit of transaction cost. When both investors buy foreign reserves, they will each buy only 5 units of reserve. If the domestic currency is devalued by 50%, then both investors will have 5/2 units of capital gain and 1 units of transaction cost. The net benefit is therefore 3/2 units for each investor.

•Note that in this game two Nash equilibria emerge. One is where both investors buy foreign exchange and the central bank devalues the domestic currency.

•The other is where no investor sells domestic currency.

•This happens when one investor expects that the other will not sell domestic currency. And the central bank will not devalue. Therefore these multiple equilibria have an element of self-fulfilling expectation because currency crisis occurs if both investors expect a devaluation, while it does not occur when both do not expect a devaluation.

the boy who cried wolf: the time-inconsistency problem and the Barro-Gordon model

in one of my classes-I came across this interesting idea: the time-inconsistency problem.
this basically departs from the idea that the government plays "games" with private agents (the textbook actually clarifies that by game it doesn't mean "entertainment" but concessions and ruseful tactics employed to achieve what one wants LOL) and that once it loses its credibilty, the outcomes could be desastrous-in others words: don't play games, baby~! :)


Here, we develop an a reputational equilibrium by using Philips Curve which means that only unexpected inflation affects the unemployment rate.


so .... this is what happens: suppose the gov't's wanting to decrease u and ㅠ at the same time  (yes, ㅠ=pie) as it is its goal.


Model (Draw a Graph with vertical axis ∏ and horizontal axis U)

In economic terms, it is said that zero inflation policy is time-inconsistent;


if the gov't announces the infla rate to be 0, and ppl believe: point A
•Clearly the government can do better than point A.

ØIt could cheat and increase the rate of inflation unexpectedly.

•This brings the economy to point B, which is on a higher indifference curve.

ØThe government has an incentive to break its promise to maintain a zero inflation rate.

•This, however, will trigger a shift of the Phillips curve upwards π e = π1. 

•Given this new expectation, it is optimal for the gov’t to move to point C.

•This will shift the Phillips curve upwards again and the process goes on until point E is reached.

--> Authorities face the problem each period that a better short term outcome is possible. Given the repeated interaction between the policymaker and the private agents, it is possible that reputational forces can substitute for formal rules. The economic agent will therefore adjust their inflationary expectations up to the point where the authorities have no incentive to cheat any more.

...

so this is a good ex why ppl have to maintain good reputation and credibility, which are really important instruments you wanna use in a DISCRETIONARY way (this word does NOT only apply to gov't but to ordinary ppl as well, I think)

as I am a European-area studies major, have to think of the Implications to EMU...

in the same way as infation rate announcements, Exchange rate instrument can be a very dangerous one if it is frequently used because of expectation effects.

A systematic use of exchange rate instrument might lead to more price variability. That is, loss of the exchange rate instrument is likely to be less costly for open markets. in the European case, only a full monetary union such as adopting a single currency can establish the required credibility. For reasons above, as a result, discussion for a full monetary union was held by the signing of the Maastricht Treaty, known for the treaty on monetary union.

Implications for life:

Trust and sincerity are really important factors that we have to take in seriously. Many choose to push and shove them aside as secondary for the short-term (potential) gains they see ahead. However, this gains are not true gains and successs built on these gains is not true success but like a house built on sand, for we do not know when it will crumble. 

Regional Monetary and Financial Integration-2010 fall

some of the things we learned in this class:

-the costs and benefits of Monetary Unions

-the costs and benefits of a common currency

-OCA and critiques (using the Barro-Gorden model)

-the impossible Trinity (it's not as blasphemous as it sounds, but I do prefer it to the other term, "unholy Trinity"

-the History of European Monetary Unon

-the Asian experience

-The collapse of the FSU monetary union

Potential Final exam questions:

1. Strong points of ERM compared to BW system

2. Explain the impossible trinity and its implication to Asia

3. Explain time-inconsistency problem and its implications to European monetary union.

4. Explain the basket currency and its implications to parallel approach backed by British government.

5. Explain why the Ruble zone collapse of the Former Soviet Union happened.





corporate governance part 2: youhooooo~!

Corporate Governance: An Assessment

 

Ⅳ. TAKEOVERS

✿ Not only regulatory competition between different countries but collusion can

   lead to the convergence of corporate-governance systems.

Ø  Marc Goergen, Marina Martynova, and Luc Renneboog: assess whether takeover regulation in European countries has converged de jure with takeover regulation in the UK and the US.

Ø  Through nine elements of takeover regulation they show the predicted effect on minority shareholder protection, and ownership structures with marked differences between the widely held and the blockholder systems.

Ø  Goergen et al.: conclude that the de jure convergence of takeover rules is no evidence of de facto convergence, because the same rule has different implications when applied in different governance contexts.

➨ Such convergence has two features: 

1.    Individual member states adopted it voluntarily.(not as a result of regulatory competition)

2.    Convergence did not occur through collusion.(No agreement could be reached at the European level.)

Ⅴ. Corporate Boards

✿ Discussions about board reform

Ø  The Start: Jay Lorsch’s influential Pawns or Potentates(1989) ; calling for strengthening the role of outside directors in the USA.

Ø  UK: the Cadbury Committee; advocating independent directors & the separation of the role of chairman and CEO.

Ø  Gerard Hertig: ①classifies board reforms into three categories;

(ⅰ)reforms that constrain board discretion, mainly by making boards more

susceptible to shareholder power, but also by giving more power to

auditors and other gatekeepers

ⅱ)reforms that reinforce board independence

Ø  ⅲ)reforms that change director incentives, by increasing reputation and

 liability risk.

              ②worries about ’one-size-fits-all’ problem: Market forces

                oblige companies to standardize, albeit the one-size-fits-all

                approach imposes a cost.

              ③Boards must fulfill multiple objectives(monitoring &

                formulating strategy, advising, etc). Reformers have put too

                much emphasis on monitoring.

              ④Much of the reform process has been capture by

                institutional investors, who themselves do not take the

                board medicine they prescribe.

        ➨ ∴ 1. Boards reforms should be less detailed and more principle based.

   2. Interest groups should be kept out of board reform as much as possible.

   3. Minimum standards should be reduced to an absolute minimum, thus avoiding the one-size-fits-all problem.

   4. Board-reform issues that have been ignored so far should be addressed.  Ex) the boards of institutional investment vehicles

   5. Board reform should be complemented with ‘market oriented implementation mechanisms’.  Ex) direct shareholder participation in board election or ex post intervention through the courts

Ⅵ. Executive Remuneration

✿ The issue of executive pay has become one of the key indicators of the ultimate performance of a corporate-governance system.

✿ Findings of Lucian Bebchuk and Yaniv Grinstein

1.    Executive pay only relates to a few individuals whose salaries are very small relative to overall company profits.

2.    However, the total compensation of the top-five executives has been increasing significantly, even though such growth is not much related to changes on the size, performance, or industrial mix of firms.

3.    The growth in total compensation has been driven by increased allocations of stock and options, but cash compensations has been increasing as well.

 ➨ These findings suggest significant changes in the market for executives, however, we should be cautious before drawing inferences about corporate governance, because the causes of the rise in executive compensation in the USA is complex.

 ✿ Then, how about the EU?

-       Guido Ferrarini and Niamh Moloney: find clear divergences between the blockholding and dispersed-ownership models.

Ø  In general, countries with more dispersed share ownership tend to employ more high-powered, equity-based compensation contracts.

Cf) Large blockholders should have adequate incentive and ability to monitor the performance of managers directly, without the need to write high-powered incentive contracts.

Ø  Effective governance in all systems relies to a great extent on effective disclosure, and greater harmonization on disclosure would be beneficial.

(Disclosure is emerging as a key corporate-governance mechanism in the EU.)

Ø  However, they caution against interventions to harmonize board structures and to increase the power of the ‘shareholder voice’.

Ⅶ. Conclusions

1.    A one-size-fits-all thesis of corporate-governance rules is not appropriate; Different types of corporate-governance rules are required.

2.    While corporate-governance rules emphasize monitoring and supervision, they may undermine the degree to which boards are able to perform their strategic and innovative functions.

3.    An area of a large measure of agreement for regulation: “disclosure of information and transparency” ; In order to promote participation by outside investors and efficient operation of economies, high level of disclosure of information and transparency is necessary.

4.    An contentious area: “takeovers & executive remuneration” ;

①    Takeovers: the least successful area of corporate legislation in Europe, and there is no immediate prospect of resolution.

②    Executive remuneration: The extent of the problem may vary between European corporations(dominated by large shareholders) and those in the USA(with dispersed shareholders).

        ∴ Large shareholders in Europe: ➨better placed to control the remuneration of

                                        their executives than dispersed shareholders

                                           in the USA.

                                        ➨better positioned to engage in wealth

                                          transfers to their own advantage at the

                                          expense of minority shareholders.

5.    Policy should be directed towards facilitating diversity in systems by allowing firms to choose their preferred arrangements and encouraging competition between systems.

DIY:Do it yourself!

I remember last winter break: idle, happy, warm and well-fed (should I say fat?)… WOW: those words sound amazing now…
But anywho,, that was about the time Ashlee got crazy about reforming every single piece of wood (and trash) she could find… and her obsession was contagious: it got me engrossed in SEVERAL DIY projects (e.g. pictures below).
‘twas also around that time we moved in to a new house (snif, I miss it so much) so we also had good excuses to conduct these seemingly useless projects (but at least it was fun!-spending huge chunks of days to cut up, paint, smoothen, etc.-basically do whatever it takes to transform that piece of wood and pieces of crap to anything-with “potential” usefulness.
Surprisingly (mainly to me!) we were able to succeed in making a few that wouldn’t go straight to the trash J and it’s been a fun experience…that I probably won’t repeat until I’m like in my 40s with 3 kids haha

thoughts on GD (yes, covered by the exam along w/ the Nikkei incident, sigh)

So how DID the Great Depression happen?

Some say that GD was cause by the stock market crash of 1929 but not so. A recession had started before the crash, and other factors played a central role later in the depression.

But crash was still important!

Crash was not caused by the sudden realization that a depression was coming . no evidence in the papers of 1929. Source of crash was almost surely the end of a speculative bubble.
The crash not only decreased consumers’ wealth, it also increased their uncertainty about their future.
Nominal money stock went down: coz M=H x money multiplier.
M=currency +checkable deposits
H=money base, currency+ bank reserves
Side note: CB holds credit and cash; cash=C(held by public) and R (held by bank=reserve)
M=C+D (D=deposit at CB)
Assumption: C=cM (where c=constant)
                           D=(1-C)M
                           R=θD=constant amount of deposit in the form of reserves
                        R=θD=θ(1-C)M
               àH=C+R

=cM+θ(1-C)M

=[c+θ(1-c)]    (θ=less than 1)

àH=(c+θ(1-C)M and M=(1/1+θ(1-c))H

M=1/(c+θ(1-c)H where c is the proportion of M ppl want to hold as currency, and θ=ratio of reserves to checkable deposits. The higher c, the lower the multiplier.
If c=1, ppl want to hold only currency, Multiplier=1
Money multiplier declined: coz of bank failures. (with decline in Y, more borrowers were unable to repay loans and more banks closed down)
Bank failure affect Ms: ppl shift checkable deposits to currency. Multiplier=1àdecrease in nominal M stock. àdecrease in P level, à real money stock remained constant, eliminating one of the mechanisms that could have led to a recovery.
LM did not change, not shift down as it would have done if the nominal money stock had remained constant, implying an increase in the real money stock.
àthe Fed was responsible for the depth of the GD: it is not directly responsible for the decrease in the nominal M supply but it should have taken steps to offset the decrease in M Multiplier by expanding the monetary base much more than it did.

If I had learned ANYTHING in studying Macroecon, it is that ppl are stupid enough to sometimes make REALLY BAD choices...for themselves and others...