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There is a large literature on the relationship between the yield curve and recessions that started in the 1980s as a result of the inability of macroeconomic models to explain sudden downturns in economic activity. In this box, we review the literature on the predictive power of the yield curve, with a particular focus on the United States, and compute the current implied probability of a recession using data ranging from 1953 to 2018. We find that a recession in the US is not likely soon, but the recent flattening of the yield curve should be monitored carefully. Recessions have often been associated with an inversion of the yield curve, moving from a positive slope to a negative one. A positive slope of the yield curve comes from the fact that investors require a premium for holding longer maturity bonds (the term premium) or expect the short-term rates to be higher in the future. A negative slope is a more unusual event – it has occurred less than 10 per cent of the time in the U...

During the recent negotiations between Greece and its creditors about a debt restructuring programme, we learned that both parties were very keen on maintaining the Eurozone intact (aka Greece staying in the Eurozone). Why is it in their interests to do so? Let's see both sides arguments. First the Greek argument. The Greeks are going through incredibly harsh times with sky-high unemployment and plummeting income, so it's fair to wonder why they are so keen on staying in the Eurozone. What is so great about the Euro that a country is ready to face the threat of economic collapse to stay in it? Indeed what is happening in Greece now, with all banks being closed, capital controls and cash redrawal close to impossible, is a financial collapse similar to the one the U.S. had feared after Lehman Brothers  bankruptcy. With no lending, an economy cannot function properly, companies face liquidity crisis leading to being shut down, people don't invest or rather emigrate and the...

The Nobel Prize in Economics has been awarded to US economists Lloyd Shapley and Alvin Roth for their work on market design . Market design is a subfield of microeconomics that studies how to make markets work efficiently. By efficiently (also called Pareto efficiency), economists mean that the outcome (in terms of who gets what in the market) cannot be improved without making at least one person worse off. Most often this outcome can be achieved by letting people freely trade goods using money as a means of exchange. However, there are some cases where money cannot be used. For example, Alvin Roth studied the market for kidney transplants where buying kidneys is not allowed on ethical grounds. By creating a database of likely donors and patients along with an algorithm to match them, his work allowed to increase the number of transplants and therefore of lives saved. Below is a lecture from Alvin Roth where he explains this case and other applications of market design: At a time...

In a paper presented at the National Bureau of Economic Research (NBER) Macro Annual Conference (April 20-21, 2012), Adrian, Colla and Song Shin (2012) present four stylized facts about financial frictions: In a contraction, bank loans are reduced but bond financing increases to make up for most of the gap. For example, during the 2007-2009 crisis, the number of bank loans issued in the USA declined by 75% whereas the number of bonds increased by two fold. Credit spreads (= risk premium) increase in a contraction Bank lending changes dollar for dollar with a change in debt, with equity being "sticky". So, credit supply by banks is the consequence of their choice of leverage. (cf. figure 1 and 2) Bank leverage is procyclical figure 1: Investment Banks: change in equity and debt in relation to the change in assets figure 2: Commercial Banks: change in Equity and Debt in relation to a change in assets They then develop a model of financial intermediation that...

Another article on the divisions of Macro schools of thoughts Just five years ago, macroeconomists talked about a new synthesis, bringing together Keynesian and Classical ideas in a unified, microfounded theoretical framework. Following the Great Recession, it appears that mainstream macroeconomics has once again split into schools of thought. This column explains why macroeconomics, unlike microeconomics, periodically fragments in this way. In the 1970s and 1980s, macroeconomics was all about ‘schools of thought’. A popular textbook (Snowdon  et al  1994) had the title  A Modern Guide to Macroeconomics: An Introduction to Competing Schools of Thought . Macroeconomists tended to take sides, and different schools had clear ideological associations. Antagonists often talked across each other, and anyone not already on one side just got totally confused. Schools of thought fragmented mainstream macroeconomics in a way that had no parallel in mainstream microeco...

Economist Jonathan Portes discusses what it means to be an Keynesian economist. Fiscal policy: What does ‘Keynesian’ mean? Jonathan Portes 7 February 2012 What does it mean to be a ‘Keynesian’? This column argues that, like so much in economics, the label has become politicised. The cost is an impoverished policy debate that is resulting in millions of avoidable job cuts. I joined the UK Treasury in 1987 and subsequently went to Princeton, where I studied with Rogoff and Campbell. Eventually, I ended up in the Cabinet Office, advising the Prime Minister, on the eve of the 2008 crisis. At no point during this period, however, did I think of myself as a ‘Keynesian’. Nor was it really a meaningful question. You might as well have asked a physicist if he was a ‘Newtonian’. Keynes was a great figure (indeed, one of the greatest Britons of the 20th century) and you had to understand his insights to understand macroeconomics; but the debate had moved on. The Treasury approa...

Here is a study I did with the help of Prof. Christian Hellwig from Toulouse School of Economics, about economic models of macroeconomic fluctuations and asset prices. I perform a review of the benchmark models with financial frictions and then propose a new model with additional frictions. I find that the benchmark models explain some of the output and price fluctuations by small aggregate shocks (to productivity, income or else). However, it is difficult to explain the magnitude of the asset price fluctuations observed in markets. The paper: https://docs.google.com/viewer?a=v&pid=explorer&chrome=true&srcid=0B1Wlp2QVrYS5MWFjMzk3YzYtNTJlMC00NDVkLTliNzgtNjFkYjkzZTQyOTVl&hl=en_US The presentation (attended by Profs. Franck Portier and Roberto Pancrazi): https://docs.google.com/viewer?a=v&pid=explorer&chrome=true&srcid=0B1Wlp2QVrYS5NGQxOTQxYjgtOGY2MC00MjMwLTg4ZGYtZTQzNTg3MjMwYTE0&hl=en_US Comments welcomed

As economics has a lot to answer following the crisis, I feel it is useful to go back to basics. Here is a rap song of Hayek vs. Keynes presenting the opposition between the Austrian and Keynesian schools of economics.