The dynamic relationship between long term interest rates and fiscal stances in the EMU


Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2018. The project is a required component of every master program.


Sybrand Brekelmans, Guillermo Sanz Marin, and Luca Tomassetti

Master’s Program:

Macroeconomic Policy and Financial Markets

Paper Abstract:

In this paper we study the dynamics and drivers of 10 year’s sovereign bond yields using a panel of the original 11 Eurozone countries (excluding Luxembourg). The interest of this study relies on the fact that despite very different macroeconomic policy stances in the variables that we believe determine interest rates among these countries, 10 years Eurozone bond yields almost perfectly converged during the 2000’s, before they suffered a sudden disconnection in the aftermath of the Great Financial Crisis.

To this end, we apply two different methodologies. A Panel Data approach (that we end discarding) and a Time Varying Coefficients model using the Kalman Filter, which allows us for capturing changes in the pricing mechanism of bond yields over time. Initially, by using the latter methodology without controlling for the volatility of the interest rates (which dramatically increased after 2008), we obtain very noisy results that are barely explainable, since the coefficients seem to be capturing these changes in volatility. Once we introduce in the filter a GARCH process for the variance-covariance matrix of the interest rates that we use in the Time Varying Coefficients approach, we manage to obtain much more meaningful and explicative results.

One of our key contributions is the inclusion of new fiscal and macroeconomic variables as determinants of yields in the different Eurozone countries, which were discarded by other studies in the field. We also contribute by controlling by common determinants to all the Eurozone countries, which we obtained by applying a common component approach. Furthermore, our findings confirm that after the period of divergence in interest rates, started in the aftermath of the Great Financial Crisis, and caused by a refocus on fundamentals, Eurozone interest rates have converged again under the effect of a normalization of bond yield drivers, similarly to their pre-crisis levels, although not to the same extent. Another implication that we find is that in times of economic uncertainty and financial hysteresis, when default risk becomes an issue, the effects of government policy on interest rates can significantly lead to accentuated crowding out effects.

Conclusions and key results:

Our work indicates that there has been a significant break in the way sovereign debt was priced after the Great Financial Crisis of 2008, indicating a return to fundamentals as main drivers of sovereign yields. We find that several factors reflective of fiscal and macroeconomic stances became increasingly important during the crisis, after having been ignored in previous years. As such, Debt to GDP, Deficit to GDP, GDP growth and Current Account balances to GDP, among others, started to play important roles in the determination of long term interest rates for Eurozone government bonds. In line with previous research, our findings confirm the existence of 3 distinct phases in the euro bond market. A period of high integration, a period of disintegration, and a phase of partial reintegration (Adam and Lo Duca (2017)).

Our findings suggest that during periods of economic uncertainty characterized by high volatility in the financial markets, investors tend to focus on fundamentals, while in times of economic boom they do not discriminate too much among the different stance of these macroeconomic determinants. This finding has important policy implications since it suggests that during economic crises interest rates react much more to unsustainable fiscal policies and macroeconomic imbalances than during calmer times, causing a great private sector crowding out effect (Laubach (2011)).

Therefore, our results suggest that governments should pay closer attention to their fiscal stances during times of economic turbulence in order to avoid the detrimental effects of high interest rates on activity in a period of economic agent´s lack of confidence. As argued before by De Grauwe and Ji (2013), this former effect is exacerbated by the fact that Eurozone governments have no control over monetary policy, making impossible for them to reduce interest rates by no other means than sound fiscal policies. In line with this result, we notice that the ECB’s unconventional monetary policy (we obtain that the impact of short term interest rates -one of our common determinants obtained by principal components- on long yields has diminished over time) helped to bring down European bond yields after 2014. This fact contributed to put the fiscal stances of these countries, and other essential macroeconomic variables, back to sustainable levels, that along with the structural reforms carried out (which in addition to the former effect, have also contributed to bring back economic confidence and dynamism) have had by its own another loosening impact in the interest rates that these countries have been facing in every debt issuance.

Regarding the methodologies used to address our research question, we were able to obtain robust results and determine which method was the most appropriate to investigate the drivers of 10 year’s sovereign bond yields. We found that panel data approaches, which are widely used in the literature, lead to unstable and unsatisfactory results, causing us to attach limited credibility to the outcomes of such analysis. However, the Time Varying Coefficients approach seems more reliable and yields more robust and plausible results after we model the changes in volatility appropriately. We believe that having a larger sample (we use the forecasts released twice a year by the IMF in its World Economic Outlook and by the OECD in their Economic Outlook in order to control by the effect of the market´s forward looking in current levels of interest rates, as well as by reverse causality) would have allowed us to obtain more reliable results on this approach as well.

A suggestion for further research would be to apply Bayesian techniques to estimate our model. Indeed, given the limited amount of data available and the complexity of our models, these methods seem to suit better in this kind of estimation, where the great amount of parameters, as well as the possible presence of non-linearities, can make the optimization process very costly. Consequently, this methodology would have allowed us to also model the variance of the Time Varying Parameters, and not only the ones of the interest rates (our observables) with another GARCH or stochastic volatility process, since we expect that these variances could also follow a conditional process, which might have an impact on our estimation results.




Download the full paper [pdf]

More about the Macro Program at the Barcelona Graduate School of Economics

Price Parity Clauses: Setting a new legal standard


Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2018. The project is a required component of every master program.


Samantha Catalina Guerrero Putz and Josep Peya

Master’s Program:

Competition and Market Regulation

Paper Abstract:

Under the context of digital platforms who act as an intermediary between consumers and sellers, Price Parity Clauses (PPCs) is a contractual restriction for the seller not to sell at a lower price through any other channel (the so-called wide PPCs), or only in its own channel (narrow PPCs). These clauses present a trade-off between efficiencies and anticompetitive effects. On one side, PPCs act as a committing device of the seller to solve the show-rooming effect suffered by platforms (a particular form of free- riding), at the same time that it ensures platforms viability and enhances its incentives to invest and innovate. On the other side, PPCs allow platforms to charge higher fees, and lead to foreclosure of the market. Currently, neither the EC nor NCAs have set a clear guidance on how to assess these clauses. The main contribution of this paper is to set a legal standard for both wide and narrow PPCs using the cost-error analysis. The conclusions we arrived to are that wide PPCs should be per se illegal; and narrow PPCs should be presumed legal unless proven otherwise, except if narrow PPCs are eliminating the competitive restraints of the platform, in which case the standard should be that of rebuttable presumption of illegality.


  1. Digital Economy will rise the use of Digital Platforms. Network externalities inherent to two-sided markets lead to high market power that make platforms an indispensable ally.
  2. Digital Platforms use PPCs and this is capturing the interest of Competition Authorities. But there is no consensus with respect to the legal standard.
  3. PPCs present a trade-off: On the one hand efficiencies results in reduction of search costs, prevents showrooming, incentives on investment and innovation. On the other hand, anti-competitive effects arise, creating high fees, foreclosure, collusion.
  4. The results of our cost-error analysis are that Wide PPCs Min Type II error, therefore should be Per se illegal. Narrow PPCs Min Type I error: Rebuttable Presumption of Legality, except if (i) One-Stop Shop/Network; (ii) Brand Positioning; (iii) Switching costs: Min. Type II: Rebuttable Presumption of illegality

Download the full paper [pdf]

More about the Competition and Market Regulation Program at the Barcelona Graduate School of Economics

Spillover Effects from the Financial Sector: A Network Analysis for the Eurozone

Master project by Jordi Gutiérrez, Domenic Kellner, Philip King, Simon Neumeyer, and Dorota Scibisz


Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2018. The project is a required component of every master program.


Jordi Gutiérrez, Domenic Kellner, Philip King, Simon Neumeyer, and Dorota Scibisz

Master’s Program:


Paper Abstract:

We identify contemporaneous and Granger-causal linkages between the 86 biggest companies, representing both the financial and real sectors, of the Eurozone economy that serve as paths of shock transmission. Network analysis lends itself very naturally to the study of systemic risk due to its preoccupation with interconnections and notions of centrality. We employ an estimation methodology introduced by Barigozzi and Brownlees (2018) using market data for daily volatilities from the Eurostoxx index. Our results are in line with the existing literature – the banking sector is found to be highly interconnected and responsible for most Granger-network spillovers. Moreover, only a small subset of firms appear to Granger-cause other residual volatilities, providing support for regulators’ targeting of Systemically Important Financial Institutions.


Following the work of Barigozzi and Brownlees (2018), this paper applies the nets algorithm to study the interconnectedness of the 86 biggest firms in the Eurozone for a sample period spanning from May 2008 to April 2018. We have estimated two sparse networks of return volatilities that allow us to measure systemic risk and detect patterns of its transmission. Compared to the original study of the US economy, we have utilised a more detailed set of industries. What is more, country-specific volatilities were added as an extra factor in order to obtain more precise firm-specific residual volatilities, while still uncovering a large number of connections.

At the contemporaneous level almost all industries exhibit high connectedness, a pattern which became immediately apparent on the initial heatmaps of residual correlations. Even when controlling for sectoral and country volatilities we find clusters of firms reacting strongly with other firms within the same business area. These co-movements are especially remarkable within the banking, industrial, and technological sectors.

However, it is a small subset of companies, mostly financial firms, that displays high interconnectedness at the Granger-causal level. Consequently, we conclude that banks are particularly important risk transmitters in the Eurozone network. The subset of banks is especially susceptible to volatilities stemming from other sectors. This makes intuitive sense as we can think of banks being highly leveraged when compared with other entities (Freixas et al., 2015). Moreover, banks amplify and transmit shocks to all the other sectors, which reflects their unique economic role as financial intermediaries. Altogether, this provides empirical support for the regulatory targeting of certain Systemically Important Financial Institutions.

Download the full paper [pdf]

More about the Economics Program at the Barcelona Graduate School of Economics

CNN interview with Miguel Angel Santos (ITFD ’11, ECON ’12) on the crisis in Venezuela

Miguel Angel Santos was interviewed on CNN’s Global Portfolio where he shared his analysis of the economic crisis in Venezuela.

Master’s alum Miguel Angel Santos was interviewed on CNN’s Global Portfolio where he shared his analysis of the economic crisis in Venezuela. From his post on LinkedIn:

“The collapse of Venezuela has a magnitude never before seen: it is the only country in the top ten of falls in GDP in five years in history (ninth, 45%), of falls in imports (third, 75%), and is also projected as one of the most intense hyperinflations in history, comparable only to Germany and Zimbabwe. There is no country on those three lists which has suffered collapses in imports, production, and hyperinflation at this level of intensity. It’s unprecedented.”


Miguel Angel is a graduate of both the Barcelona GSE Master’s Program in International Trade, Finance, and Development and the Master’s Program in Economics. He is now Adjunct Lecturer in Public Policy at Harvard Kennedy School, and Senior Research Fellow at the Center for International Development (CID) at Harvard University.

Can import promotion increase export performance in times of global value chains? Firm-level evidence from Russia

Master project by Deepshikha Deb, Nils Handler, Vladimir Peciar, Ksenia Proka, Juliane Stolle

Port of Novorossiysk

Editor’s note: This post is part of a series showcasing Barcelona GSE master projects by students in the Class of 2018. The project is a required component of every master program.


Deepshikha DebNils HandlerVladimir PeciarKsenia ProkaJuliane Stolle

Master’s Program:

International Trade, Finance, and Development

Paper Abstract:

This paper analyzes whether access to imported intermediate goods can raise export performance of Russian firms. We employ an instrumental variable strategy which exploits variation in firm-specific input tariffs to identify the effect of imported intermediates on firm exports during the period 2007-2013, utilizing a unique firm-level database on firm characteristics and customs declarations. We find that input tariff reductions can raise firm exports significantly, as can other measures aimed at increasing imports of intermediate goods of exporting firms in Russia. Import promotion targeted at exporting firms in high-tech sectors can be up to three times more effective. Better access to imports can also help increase the currently low share of exporting firms within the Russian enterprise landscape. Our results suggest that with the rising globalization and fragmentation of production processes, countries interested in raising exports need to think strategically of promoting imports as well. We propose and discuss several policy measures for Russia in the areas of tariff regulation, non- tariff measures, trade facilitation and trade integration.


Using a comprehensive firm-level dataset which combines information on Russian company characteristics, involvement in trade and input tariff rates, we reveal a strong positive impact of intermediate imports on firm exports in the manufacturing sector. These results imply that improved access to intermediate goods at the international market can serve as a means to raise Russia’s currently weak export performance outside the natural resource sector. Import promotion policies targeted at intermediate goods imported by firms in high-tech sectors can be especially effective and raise exports by up to three times more than in other sectors. Better access to imports can also help increase the currently low share of exporting firms within the Russian enterprise landscape.

Our estimation results indicate that a one percentage point decrease in input tariffs would raise firm exports by approximately one percent. Even though tariffs have been significantly decreased over the past decade in the context of regional integration and Russia’s WTO accession (see figure 1), there is still ample room to lower input tariffs in order to promote exports. More than 40 percent of intermediate goods imported by Russian exporting manufacturing firms and more than 30 percent of goods imported by exporting firms in high-tech manufacturing sectors still entered the customs union at a tariff rate above 5 percent in 2015. Besides tariff reductions, Russia could consider lowering non-tariff measures (NTMs) and enhancing trade facilitation, which can also contribute to better access to intermediate goods of exporting firms, as suggested by our IV results. As can be seen from figure 2, NTMs have increased sharply since Russia joined the WTO in 2012. It should be pointed out, however, that trade policies aimed at promoting imports of intermediate goods alone will not be sufficient to boost non-oil export growth and export competitiveness of Russian firms. To bring the desired success, they need to be combined with a range of other important policies, including improving access of Russian exporters to foreign markets and simplifying the existing export regulation, as well as comprehensive structural reforms and measures to improve the business environment.

Key Figures:

figure figure

Download the full paper [pdf]

More about the ITFD Program at the Barcelona Graduate School of Economics

The new wealth of our nation: the case for a citizen’s inheritance

George Bangham (Economics of Public Policy ’17) is an economic researcher at the Resolution Foundation, a London-based think-tank that carries out research and policy analysis to improve the living standards of people in the UK on low and middle incomes.

report cover

George Bangham (Economics of Public Policy ’17) is an economic researcher at the Resolution Foundation, a London-based think-tank that carries out research and policy analysis to improve the living standards of people in the UK on low and middle incomes. In recent years the Foundation has been influential in advocating for a living wage and for policymakers to consider the intergenerational impact of public policy. George’s own work focuses on labour markets and social security policy, with his recent publications covering issues from working hours to tax reform.

One of his recent papers, “The new wealth of our nation: the case for a citizen’s inheritance,” has received international attention in the media and was featured in an article in La Vanguardia newspaper this May.

Report summary:

The Intergenerational Commission has identified two major trends affecting young adults today, beside the weak performance of their incomes and earnings, which barely featured in political debate for much of the 20thcentury. The first is that risk is being transferred from firms and government to families and individuals, in their jobs, their pensions and the houses they live in. The second is that assets are growing in importance as a determinant of people’s living standards, and asset ownership is becoming concentrated within older generations – on average only those born before 1960 have benefited from Britain’s wealth boom to the extent that they have been able to improve on the asset accumulation of their predecessors. Both trends risk weakening the social contract between the generations that the state has a duty to uphold, as well as undermining the notion that individuals have a fair opportunity to acquire wealth by their own efforts during their working lives.

This paper, the 22nd report for the Intergenerational Commission, makes the case for the UK to adopt a citizen’s inheritance – a universal sum of money made available to every young person when they reach the age of 25 to address some of the key risks they face – as a central component of a policy programme to renew the intergenerational contract that underpins society.

Policy recommendations from the report:

  1. From 2030, citizen’s inheritances of £10,000 should be available from the age of 25 to all British nationals or people born in Britain as restricted-use cash grants, at a cost of £7 billion per year.
  2. To reflect the experiences of those who entered the labour market during and since the financial crisis, and to minimise cliff edges between recipients and non-recipients, the introduction of citizen’s inheritances should be phased in, starting with 34 and 35 year olds receiving £1,000 in 2020. Each subsequent year, citizen’s inheritance amounts should then rise and be paid to younger groups, until the policy reaches a steady-state in 2030 when it is paid to 25 year olds only from then on.
  3. The citizen’s inheritance should have four permitted uses: funding education and training or paying off tuition fee debt; deposits for rental or home purchase; investment in pensions; and start-up costs for new businesses that are also being supported through recognised entrepreneurship schemes.
  4. The citizen’s inheritance should be funded principally by the new lifetime receipts tax, with additional revenues from terminating existing matched savings schemes – the Help to Buy and Lifetime ISAs.

Visit the Resolution Foundation’s website to download the full report

Press release from the Intergenerational Commission

Connect with George on LinkedIn

Barcelona GSE Master’s in Economics of Public Policy

Barriers to Free-Trade: Is it only Trump?

 By Carl Christian Kontz (ITFD ’18)

As a European liberal and free-trade advocate, it has become quite entertaining to skim through social media, opinion pages, or listen to conversations about the latest tariffs imposed by the U.S. administration. One cannot help but wonder why a large fraction of Europeans, who just three years ago where protesting on the streets across all major European cities against the Transatlantic Trade and Investment Partnership (TTIP) and the infamous U.S. chlorinated chicken, are now the ones running their mouth about how “ignorant,” “stupid,” and “dangerous” Donald J. Trump’s decision to impose steel tariffs is. Surely, a lot of this has to be attributed to the very person associated with the tariff. It seems unlikely that people who regularly blame “neo-liberal” politics for the demise of literally everything are now in favor of a liberal stance on free trade and see a trade war as a threat to the welfare of the world.

Whatever one’s personal opinion about the 45th President of the United States is, we should acknowledge one thing: He is not alone in putting up trade barriers. Contrary to recent common belief, it’s not only Donald Trump who’s the biggest threat to increased welfare through global trade but also Argentina, Australia, Brazil, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, Russia, Saudi Arabia, South Africa, South Korea, Turkey, the United Kingdom, the United States and the European Union. If you counted the latter, you already know where this is going: G20.

A recent policy brief addressed to the G20 members and their policymakers by Evenett[1] et al. (2018) shows this clearly. The policy brief states that over 6,000 interventions introduced by G20 members since the crises of 2009 that harm commercial interests are still in force. This is quite remarkable given the responses of the G7 members to the refusal of the United States to stand behind a common declaration of the recent sitting condemning protectionism. Moreover, it is in direct contradiction to the G20 summit declaration of 2008 and 2009, which posits that the G20 governments reject protectionism.

Further, the policy brief holds some uncomfortable truths for free-trade advocates as well as for globalization critiques. The former might be surprised by the extent to which trade barriers have grown since 2009, whereas the latter might be dazed by the consequences these barriers have on the least developed countries (LDCs).

Since the Great Recession and the financial crises of the late 2000s, trade barriers have risen sharply. Data gathered by Global Trader Alert, which has the most comprehensive coverage of all types of trade-discriminatory measures according to the IMF, indicates that a total of 200-250 new policies that harm foreign commercial interests have been implemented each quarter by G20 governments since November 2008. This amounts to a staggering 6,842 distortions to global commerce. It is imperative to emphasize that only 34% of them were outright import and export restrictions that a non-economist would normally think of when asked about trade barriers. Almost half of the trade distortions involve some type of state aid (e.g. subsidies, export incentives, and the like). Figure 2 of Evenett et al. (2018) summarizes this trend in the state of trade distortions by G20 members.


Notwithstanding, the picture of who imposes trade distortions is quite heterogeneous. Figure 3 of Evenett et al. (2018) gives an impressive graphical presentation of the reciprocal nature of the trade distortions of G20 members vis-á-vis each other. The heat map also unmasks one of Trumps notorious lies, or ignorance, i.e. that the United States is the “fair player” in global trade and that the world is cheating them. From the figure it is evident that since 2009 the U.S. has established a high number of protectionist measures across all G20 member countries, whereas only Germany, India, and Russia seem to have the same level of reciprocal measures against the U.S.. Poster children of free trade are emerging market economies like Turkey and South Africa, whereas the long-standing free-trade advocate United Kingdom is only somewhere in the upper third of free-traders. Unsurprisingly, the country which suffers the least from protectionist measures is Saudi Arabia, given its status as the world’s largest oil producer.



Using fine-grained UN trade data, the authors are able to identify to what extent these distortionary measures are affecting the export of goods of G20 members:


  • The percentage of G20 goods exports facing harmful policy acts has risen from 40% in 2009 to 80% in the first quarter of 2018.
  • Close to 9% of G20 goods exports compete in foreign markets where import tariffs have been raised.
  • Just under 19% of G20 exports compete in foreign markets against subsidies or bailed out domestic firms.
  • 75% of G20 exports now compete in foreign markets against foreign rivals that are eligible for some sort of state export incentive (mostly through incentives in the national tax systems).
  • 79% of LDC’s goods export compete in foreign markets against trade distortions implemented by G20 countries.


Where the final point should be emphasized. The trade distortions that LDCs face in exporting to G20 countries are also present in the competition on third country markets, further limiting the growth and development prospects of the poorest of the poor. Moreover, if the developed countries go ahead with this kind of policy and less developed countries adapt to this new state of the world by imposing trade distortions, we might end up in a bad equilibrium where less developed countries are excluded from global value chains.


We actually see this already happening. In the wake of the financial crises, the U.S. whipped up a massive fiscal stimulus to help their economy (and ours!) recover. However, the stimulus package had a provision that demanded that public procurement should buy national, effectively putting up a huge barrier to import goods. Figure 4 of Evenett et al. (2018) shows how fast this idea spread around the world. Almost all of the other G20 countries followed suit and so did some developing countries. Policymakers might think this kind of procurement provision helps their national industries, however, they have to take into account that it also might have a negative effect on the government budget through higher prices, because domestic producers do not face international competition.

If we want globalization and trade to be inclusive and lead to sustainable growth and development even in the least fortunate parts of the world, we must acknowledge that the trade barriers the G20 put in place are detrimental to this effort.


The policy brief by Evenett et al. (which includes two proposals to reverse the dangerous path we are on) can be obtained here.



[1]Simon J. Evenett is Professor of International Trade and Economic Development at the University of St. Gallen, Switzerland, and Co-Director of the CEPR Programme in International Trade and Regional Economics. He gives Policy Lessons on the international trade systems to students in the ITFD programme.

Economics articles by BGSE alumni at CaixaBank Research

Ricard Murillo, Marta Guasch, and Mar Domènech in front of Caixabank. Photo by Marta Guasch.

We’ve just come across some articles written by several Barcelona GSE Alumni who are now Research Assistants and Economists at Caixabank Research in Barcelona. New articles are published each month on a range of topics.

Below is a list of all the alumni we found listed as article contributors, as well as their most recent publications in English (click each author to view his or her full list of articles in English, Catalan, and Spanish).

If you’re an alum and you’re also writing about Economics, let us know where we can find your stuff!

Gerard Arqué (Master’s in Macroeconomic Policy and Financial Markets ’09)

The (r)evolution in the regulatory and supervisory framework resulting from the crisis

Mar Domènech (Master’s in International Trade, Finance, and Development ’17)

Registered workers affiliated to Social Security: situation and outlook across sectors

Active labour market policies: a results-based evaluation

Equal opportunities: levelling the playing field for everyone

Cristina Farràs (Master’s in Macroeconomic Policy and Financial Markets ’17)

The financial situation of Millennial households in the US and Spain: will they catch up with previous generations?

Measures to improve equality of opportunities

Marta Guasch (Master’s in International Trade, Finance, and Development ’17)
and Adrià Morron (Master’s in Economics ’12)

Jay Gatsby’s American Dream: between inequality and social mobility

Ricard Murillo (Master’s in International Trade, Finance, and Development ’17)

Inflation will gradually recover in the euro area

Millenials and politics: mind the gap!

The sensitivity of inflation to the euro’s appreciation

Ariadna Vidal Martínez (Master’s in Finance ’12)

Situation and outlook for consumer financing

Source: Caixabank Research

May the 4th be with you: Economics of Star Wars

By Marco Albori (Economics ’18)

Cartoon by Marco Albori '18

Economics students, as all those students specializing in a particular field, love to share memes about their favorite subject, like jokes about strange convergence theorems, weird topological spaces, or absurd economic policy statements. However, it turns out that at least one day a year our nerdy preferences align, like planets would do, with those of the people outside the world of supply and demand, in name of the movie series that makes all nerd hearts beat: Star Wars! (If you thought it was Star Trek please leave this page!)

May the 4th, which is pronounced as “May the Force” if you studied English with Jar Jar Binks or if you are drunk enough after a night out in a disreputable bar of Tatooine with Han Solo, is the day chosen by Star Wars fans to celebrate the saga. Actually, it seems that this word pun was used for the first time not by a geeky guy brandishing a Made-in-Taiwan lightsaber but by the Conservative Party to wish good luck to the new elected Prime Minister Margaret Thatcher in 1979, “May the Fourth Be with You, Maggie. Congratulations.” [1] Too much culture already, let’s go back to the point.

Fun apart, we like the plot of Star Wars because it could be used to explain many of the real world past and current issues in political economy and international trade. Consider for instance the beginning of the story: Qui-Gon Jinn and his apprentice Obi-Wan Kenobi have to negotiate with the Trade Federation, which blockaded the planet Naboo as a protest against the Galactic Republic taxation of commercial routes. Sound realistic, doesn’t it?

The storyline continues with political conspiracies, taking us across the galaxy from highly developed planets where the production process is made mainly by droids to poor constellations where aliens harvest or starve, from growing free trade zones to stagnating stars. This also reminds us the issues our fellows from the Barcelona GSE International Trade, Finance, and Development (ITFD) Program are studying day after day. Investopedia [2] tells you all need to know about the “economics” of Star Wars galaxy, while Mark Thorton wrote a couple of interesting blog posts [3] for the Mises Institute discussing it from a political economy point of view, which, drawing from the Austrian tradition, is a liberal one. Indeed he defines The Phantom Menace as “one of the finest allegories on classical liberal political economy to ever appear on screen.”

Sometimes we just want to quote the saga to paint a little our mathematically intensive works: it is the case of Brodeur et al. (2016) who titled their paper on econometrics and the worry of every researcher (getting as many stars as possible on his regression coefficients) “Star Wars: The Empirics Strike Back.

Some other times we definitely go wild with creativity, as Zachary Feinstein, a financial engineer who estimated the cost of building the two Death Stars and the loss caused by their destruction due to the Rebels. His paper “It’s a Trap: Emperor Palpatine’s Poison Pill” [4] not only does an accurate accounting of the aforementioned costs in terms of Gross Galactic Product, but also analyses the systemic risk implication of such a disruption on the galactic banking and financial system. According to the author: “this would have been worse than the Great Depression. It would have been beyond anything that we’ve ever seen on Earth.” [5]

At this point it seems legit to ask ourselves: among the famous people named Lucas, are economists more like Robert or George?

No matter whether you are a galactic empiricist or a interstellar growth theorist, as an economist you have a lot of reasons to love Star Wars and watch the whole saga again or do it for the first time if you haven’t done it yet (shame!). And, let’s confess it, we would all like Yoda’s wisdom helping us during our homework nights at the library, of course keeping him away from Latex (imagine the mess caused by convoluted his talking way). Or even better, Chewbacca as a partner in crime when we have to go to an exam revision at the professor’s office.

Lego Chewbacca and economics paper
Photo by Marco Albori ’18

May the 4th be with you!

[1] Wikipedia

[2] Investopedia

[3] Mises Institute

[4] Feinstein

[5] CBC

Friedman’s Presidential Address in the Evolution of Macroeconomic Thought

 By Marco Albori (Economics ’18)

Summary of Gregory Mankiw and Ricardo Reis:                                                                      “Friedman’s Presidential Address in the Evolution of Macroeconomic Thought”

Fifty years ago Milton Friedman delivered his presidential address [1] to the American Economic Association. His speech is the third most-cited presidential address, preceded only by those of Kuznets [2] and Schultz [3], with more than 7500 citations. Why has it been so influential? Friedman stressed his opinion, built over years of study of monetary theory and history, distinguishing what monetary policy could and could not do. In less than 17 pages, with a simple writing not common to most of economic papers, without any equation or complicated model, he challenged the mainstream thought, opening a new era in macroeconomic research.

In occasion of this anniversary, Gregor Mankiw and Ricardo Reis explore the state of the art at that time, the main points of the address and the consequences it had not only on the field but most importantly on policy in a recent paper, “Friedman’s Presidential Address in the Evolution of Macroeconomic Though”, published in the Journal of Economic Perspectives.

Looking back at the beginning of the 60s, the mainstream thought in macroeconomics was the Keynesian one, based on Hicks and Hansen’s simplification of the general theory: the IS-LM model as a building block, accompanied by the belief that the Phillips curve was an actual instrument in the toolkit of policymakers and finally that the long-run behaviour of the economy was the results of the sum of Keynesian short runs. The Keynesian approach to the short and medium run, corrected with the advance made by theorists, is still the starting point of any introductory course on macro, while most of students are initiated to long-run theory through the Solow growth model.

On the contrary of Keynes, Friedman was  convinced that the long-run is the realm of classical economics and thus monetary policy, being neutral, cannot do anything to change real variable like the natural rate of unemployment which is pinned down by the characteristics of the market structure. Moreover, according to his view, the trade-off between inflation and unemployment is always necessarily temporary, as expectations evolve through time, frustrating central bank’s attempts. Milton Friedman’s definition of long-run was indeed the time horizon over which people become informed and align their expectations to the reality. The ground for the rational expectations revolution (and later the development of the RBC model) had been put in place, even though Friedman thought expectations were slow to adapt, sluggish rather than rational.

Following Friedman’s reasoning, central banks cannot take advantage of the Phillips curve infinitely to control real variables in the long run, as it will eventually disappear as expectations adjusts (it should be stressed that he did not consider feedbacks between inflation and unemployment in a fashion like the modern Taylor rule). Notwithstanding this view, and the fact that monetary policy is not timely but takes time to exert its effects, he was not a complete advocate of passive policy, as he believed that monetary policy and credit policy could be used to offset disturbances caused by other sources like fiscal policy (yes, he considered fiscal policy a disturbance, didn’t you know?). He finally proposed to use the rate of growth of some monetary aggregate as the baseline instrument of monetary policy, ruling out the exchange rate and the interest rate instead.

But decades have passed, and nowadays monetary policy could not be more different than that simple rule, with balance sheet policy, fine tuning operations and unconventional “weapons” used by central banks all around the world to cope with the crisis and impaired transmission mechanisms. Monetary policy today is mostly based on the interest rate instead, given its central role in asset pricing and as a driver of investment and saving decisions, and the paper explains the role of monetary policy today, digging into the current ideas which Friedman would have agreed with as well as those he would have opposed. Just to cite one, Galí and Gertler [4] point out the “significant role of expectations” in the transmission mechanism of monetary policy (which Friedman would be totally fine with), as opposed to “the importance for the central bank of tracking the flexible price equilibrium values of the natural levels of output and the real interest rate” which fosters the monetary policy activism criticized by the Nobel prize laureate.

The final section of the paper illustrates the “road ahead” and current research themes (and associated real world problems) which relate to Friedman’s theories. First, the natural rate hypothesis clashes against the stagnation affecting our economies, with the latter opening both to the competing views of hysteresis and shortage of aggregate demand. Second, the Philipps curve is still alive as a synonym of nominal rigidities and investigation of price and wage setting flourishes as that on expectations, recently driven by progresses in surveys and experimental/behavioural economics.

On the policy side, the effects of massive central banks interventions on the potential of fiscal authorities and their constraint and vice versa ask for a compelling understanding, as well as the role of liquidity in financial markets, the potential of macroprudential policy and finally the effectiveness of macroeconomic policy at the zero lower bound. As a matter of fact Friedman did not discuss the last two, which are today central issues in macroeconomic policy: the view that monetary policy could be ineffective and different instruments are needed as the interest rate approaches zero was Keynesian, and he did not reserved a role in macroprudential regulation to central banks. On the contrary, today it is recognized that monetary authorities should pay attention to credit variables as they are related to potential risks for financial stability and crises and ultimately to the potential functioning of the transmission mechanisms of monetary policy, in good and bad times.

Concluding, Mankiw and Reis article on the Journal is accompanied by two other related essays  “Should we reject the natural rate hypothesis?” by Blanchard and “Short-Run and Long-Run effects of Milton Friedman’s Presidential Address” by Hall and Sargent, which further contribute to the discussion surrounding Milton Friedman’s inheritance.



[2] “Economic Growth and Income Inequality”, The American Economic Review, 1955

[3] “Investment in Human Capital”, The American Economic Review, 1961

[4] “Macroeconomic Modelling for Monetary Policy Evaluation.”, Journal of Economic Perspectives, 2007