Results for “mehrling”
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Monday assorted links

1. Gross and Emanuel on reforming the NIH (recommended, Atlantic).  The world really is coming around on this issue.

2. FIRE will move into broader free speech issues.

3. New Perry Mehrling book on Charles Kindleberger is coming.

4. “…we find that adding cultural measures to the model increases the explanatory power from 44% to 95% of the gender compensation gap.

5. How did civil service exams affect who gets employed by the federal government? p.s. Is there any chance here that “elitism” is good rather than bad?

6. Comparing past and present inflation.

Fischer Black’s classic 1986 essay “Noise”

Here is the pdf link, every now and then I feel I should put up an “oldie but goodie.”  This is one of the essays that has influenced my thought the most, noting that Fischer had his own language and could be quite opaque.  Here is the abstract of his 17 pp. essay:

The effects of noise on the world, and on our views of the world, are profound.  Noise in the sense of a large number of small events is often a causal factor much more powerful than a small number of large events can be.  Noise makes trading in financial markets possible, and thus allows us to observe prices for financial assets.  Noise causes markets to be somewhat inefficient, but often prevents us from taking advantage of inefficiencies.  Noise in the form of uncertainty about future tastes and technology by sector causes business cycles, and makes them highly resistant to improvement through government intervention.  Noise in the form of expectations that need not follow rational rules causes inflation to be what it is, at least in the absence of a gold standard or fixed exchange rates.  Noise in the form of uncertainty about what relative prices would be with other exchange rates makes us think incorrectly that changes in exchange rates or inflation rates cause changes in trade or investment flows or economic activity.  Most generally, noise makes it very difficult to test either practical or academic theories about the way that financial or economic markets work.  We are forced to act largely in the dark.

Both of Black’s books are worth studying, as well as the Perry Mehrling biography of Black.

Assorted links

1. Do markets care who chairs the central bank? (pdf)

2. Indian banks are possibly in trouble.

3. al Qaeda is looking for ways to counter drone attacks.

4. Urbanization and China’s unbalanced growth.

5. Perry Mehrling’s Coursera course on money and banking.

6. How lucky are chess world champions? (this research is done by an economist, by the way).

7. Why Ronald Coase was chased out of UVA.

I didn’t mean to leave anybody out

From my entering class at Harvard, that is.  A few emails prompt me to produce a longer list:

Douglas Elmendorf, now head of the CBO in addition to his previous illustrious career in research and policy.

Rob Stavins, teaches at the Kennedy School and is one of the leading researchers in environmental economics including climate change.

Perry Mehrling, we’ve covered him a lot on MR, most of all I love his book on Fischer Black.

Asher Blass, living in Israel, working as a partner in a consulting firm, for a while he was chief economist at Bank of Israel.  I recall Asher once telling me that an individual can have a larger impact in a country with a small population.

Kenneth Kuttner, he has spent time at the San Francisco Fed and co-authored several important papers on money and credit.  Now at Williams College.

John Nachbar, a noted theorist at Washington University and for a while he was department chair.

David Corbett, he now works as a lawyer.

Allen Sanguines, he was brilliant in theory, he is now the President of Rasaland, a development fund in Mexico.

Mark Sundberg, a while ago he was at the World Bank.

Mary Hirschfeld, former Jeopardy champion, went on to get a Ph.D in theology at Notre Dame, now teaching humanities at Villanova.

Greg Duffie, macro and money, professor at Johns Hopkins.

Richard Grossman, at Wesleyan, he is well known in financial history.

Hamish Stewart, has done well recognized work in economics and philosophy.

Deborah Weiss, for a while she was my colleague at GMU Law, now she is living in Texas and raising a family.

My earlier coverage of the class was here.  Our TAs included Michael Mandel and Nobu Kiyotaki.  There are more, perhaps Miles can help me out in the comments.

Assorted links

1. How the sellers of wedding dresses limit arbitrage, and is the Target 2 debate all screwed up?

2. How to reemploy some ZMPers (an epistolary romance), and British royalty adopt ZMP Greek donkeys.

3. No one has a good theory of collateral.

4. Markets in everything, at two different levels, British royalty edition, via Bob Cottrell.

5. Blog with Perry Mehrling and others.

6. What the Khan Academy is really up to, namely measuring when learning occurs or not.

*The New Lombard Street*

The subtitle is How the Fed Became the Dealer of Last Resort (home page here) and the author is Perry Mehrling.  The entire book is good but the paydirt comes in the last two chapters, where we are treated to a persuasive and original account of what the crash- and post-crash Fed is all about.

Mehrling tells us that the Fed is now committed to supplying liquidity in money markets through its role as a dealer, on both sides of its balance sheet, and that is a critical shift in the nature of central banking.  He discusses (pp.126-127) how the collateral behind the shadow banking system relied on CDS markets for its pricing.  In Mehrling's account, insurance companies (including AIG) were indirectly serving as dealers of last resort, believing that they held invulnerable positions but nonetheless exposed.  Investment banks, on their side, thought they held matched books but the higher and lower CDO tranches turned out to be less similar than they had been expecting, based on historical price risk.  None of these expectations survived contact with the reality of the crash.

Now it's the central bank which sells AAA protection because eventually, in Mehrling's view, this activity cannot forever remain a private function (for a start, which insurer is itself safer than AAA?).  A good and indeed central question to ask anyone who is proposing a financial system is to ask who will sell AAA insurance.  

To quote Perry, the new Fed principle seems to be: "insure freely but at a high premium."

Mehrling also suggests that looking at the Fed's balance sheet, or its transactions, is misleading.  The key question is what kind of liquidity dealing option the Fed is promising to the market.

I continue to ponder Mehrling's main claims, but in any case this is an important book about the new Fed.

A new insurance proposal

From Mehrling and Kotlikoff:

Rather than ask Hank Paulson to
determine the price of each and every toxic asset, let’s have him
simply set prices for the ABX insurance policies (or credit default
swaps, as they are called). Right now these insurance policies are
selling for crazy prices because nobody can insure against systemic
risk. Nobody, that is, except the government. The government is in a
unique position to insure against system-wide risk because its own
decisions determine, to a very large degree, the extent of this risk.

Were the government to start selling the ABX insurance policies at
reasonable prices, our Cinderella mortgage-derivatives market would
suddenly wake up and start pricing every mortgage-related security in
sight based on these ABX prices. If Hank does this, the market will do
essentially all the pricing; Hank will have only a handful of prices to
set, not thousands.

Here is another explanation of the same.  And more here.  I miss the good ‘ol days of squabbling about single-payer plans and the Milton Friedman Institute.

Fischer Black and Macroeconomics, part II

Imagine a group of producers preparing for the Christmas season.  Some years they will produce bracelets instead of Star Wars figurines, and turkeys instead of ducks.  Business cycles are then the result of forecasting noise.  Every now and then, we simply have bad luck.

In contrast, Keynesian theories see weak aggregate demand as the problem.  "Real" business cycle theories cite negative real shocks; one example might be oil price hikes.  Black’s theory focuses on mismatched demands.

The bust would seem to be a partial example of Black’s thesis.  Entrepreneurs believed that consumers would pay for Web-ordered, home-delivered groceries, when in fact they wanted to buy more homes.

Black also believed that adjustment processes are slow.  Human capital is highly specific to particular endeavors.  So it takes an economy a good bit of time to recover from its bad guesses.

OK, but why do so many entrepreneurs err in forecasting consumer demand at the same time?  The Law of Large Numbers would seem to imply a more even distribution of errors.  You might expect that about ‘n’ percent of entrepreneurs guess wrong this year, next year, and so on.  I can think of three possible (and possibly wrong) answers to this criticism:

1. The American economy does not, in reality, have so many independent sectors.  Bad luck in a few of the larger sectors spreads to all or most sectors.

2. Many sectors may rely on common and sometimes erroneous forecasting techniques, or may be trying to forecast common variables.  (But what are those common variables?  Does Black’s theory then collapse into the Austrian or Lucasian argument that people are fooled by monetary policy?  What else could be fooling them?)

3. The Law of Large Numbers does imply that an economy, of a given size, is less risky when it has more independent sectors.  This does not mean that business cycles are impossible.  The frequency of cycles will depend on how many independent sectors are operating, how risky is each sector, and how frequently we are "rolling the dice" with demand forecasts.  So we can still get a business cycle more than once every 2 million years.

Black’s theory has one feature which is simultaneously appearling and infuriating.  It explains why economists find business cycles so hard to predict.  But at the same time this drains Black’s theory of any obvious testable predictions.  Black did not mind.  He once said to me: "The easiest theory to falsify is a theory which is false."

We might make other criticisms of Black’s account as well.  Must we not look to labor markets for a closer account of the true action?  What was the taste mismatch in the Great Depression?  Why does everyone pay so much attention to the Fed?

The final verdict: There are very few serious contenders in the area of business cycle theory, so I am not ready to dismiss this one, warts and all.

My Ph.d. Macro reading list

Books: J. Bradford DeLong: Intermediate Macroeconomics, and Paul Blustein, And the Money Kept Rolling in (and Out)

Real Business Cycles

Stadler, George. “Real Business Cycles,” Journal of Economic Literature, December 1994, 1750-1783.

Long, John B. and Plosser, Charles. “Real Business Cycles,” Journal of Political Economy, 1983, 39-69.

Barsky, Robert and Miron, Jeffrey. “The Seasonal Cycle and the Business Cycle,” Journal of Political Economy, 1989, 503-534.

Prescott-Summers debate, Quarterly Review, Minneapolis Fed., “Theory Ahead of Business Cycle Measurement,” “Some Skeptical Observations on Real Business Cycle Theory,” and “Response to a Skeptic.”

Bils, Mark. “The Cyclical Behavior of Marginal Cost and Price,” American Economic Review, 1987, 838-55.

Romer, Christina. “Changes in Business Cycles,” Journal of Economic Perspectives, Spring 1999, 23-45.

Black, Fischer. “Noise,” Journal of Finance, 1986.

Mehrling, Perry. “Understanding Fischer Black,” you can find this paper at:

Finance and interest rates

Ross, Stephen. “Finance,” In The New Palgrave, pp.322-336.

Chapters six and seven, “Objects of Choice,” and “Market Equilibrium”.

Jagannathan, Ravi  and McGrattan, Ellen. “The CAPM Debate.” Federal Reserve Bank of Minneapolis,  Fall 1995, 2-17.

Campbell,  John Y. and Vuolteenaho, Tuomo, “Bad Beta, Good Beta,” American Economic Review, December 2004, 1249-1275.

Campbell, John, “Some Lessons for the Yield Curve,” Journal of Economic Perspectives, Summer 1995, 129-152.

Siegel, Jeremy and Thaler, Richard. “The Equity Premium Puzzle,” Journal of Economic Perspectives, Winter 1997, 191-200.

Kocherlakota, Narayana R. “The Equity Premium: It’s Still a Puzzle,” Journal of Economic Literature, March 1996, 42-71.

Lee, Charles, Shleifer, Andrei, and Thaler, Richard. “Anomalies: Closed End Mutual Funds,” Journal of Economic Perspectives, Fall 1990, 153-164.

Keynesian Economics

Cowen, Tyler. “Why Keynesianism Triumphed Or, Could So Many Keynesians Have Been Wrong?”, Critical Review, Summer/Fall 1989, 518-530.

“Symposium: Keynesian Economics Today,” Journal of Economic Perspectives, Winter 1993, 3-82.

“Is There a Core of Practical Macroeconomics That We Should All Believe?” American Economic Review, symposium, May 1997, 230-246.

Taylor, John. “Reassessing Discretionary Fiscal Policy,” Journal of Economic Perspectives, Summer 2000, 21-36.

Bernheim, B. Douglas. “A Neoclassical Perspective on Budget Deficits,” Journal of Economic Perspectives, Spring 1989, 55-72.

Eisner, Robert. “Budget Deficits: Rhetoric and Reality,” Journal of Economic Perspectives, Spring 1989.

Stiglitz, Joseph E. “The Causes and Consequences of the Dependence of Quality on Price.” Journal of Economic Literature, March 1987, 1-48.

Hall, Robert E. “Employment Fluctuations with Equilibrium Wage Stickiness,” American Economic Review, March 2005, 50-65.

Summers, Lawrence. “The Scientific Illusion in Empirical Macroeconomics,” Scandinavian Journal of Economics, 1991, 129-148.

Monetary Policy

Blinder, Alan. “What Central Bankers Can Learn From Academics – and Vice Versa,” Journal of Economic Perspectives, Spring 1997, 3-20.

Bernanke, Ben and Mishkin, F. “Inflation Targeting,” Journal of Economic Perspectives, Spring 1997, 97-117.

Aiyagari, S. Rao, “Deflating the Case for Zero Inflation,” Federal Reserve Bank of Minneapolis, Quarterly Review, Summer 1990, 2-11.

“Symposium on the Monetary Transmission Mechanism,” Journal of Economic Perspectives, Fall 1995, 3-96.

Roberds, William. “What Hath the Fed Wrought? Interest Rate Smoothing in Theory and Practice,” Federal Reserve Bank of Atlanta, Economic Review, January/February 1992.

Shafir, Eldar, Diamond, Peter, and Tversky, Amos. “Money Illusion,” Quarterly Journal of Economics, May 1997, 341-374.

Caplin, Andrew and Spulber, Daniel. “Menu Costs and the Neutrality of Money,” Quarterly Journal of Economics, November 1987, 703-725.

Sargent, Thomas and Wallace, Neil. “Some Unpleasant Monetarist Arithmetic,” Federal Reserve Bank of Minneapolis, Quarterly Review, 1985, 1-17.

Wallace, Neil. “A Legal Restrictions Theory of the Demand for “Money” and the Role of Monetary Policy,” Federal Reserve Bank of Minneapolis Quarterly Review, Winter 1983.

Posen, Adam. “Why Central Bank

Independence Does Not Cause Low Inflation: There is No Institutional Fix for Politics,” in Finance and the International Economy, edited by Richard O’Brien, 1993.

Garrison, Roger, “The Austrian Theory of the Business Cycle,” At  href=""

Krugman, Paul. “The Hangover Theory,” at

Cowen, Tyler. Risk and Business Cycles, chapter three.

Savings and social security

Hubbard, R. Glenn and Skinner, Jonathan. “Assessing the Effectiveness of Savings Incentives.” Journal of Economic Perspectives, Fall 1996, 73-90.

Choi, Laibson, Madrian, and Metrick, “Optimal Defaults,” American Economic Review, May 2003, also at ttp://

Samwick, Andrew. Voxbaby weblog, read the entries on social security.

International Economics

Current issues:

“If I Believed in Austrian Business Cycle Theory,” by

Tyler  Cowen, on

Brad Setser’s WebLog.

Dornbusch, Rudiger. “Purchasing Power Parity,” in The New Palgrave.

Friedman, Milton. “The Case for Flexible Exchange Rates.” In Essays in Positive Economics, 1953, University Chicago Press.

Mundell-Fleming model, see Brad’s book.

The World


Krugman, Paul R. “It’s Baaack:

Japan’s Slump and the Return of the Liquidity Trap,” Brookings Papers on Economic Activity, 1998, 29, 2, 137-87.

Kashyap, Anil K. “Sorting out Japan’s Financial Crisis,” Federal Reserve Bank of Chicago Economic Perspectives, 2002, 26, 4, 42-55.





Developing Nations



Bordo, Michael D. “Essays in Exploration: A Survey of the Literature,” Explorations in Economic History, 1986, 339-415.

“Symposium: The Great Depression,” Journal of Economic Perspectives, Spring 1993, 3-102.

Romer, Christina H “What Ended the Great Depression?” Journal of Economic History, 1992, 52, 4, 757-84.

Here is a searchable link to Brad DeLong’s website:

Usually I find books like this only in my dreams

Fischer Black and the Revolutionary Idea of Finance, by Perry Mehrling.

Fischer Black spanned the worlds of academia and finance.  His formula for the pricing of options remains essential on Wall Street.  His macroeconomic theories — which claim money does not matter, not even for the price level (more on this soon) — are still regarded as crazy.  His personal life sounds like that of a high-functioning Asperger’s:

He did almost all of his work in an outlining program called ThinkTank, which he used as a kind of external associative emmory to supplement his own.  Everything he read, every conversation he had, every thought that occurred, everything got summarized and added to the data base that swelled eventually to 20 million bytes organized in 2000 alphabetical files…Reading, discussion and thinking that Fischer did outside the office was recorded on slips to paper to be entered into the database later.  Reading, discussion, and thinking that took place inside the office was recorded directly.  While he was on the phone, he was typing.  While he was talking to you in person, he was typing.  Sometimes he even typed while he was interviewing a prospective job candidate, looking at the screen not the candidate.

Robert Skidelsky and Sylvia Nasar raised the bar for economic biographies some time ago.  This book is the next step in that chain.  Pre-order it here, in the meantime here is a Perry Mehrling paper "Understanding Fischer Black."

A readable treatment of current macroeconomics

Is there a new consensus about macroeconomics? Read this recent essay by Perry Mehrling.

Mehrling makes the following points:

1. Macroeconomists are more optimistic than before, in part due to the 1990s extended, low-inflation boom.

2. Monetary policy has replaced fiscal policy as the preferred instrument of stabilization.

3. The current consensus would look remarkably familiar to many of the pre-Keynesian monetary theorists, such as Ralph Hawtrey.

4. The more concerned we are with price stabilization, the more our economies take on properties of commodity money standards. Money is moving again toward the notion of a “promise to pay.”

Read the whole article for a stimulating treatment of further critical issues. If you would like a more technical and theoretical treatment, for macro nerds only, try Michael Woodford’s recent Interest and Prices: Foundations of a Theory of Monetary Policy. Fans of Wicksell (notice the title) and the conundrums of Fischer Black will enjoy Woodford’s work, which reexamines the central assumptions of monetary theory. Think of the book as the 21st century version of Don Patinkin’s Money, Interest, and Prices. And what are we told in practical terms? The price level is best controlled through interest rate policy.

Thanks to Daniel Davies for the pointer to Mehrling’s home page.