Lectures on Economic Policy

1. Lectures on Economic Policy Prague University of Economics 22.04.2013 Andreas Wörgötter, andreas.woergoetter@oecd.org

2. What Applied Economics is about Bringing together three building blocks: • Data – Defining what to observe/monitor • Econometrics – extracting information which is in the data • Economic theory – “smart simplification” of driving forces behind economic activity The aim is to understand how the economy works and how to improve it

3. Applied Economics is an input for economic policy • Policy needs to be triggered by the observation that something is not working as it should – for instance high unemployment • Economic theory provides hints about the transmission mechanism between the policy instruments and the ultimate targets – for instance the impact of a tax cut on employment, output and unemployment • Econometrics provides quantitative estimates for the impact of policy measures – for instance the size of the multiplier

4. Government is the main client for applied economics • Results need to be robust • Trade-offs should be clearly indicated • Delicate balance between - relevance (which is determined by government priorities) - trust (which makes the economist an insider) - sophistication (limited by absorption capacity within the govt. administration) - independence (which helps avoiding capture)

5. How do we find out what is right and wrong? • Applied Economics is about human action. It is time specific and taking place in a social context. It is a social science • Experiments are only possible to a very limited extent • Economic theory can be right in a logical sense, but what is left open is the extent to which its conclusions are relevant • Data collection is a matter for itself. • Econometric methods can be more or less appropriate (as the debate about Reinhart-Rogoff shows). • It is therefore not possible to proof that a hypothesis is right, but only that it may be too likely that it is wrong (Popper’s falsification theorem) – which requires permanent effort

6. How to find the “right” economic advice? • Keep a critical mind, ask questions • Don’t believe in wonders • Look for international experience, learn from good and bad examples • Be cautious about excuses • Is the advice “replicable”?

7. The OECD ApproachEconomic Surveys • Bi-Annual for all member countries and key partners • Drafted by Secretariat experts in consultation with national administration • Intense discussions internally and externally • Special role for Committees with representatives from all member countries • Public presentation

8. Data – Basis Principles • Reliability • Timeliness • Comparability • Edward Leamer: Economics is about pattern finding and story telling – data should allow to find a pattern • OECD – principle of evidence based policy recommendations

9. Important data to watch - I • GDP – level, structure and growth • Issues: Seasonality, Weather and one-offs Purchasing Power Parity – catching up economies look poorer than they are Dutch Disease – structural change and terms of trade changes Boom/Bust – unsustainable indebtedness of households Pro-cyclicality of financial markets and fiscal policies Unbalanced growth and external imbalances – Germany Regional disparities – mobility and convergence

10. Important data to watch - II • When should government intervene? • The output gap – identifying the cyclical position of the economy: Output gap = actual output - potential output Potential output = what could be produced if all resources (labour and capital) are normally utilised 2 Measurement methodologies: production function approach smoothing (separating trend and cycle)

11. Important data to watch - III • Going beyond GDP – How’s life in the Czech Republic? • GDP (material basis for wellbeing) is important, but not everything

12. Czech Republic has a low income inequality

13. Which is a consequence of redistribution

14. Generating the lowest poverty risk

15. Econometrics • Statistics applied to economic data • Always start with looking at data • First think, then estimate • Avoid sample selection bias • Be open to robustness tests • Keep it simple

16. Economic Theory • Keynes – involuntary unemployment • Macroeconomics - SNA • Responsibility for smoothing cyclical development • The transmission mechanism – the multiplier • Questions I – how much is current consumption constrained by current income • Questions II – how distorting is expansionary fiscal policy • Questions III – What are consequences of quantitative easing

17. The Future of Applied Economics • The crisis is signalling the need and chance for change • Is more always better? • What is the relation between protection and innovation?