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Please note that your graph is not a graph of any of the data used in the regression you criticize.  That is explained here:

<a href="http://www.econbrowser.com/archives/2013/03/why_im_more_wor.html">http://www.econbrowser.com/archives/2013/03/why_im_more_wor.html</a>

Also please describe when in your statistics course you get around to explaining how country and year fixed effects work.

by James Hamilton on Thu Mar 14th, 2013 at 11:18:26 AM EST
by afew (afew(a in a circle)eurotrib_dot_com) on Thu Mar 14th, 2013 at 11:34:21 AM EST
[ Parent ]
Your reply, and the blog post linked, do nothing to enhance your scientific credibility.

My take-away from the blog post is this : you claim that showing a correlation between EU countries' debt levels and bond interest rates has policy implications for the USA.

This is a political assertion, and frankly laughable from an economics point of view. The graph from your blog (below) demonstrates that, as long as the market was under the illusion that the Euro was a normal currency, debt levels had no influence on interest rates for member countries. It was precisely when it became apparent that the ECB was unwilling to function as a true central bank, and was in fact prepared to let member countries' economies go to the wall, that the correlation between debt levels and interest rates becomes apparent.



It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Thu Mar 14th, 2013 at 11:47:29 AM EST
[ Parent ]
The US comparison would have to be with the state or municipal bond market.

I distribute. You re-distribute. He gives your hard-earned money to lazy scroungers. -- JakeS
by Migeru (migeru at eurotrib dot com) on Thu Mar 14th, 2013 at 11:50:25 AM EST
[ Parent ]
Like to like : non-sovereign entities can become insolvent, they have to pay their credit risk with the interest rate.

For sovereign entities, the policy takeaway from the ongoing failure of the euro is this : if you want interest rates to correlate with debt levels, then kneecap your central bank. The Fed has made it abundantly clear that it will find creative ways to print money, as much and as long as necessary. If it were to signal that it was no longer willing to accommodate debt-based stimulus, then buying US treasuries would suddenly become dangerous. And the interest rates would soar. Wouldn't that be nice?

It is rightly acknowledged that people of faith have no monopoly of virtue - Queen Elizabeth II

by eurogreen on Thu Mar 14th, 2013 at 12:14:20 PM EST
[ Parent ]
There is the additional complication that there is no other safe dollar asset you could hold instead.
by generic on Thu Mar 14th, 2013 at 01:16:00 PM EST
[ Parent ]
Municipal bonds are not a "safe dollar asset", that would be the US treadury debt.

That's why US municipal bond insurance exists (remember AIG?).

Or do you mean there's no "safe Euro asset"?

I distribute. You re-distribute. He gives your hard-earned money to lazy scroungers. -- JakeS

by Migeru (migeru at eurotrib dot com) on Thu Mar 14th, 2013 at 01:24:07 PM EST
[ Parent ]
Should have quoted:

If it were to signal that it was no longer willing to accommodate debt-based stimulus, then buying US treasuries would suddenly become dangerous.

There still wouldn't be an asset that is inherently safer than treasuries. In Europe you could rank national debt after how credible the non backing by the ECB was.

by generic on Thu Mar 14th, 2013 at 01:34:19 PM EST
[ Parent ]
Yes, if the Fed were to signal that it was willing to put ideological purity ahead of financial stability, or the maintenance of the full faith and credit of the US government; in other words, if the Fed were to signal its willingness to let the US government default, then buying US treasuries would become dangerous.

But faced with the choice of defaulting on the debt or shutting down the government, both the US Congress and the Treasury appear to lean on the side of shutting down the government. So even in case the Fed decided to become the Bundesbank US treasuries would remain safe.

I distribute. You re-distribute. He gives your hard-earned money to lazy scroungers. -- JakeS

by Migeru (migeru at eurotrib dot com) on Thu Mar 14th, 2013 at 01:44:48 PM EST
[ Parent ]
"It is true that you won't find statistical confirmation of the nonlinearities reported in equation (3) if you confine yourself to recent experience in the major non-eurozone advanced economies. There's a simple reason for that-- these countries have not yet reached the tipping point in the dynamics of fiscal debt loads."

You seem to introduce this tipping point - not defined - after the fact to defend your conclusions.

by IM on Thu Mar 14th, 2013 at 11:51:40 AM EST
[ Parent ]
The tipping point is described in detail in pages 4-12 of our paper:
http://dss.ucsd.edu/~jhamilto/USMPF13_final.pdf
by James Hamilton on Thu Mar 14th, 2013 at 12:01:49 PM EST
[ Parent ]
But you cannot fit to the linear part and then claim that it validates, by extrapolation, the nonlinear part.

I distribute. You re-distribute. He gives your hard-earned money to lazy scroungers. -- JakeS
by Migeru (migeru at eurotrib dot com) on Thu Mar 14th, 2013 at 12:07:33 PM EST
[ Parent ]
First, let me welcome you to European Tribune

You claim, in your linked post, that using a fixed-effect estimator suffices to account for the effect of being a member of the Eurozone.

This is obviously false. In order to properly account for higher-order effects, you would have needed cross-terms of a Eurozone dummy with each of your independent variables. Just as (and for the same reason) you include cross-terms between the independent variables in question.

As you correctly note, this would have reduced the statistical power of your test. You are incorrect about the magnitude of the reduction, however: Including Eurozone dummy cross-terms would increase the number of estimated coefficients by only five, not one hundred as you allege.

But more fundamentally, the fact that your data is insufficient to power a proper estimator does not in any way, shape or form justify using an obvious misspecification. In point of fact, using an obvious misspecification to generate fake statistical power is a strong indicator of pseudoscience in action, and hence an argument in favor of the original diary's conclusion.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Mar 14th, 2013 at 06:01:51 PM EST
[ Parent ]
Your post contains a crucial, yet wholly unsubstantiated, assertion:

It is true that an unanticipated inflation would succeed in bringing the real debt burden down. But as soon as creditors become concerned that this is the way the problem will be resolved, nominal rates will rise

The central bank sets interest rates net of compensation for nominal default risk. In extremis, the central bank sets interest rates for all maturities if it wants to.

And indeed, the central bank should set interest rates for all maturities: If the central bank does not do so, the long-maturity end of the yield curve depends exclusively on animal spirits and expectations about future central bank policy.

But either way, there is no connection to the government budget, let alone any economic fundamentals. At all.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Thu Mar 14th, 2013 at 06:13:56 PM EST
[ Parent ]
It is somewhat gratifying that Cyrille's diary drew a response from one to the authors of the paper he critiqued.

"It is not necessary to have hope in order to persevere."
by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Mar 15th, 2013 at 11:19:40 AM EST
[ Parent ]
We have a high google page rank.

I distribute. You re-distribute. He gives your hard-earned money to lazy scroungers. -- JakeS
by Migeru (migeru at eurotrib dot com) on Fri Mar 15th, 2013 at 11:50:46 AM EST
[ Parent ]
But the diary could have been ignored. It is interesting that so much effort has gone into defending lumping together similar numbers of EU countries and non-EU countries when the common constraint on all EU countries of having to act as though they are on a gold standard is having such dramatic effects on them. Perhaps this is unremarkable to 'mainstream' economists, but to me it seems it would be better to 'compare and contrast' EU countries to countries with their own sovereign currency AND a central bank committed to protecting the solvency of its banks, (full stop).

It also raises the question of whether the authors consider such defense appropriate, even if it should entail 3-5%/yr inflation for smaller countries - or even if it entails no inflation - as is currently the case with the Fed policy in the USA.  

"It is not necessary to have hope in order to persevere."

by ARGeezer (ARGeezer a in a circle eurotrib daught com) on Fri Mar 15th, 2013 at 02:18:17 PM EST
[ Parent ]
Failing to do a simple general-to-specific specification search is not at all unremarkable to mainstream economists. It's the sort of thing that would cause you to fail any half-way respectable undergraduate course on time-series statistics.

- Jake

Friends come and go. Enemies accumulate.

by JakeS (JangoSierra 'at' gmail 'dot' com) on Fri Mar 15th, 2013 at 02:21:40 PM EST
[ Parent ]

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