Jan 23

Giffen good

Giffen’s paradox is an economic term named after the British economist and statistician Robert Giffen. The law of demand states that when the price of a commodity falls, the demand for it rises. However Giffen’s Paradox is an exception to this law. This is, Giffen goods are those goods whose demand moves in the same direction as the price variation. In other words, raising the price of the good will increase its demand. Consequently any Giffen good has an upward-sloping demand curve.

Alfred Marshall coined this term in his third edition of his “Principles of Economics”, 1895, where he wrote:

“As Mr. Giffen has pointed out, a rise in the price of bread makes so large a drain on the resources of the poorer labouring families and raises so much the marginal utility of money to them, that they are forced to curtail their consumption of meat and the more expensive farinaceous foods: and, bread being still the cheapest food which they can get and will take, they consume more, and not less of it.”

Jan 23

Lope Gallego

Robert Giffen

Robert Giffen, 1837-1910, was a Scottish economist and statistician who also had a great reputation in the fields of finance and taxation. He also participated in the editing process in numerous publication, such as the Daily News, The Economist and The Times. However, Robert Giffen is mostly known for giving name to the concept Giffen goods.

It was Alfred Marshall who, in the third edition of his “Principles of Economics”,1895, wrote:

In other words, Giffen goods are those inferior goods whose demand moves in the same direction as the price variation. This meaning, raising the price of the good will increase its demand.

Jan 23

Lope Gallego

Gottfried von Haberler

Gottfried Haberler

Gottfried von Haberler, 1900-1995, was an Austrian-American economist that specially known for his original contribution in the fields of international trade and business cycles.

He studied at the University of Vienna where he was in contact with other Austrian School economist such as Friedrich von Wieser and Ludwig von Mises and became close friends with other renowned economists in the decades to come: F.A. Hayek, Oskar Morgenstern, and Fritz Machlup. He later went to the United States where he held positions at Harvard University, where he worked with Joseph Schumpeter, and later as consultant and scholar in Washington D.C.

Haberler reformulated David Ricardo’s theory of comparative advantage in his work “The Theory of International Trade”, 1931, in an Austrian School view by using an opportunity cost view instead of the labour theory of value. In addition, he demonstrated that international trade increases economic efficiency and high living standards, and so he was a fervent defender of free trade.

Concerning business cycles, Haberler wrote “Money and Business Cycle”, 1932, which can be seen as an excellent exposition of the Austrian theory of the trade cycle. Other great contributions includes his critic to the Keynesian theory of the liquidity trap in his paper “Money and the Business Cycle”. His argument would later be further developed by the economist Arthur Cecil Pigou into the economic term known as the Pigou effect.

Jan 23

Lope Gallego

Abram Bergson

Abram Bergson, 1914-2003, was an American economist that worked for many governmental and federal agencies including the Russian Economic subdivision of the Office of Strategic Services. He was also a professor at Columbia University, Texas and Harvard. His main area of research was welfare economics but he also provided a lot of research and studies of the Soviet Union economy, marked by a combination of encyclopaedic knowledge of Soviet statistics, theoretical analysis and immense industry knowledge.

Concerning welfare economics, in Bergson’s famous paper “A Reformulation of Certain Aspects of Welfare Economics”, 1938, he defined and discussed the concept of an individualistic social welfare function. This function enables the necessary conditions for an economic optimum to be calculated without the assumption of cardinal utility. Furthermore, the function is used as a way to prioritise and establish an order of preference between different situations that meet the requirements of Vilfredo Pareto for social optima. Bergson postulated the need to explicitly accept judgments of value as a way to develop indifference functions. This concept was subsequently utilised and developed by Paul Samuelson and became an integral part of the welfare economics literature.

Jan 23

Lope Gallego

Roy Harrod

Roy F. Harrod Roy Forbes Harrod, 1900-1978, was an English economist, friend and a follower of John Maynard Keynes. He published a wide variety of economic papers, many of which were on economic growth, but he also conducted research on currency and inflation. In addition, he also wrote about memory and the theory of knowledge, reflecting on probability as a limitation to induction. Through his works underlines a dynamic view of the economy, more sophisticated and realistic, therefore, than the static view of most theorists.

However, Harrod is best known for his work “The life of John Maynard Keynes”, 1951, a biography of his fellow. He is also known for developing what is nowadays known as the Harrod–Domar model that was initially proposed by him in 1939 and later developed independently by Evsey Domar. This theory was a pioneering mathematical model about the dynamics of economic growth that laid the foundations of the economic growth theory after World War II.

Mar 23

Lope Gallego

Abba Lerner

Abraham (Abba) Ptachya Lerner, 1903-1982, was a Russian-born British economist and professor. He entered the London School of Economics at the age of 26 where he learned from Friedrich Hayek, and where he would later become a professor himself. Later, he went to the United States where he taught at a number of universities such as Virginia, Kansas City, Amherst, the New School for Social Research, Roosevelt, John Hopkins, Michigan State and the University of California, Berkeley. Lerner is regarded as a brilliant expositor of the economic science, since he was able to explain complex concepts in a concise and understandable way.

Even though Lerner can be considered to have been a socialist, he was an unusual one as he disliked government power over people’s lives and was in favour of free markets and free price systems.

Lerner contributed to the field of international trade theory with some noteworthy publications concerning the effects of free trade for factor price equalisation, where he developed the concept known as the Lerner–Samuelson theorem. He also participated along with Oskar Lange and Ludwig von Mises in the calculation of the social dividend.

However, he is better known for his article “The Concept of Monopoly and the Measurement of Monopoly Power”, 1934. In this article, which focused on welfare economics, Lerner introduced the idea that monopolies are a matter of degree, stating that their power depends on the excess of price over marginal costs, discussing also Pareto optimality and loss of total welfare in monopolies. Furthermore, he relates all this into the Lerner index, which measures a firm’s level of market power by relating price to marginal cost.

For many of his followers, Lerner’s magnus opus was “The Economic of Controls”,1944, where he analyses, arguments and justifies the use by governments of “functional finances”, which is the use of public finance in order to achieve a full employment and price stability situation. This would help give shape to many of John M. Keynes ideas (Keynesianism) that relied on fiscal policies to increase or decrease aggregate demand depending on the needs of the economy.

Dec 4

Lope Gallego

Monetary union

A monetary union (also known as currency union) is an exchange rate regime where two or more countries use the same currency. However, in some special cases there may also be a monetary union even if there is more than a single currency, if the currencies have a fixed exchange rate with each other. In that case, total and irreversible convertibility of the currencies of those countries is required. Their parity relationships are fixed irrevocably, without admitting fluctuation of exchange rates. This process is progressively implemented, until reaching full monetary integration.

One of the first known examples of monetary union was the Latin Monetary Union, which was created in the 19^th century, when most of Europe’s currencies were still made out of gold and silver. Even though the project failed for a number of reasons, it properly worked for a few decades. The best known example of a current monetary union is found in Europe were 18 countries share the Euro. However it should be said that in this case the monetary union comes along an economic union (thus forming an economic and monetary union), which is not necessarily always the case.

As explained by the impossible trilemma, in a monetary union there is exchange rate stability and a full financial integration enjoyed among the countries in it, at the cost of monetary independence. A common central bank should exist in order to coordinate the adequate monetary policy to assure a correct functioning of the monetary union, independently from national central banks, which lose many of its competencies. Economist Robert Mundell made a great contribution to the analysis on monetary unions in his paper “A Theory of Optimum Currency Areas”, 1961. The theory of optimum currency areas determines the characteristics that are necessary so that monetary unions can be optimal, and therefore sustainable and economically efficient in the long run.

When analysing the impact of monetary unions on the members’ economic performance, there are positive and negative effects. Negative effects of the establishment of a monetary union are, among others: the loss of monetary policy independence, the emergence of problems due to the initial establishment of parities or the difficulties in establishing full capital mobility. Positive effects include: the disappearance of the uncertainty in the fluctuation of exchange rates, lower transaction costs between countries, higher monetary stability and inflation controlling by the supranational central bank.

The following figure shows the different exchange rate regimes according to four different variables: exchange rate flexibility, loss of monetary policy independence, anti-inflation effect and credibility of the exchange rate commitment:

Nov 29

Lope Gallego

Crawling peg

A crawling peg is an exchange rate system mainly defined by two characteristics: a fixed par value of the currency which is frequently revised and adjusted due to market factors such as inflation; and a band of rates within which it is allowed to fluctuate.

As the IMF puts it, in crawling pegs “the currency is adjusted periodically in small amounts at a fixed rate or in response to changes in selective quantitative indicators, such as past inflation differentials vis-à-vis major trading partners, differentials between inflation target and expected inflation in major trading partners”. The crawling rate can be set in a backward-looking manner (adjusting depending on inflation or other indicators), or in a forward-looking manner (adjusting depending on preannounced fixed rate and/or the projected inflation). It must be noted that maintaining a crawling peg limits monetary policymaking, to a similar degree than for target zone arrangements.

These characteristics allow for progressive devaluation of the currency which has a less traumatic effect in the country’s economy. Furthermore, this technique helps prevent, or at least soften, speculation over the currency. For these reasons, this type of exchange rate system is most commonly used with “weak” currencies. Latin American countries are known for being prone to use the crawling peg exchange system against the United States dollar, where in some cases devaluation can be seen occurring on a daily basis.

Nov 29

Lope Gallego

Target zone arrangement

A target zone arrangement is an agreed exchange rate system in which certain countries pledge to maintain their currency exchange rate within a specific fluctuation margin or band. This margins can be set vis-à-vis another currency, a cooperative arrangement (such as the ERMII), or a basket of currencies. The spread of this margin can however vary, giving way to two different versions:

Strong version: also known as conventional fixed peg arrangements. The exchange rate, fluctuates within margins of ±1% or less, and is revised quite infrequently. The monetary authority can maintain the exchange rate within margins through direct intervention (for instance, purchasing and selling domestic and foreign currency in the market) or through indirect intervention (for instance influencing on interest rates). The flexibility of monetary policy is larger than for exchange arrangements with no separate legal tender.

Weak version: also known as pegged exchange rates within horizontal bands. In this case, the exchange rate fluctuates more than ±1% around the fixed central rate. Here, there is a limited degree of monetary policy discretion.

Target zone arrangements can be seen as being half way between fixed and flexible exchange rates. This kind of exchange rate system therefore allows for relatively stable trading conditions to prevail between countries, and at the same time allows some fluctuation in foreign exchange rates depending on relative economic conditions and trade flows.

Nov 28

Lope Gallego

No separate legal tender

Under a no separate legal tender regime, a country uses another one’s currency and thus gives away its capacity of using monetary policies. As stated by the IMF, under an exchange arrangement with no separate legal tender, “the currency of another country circulates as the sole legal tender, or the member belongs to a monetary or currency union in which the same legal tender is shared by the members of the union”. Following this definition, we could include every country in the Eurozone. However, since in that case a new central governing entity, the European Central Bank, was created, it is considered as a pure monetary union.

The most widely used example of an exchange arrangement with no separate legal tender is a formal dollarization. In this case, the country adopts the dollar as its currency. The most common examples are the cases of Ecuador, Panama and El Salvador. El Salvador is a rare case since dollars coexist with the former domestic currency, the colón. However, the printing of new colones is prohibited, so they will coexist with dollars until all colón notes wear out physically.

The main implication for a country to adopt an exchange arrangement with no separate legal tender is that it completely surrenders its control over monetary policy. Therefore, usually this regime is adopted by governments that are considered as non-reliable, substituting their currency in favour of a currency of another country considered to be stable and with an effective monetary policy.

The following figure shows the different regimes according to four different variables: exchange rate flexibility, loss of monetary policy independence, anti-inflation effect and credibility of the exchange rate commitment: