Sunday, July 31, 2011

Differences in saving rates

Consider two countries that are equal in every respect but have different saving rate. The country with the higher saving rates accumulates more capital and therefore converges to an higher level of capital stock and output per worker.

This prediction of the model seems roughly consistent with the empirical evidence that emerges from looking at a cross section of countries. Statistics suggest that high investment rates are associated with high level of GDP per capita. But does the picture really tells us that if Gambia increases its saving rate from 5% to 10% this will lead to a doubling of GDP per capita in Gambia? We will go back to this point later. For now keep in mind that this relation has motivated many policy choices.

The Stalin 5 years plans in the thirties were basically based on this theory and a lot of programs in developing countries in the 60s had as a main goal the increase in saving (even forced saving though taxes) to increase capital stock and achieve a higher output per worker. Even more recently the IMF has stated that "To achieve gains in real per capita GDP an expansion in private saving and investment is key".

The Golden rule of saving

An interesting question is whether higher saving, even if it always yields higher levels of steady state income, always yields higher steady state consumption. The answer is no and the intuition comes from the fact that returns to capital are decreasing.
Increasing my saving by 5% always reduces my consumption by 5% but the benefit it will bring in terms of future consumption depend on the returns to capital. If I have little capital returns to capital are high and my consumption will eventually increase.

If I have a lot of capital returns to capital are low, the benefits of additional saving are low and consumption might actually decline. The steady state level of consumption depends on the saving rate. It reaches a maximum at the point in which the marginal product of capital is equal to the depreciation rate. This saving for which the maximum consumption is achieved is called the “golden rule" of saving.

But if savings and investment is so important why do some countries (for example the African countries) fail to realize that and do not save and invest? So far we've been treating savings as an exogenous variable and so we are not really equipped to answer this question. A first simple theory of saving rates might be based on basic needs: some countries do not save simply because they are too poor to save. Suppose that when people have very low income they need all their income to satisfy their basic needs (like food) and thus their saving rate is 0 (They consume all their income).

When income reaches a basic level people start saving and save a constant fraction of their income as in the previous example. Also assume that this rate is the same across countries.

The model will display two steady states. Notice that the one steady state (the one with low capital) is unstable in the sense that if capital is above it , it will move toward the higher capital steady state but if a country starts with a capital below that level that country will converge toward a level of 0 capital stock. The situation depicted is called a poverty trap. Countries that start with a level of capital stock that is very low will never take off. Notice that here we have reversed the causality: it is not that countries are poor because they don't save but they do not save because they are poor.

The poverty trap model has been the rational for the kind of policy denominated big push, that is a massive investment from abroad that is able to raise the capital stock just above the first steady state so convergence to the higher steady state can happen. The big problem with this theory has been that even though these type of big push policies have been tried repeatedly (from Zambia in the 60s to Cambodia or Lithuania in the 1990s) they do not seem to have generated sustained growth. For example in the period 1960-1988 of 87 developing countries (income per capita below US$ 5000) 47 of them have failed to even improve their standard of living. So why are some countries unable to takeoff even with massive foreign aid?

Thursday, July 28, 2011

SAS (software)

This software is an integrated system of software products provided by SAS Institute Inc. that enables programmers to perform data entry, retrieval, management, and mining, report writing and graphics. It is very useful in providing statistical analysis for business planning, forecasting, and decision support. Additionally, I see it widely used in operations research and project management.

Recently I have been looking into preparation for the SAS base and advanced exams and also whether it is worth getting the qualification. 

I have been hearing that the exams are really easy, if you have used SAS at all in a real environment. The biggest areas to study are DATA [especially the different input FORMATs] and MERGE for the Base one.PROC SQL, and Macros for the Advanced one. As far as books are concerned, Burlew's "SAS Macro Programming Made Easy " seems to be good buy and so is Cody's books.

SAS seems to be having great potential in India. From what I have been researching, business analytics in India is in  a growth stage and now is the right time enter this field. In New Delhi,there are 2-3 good Institutes which provide training for BASE & Advance SAS.

There seems to be some study material for both Base and Advanced SAS exam here:

The key point I think is, after you passed the exam, you still need a lot of practice to really understand SAS programming. As always, no shortcut to become an expert!                      

Sunday, July 24, 2011

Money, inflation and interest rates

What is money?
A standard way to begin a discussion about money is to try to define what it is. This is somewhat difficult to do because historically many things have been used as money - shells, beads, cigarettes, pieces of paper. What characteristics make any of these suitable as a form of money? 

One way to think about this is to define money in terms of the services it provides. Money is an asset. An asset is something that serves as a store of value, that is something that can transfer purchasing power from today to the future. Notice that money might not be the best way to store value (cash for example is money and does not pay interest and loses value because of inflation). But, lots of things, stocks, bonds, real estate, can and do fulfill that function. Money is really quite different from other assets because it provides
another important service - it serves as a medium of exchange. The medium of exchange role implies that it is freely exchanged for goods and services and it has wide acceptance and (generally) well understood value; in other words money can be used to make transactions. Another service that money provides is that it serves as
a unit of account. The role of unit of account means that when we talk about the value of other assets or consumption goods we use monetary units as a standard way of denominating them. The unit of account means also means that money is the good we use to measure prices, that is we define the concept of price of an object as the number of units of money that are required to purchase that object. This is important to recognize as when we think about inflation, that is how price level change, we have to think about how the stock of money changes. The fundamental prerequisite for functions 1,2 and 3 is that money has to have current and future value.
After outlining its functions we can then state that money is the stock of assets that can be used to make transactions (stock of liquid assets). How does money come into being and why are people willing to accept some forms of money? Or in other words where does the value we attach to money come from? We know that different forms of money have evolved naturally in many societies. One example that is often cited is that cigarettes became used as a form of money in POW camps during World War II. They are also often used as a form of money in U.S. prisons. What problems does the existence of an accepted form of money solve? The easiest way to understand this is to imagine a simple economy in which individuals all specialize in the production of a single good. Some grow wheat, some harvest wood, some raise chickens and some educate the young. Specialization, as we learned studying international trade, is efficient but how do educators and wood harvesters get to eat? how food producers get wood and educate their young?. People benefit from
transacting with one another. But if this were a pure barter world, then transactions could only take place when we found someone who offered in trade something we desire and who desired that which we produce. This is called the double coincidence of wants. The point is that transacting in such a world would be very inefficient.
Suppose, instead that there were some accepted medium of exchange. It need not be anything with intrinsic value. It could be stones of a certain size and shape, or pieces of paper embossed with a picture of long dead politicians. All that is required is that everyone agree that it is the medium of exchange and agree on its relative
value. In this world, educators could now exchange education services for money and use the money to purchase wheat and wood without worrying about whether the producers of wheat and woods that he encountered had any need for education services. The acceptance of a medium of exchange thus facilitates transactions in the society because it removes an important impediment to economic activity. As money
plays an important role in society it is important that its supply keeps up with the growth of the society. But who decides what is money?
There can be two main types of money: Commodity money and Fiat Money. Commodity money is a form of money that also has intrinsic value (for example gold coins or cigarettes): everything can be commodity money as long as it is accepted: for example candies sometimes are given as change: this is the case of commodity money. Fiat Money is a form of money that has no intrinsic value (for example dollar bills). Fiat money is declared money by some institution. Commodity money was the only form of money that was used on the world until fairly recent times. Now most countries use Fiat Money even though some countries are still -de facto- using commodity money systems. The main advantage of commodity money (for example gold) is that its value is guaranteed from the fact that people use gold for a variety of reasons (jewelry, industrial use etc.) and so it does not require a social convention.
The main disadvantage of commodity money is that its supply cannot be controlled easily. For example when gold was the only form of money, shortages of gold or big gold discoveries affected the quantity of money. Fiat money (Let it be money) on the other hand does not have intrinsic value (it is useless) and all its value comes from social acceptance, from the diffused belief that money will be used and accepted in
the future. The quantity of Fiat money can be controlled easily and cheaply, since mostly it consists of pieces of paper. The fact that Fiat money can be controlled by the issuer might be an advantage and a disadvantage. If the issuer is trustworthy (like for example the Federal Reserve Bank) having control over the money supply is a good thing because it can be used to achieve price stability. If on the other hand the issuer is not very trustworthy (like the Argentinian Central Bank in the '80s ) then control is a bad thing because it allows the government to use money creation to finance all sort of expenditures and this leads to price instability, to large unexpected wealth transfers and, in extreme cases, to the collapse of the exchange system (we
will discuss more about this later).