Notes and Communications

Summary This essay explores the occurrence of illusionary images or trompe-l’oeil in economics and their role in economic policy design. In this context four specific examples are discussed, relating to money illusion, the bias in the consumer price index to measure purchasing power, the econometrics of hyperinflation and the measurement of scholarly productivity. Fellow Tinbergen Institute and the Managing editor of De Economist. Until 2001 deputy executive director as well as head of research with De Nederlandsche Bank and from January 2003 professor emeritus in monetary economics, University of Amsterdam. I am grateful to professor J.S. Cramer and dr Peter van Els for their useful comments.     

Prediction of the Netherlands' money stock

Summary This article describes the operational procedure for a mechanical monthly forecast of the money stock in The Netherlands for up to twelve months ahead. In addition to time series data of the money stock itself, the procedure uses the information provided by the disaggregation of the money stock into financial assets, sources of money supply and holdership. The forecast from a univariate ARIMA model of the money stock is combined with three different forecasts from vector ARIMA models for the components distinguished by the three ways of disaggregation. The combination weights, which differ for each number of months to be forecasted ahead, are determined by regression analysis.Professor of Economics at the Free University, Amsterdam and staff member of the Econometric Research and Special Studies Department of De Nederlandsche Bank NV, Amsterdam, respectively. This study was completed when the first author was at the Nederlandsche Bank. We gratefully acknowledge the useful comments of a referee on a previous version of this article.     

Estimation of demand systems using both time series and cross section data

Summary This article deals with three models of complete systems of demand equations (Rotterdam model, AIDS and CBS model). After the models and the theoretical restrictions have been described the parameters are estimated subject to an increasing number of restrictions and using aggregate time series for the Netherlands on five commodity groups. As the initial results are not altogether satisfactory an attempt is made to improve the estimates by combining the time-series information with cross section data from the Dutch 1974/1975 budget survey. While the revised estimates of the income elasticities are more plausible than the initial ones, the reverse is true for the estimated price elasticities. This paper originated when I was a student of economics at the University of Amsterdam. I am greatly indebted to J.G. Odink who never failed to support and inspire me while I worked on this paper. Also I thank J.S. Cramer, D.A. Kodde and J. van Driel for their comments on an earlier draft, and G. Ridder for his econometric advice. Finally the comments of two anonymous referees are gratefully acknowledged. Of course all remaining errors and omissions are my own.     

Arrow's impossibility theorem

Summary It is the purpose of this article to give an exact formulation of Arrow's famous impossibility theorem and its proof. Although the results presented here are not new in the sense that the theorem is refuted or questionned, it may be of some interest especially for the reader who wants to get a more or less complete view of the argumentation leading up to the theorem. Special attention is paid to the logical structure of the argument in the conviction that a lot of misunderstanding exists about what Arrow and subsequent writers tried to say. By way of introduction to the central theme some remarks are made concerning the relation of the Arrow problem to welfare economics.The author would like to thank Mr. W. R. de Jong of the Department of Philosophy of the Free University for his valuable advice in the field of logic and in particular Keimpe Reitsma, student of economics at the Free University, for the extensive discussions which formed an indispensable element in realizing this article. Thanks are due also to two referees for their useful suggestions.During the preparation of this article I was Assistant Professor at the Faculty of Economics, Free University, Amsterdam, The Netherlands. At present I am with the Ministry for Social Affairs, Directorate for General Economic Affairs.     

Financing government spending in the Netherlands

Summary This article addresses the issue of financing government spending from the viewpoint of the Ricardian equivalence theory. After a review of the literature, including a discussion of the underlying assumptions and a comparison with the Keynesian and classical views, we look for empirical evidence for The Netherlands. The empirical results correspond with the findings of many other studies: Ricardian equivalence has to be rejected, although consumers do not completely ignore the government budget constraint. We stress, however, that alternative mechanisms might also be responsible for the empirical findings.Staff members of the Centraal Planbureau, Den Haag and Econometric Research and Special Studies Department, De Nederlandsche Bank NV, Amsterdam. The research project was carried out when the first author was employed at De Nederlandsche Bank. The authors are indebted to J. Pen, M.M.G. Fase, W.C. Boeschoten and A.P. Ros for their valuable comments on an earlier draft.     

Interdependence between The Netherlands and Germany: Forecasting with VAR models

Summary The German economy is usually assumed to take a leading position. In principle this gives smaller countries, which are dependent on Germany, the opportunity to predict their own economic future conditional on the state of the German economy. This paper uses this opportunity for The Netherlands by applying a Vector Auto Regressive model on Dutch and German series. Because the traditional VAR models appear to be overparameterized, their forecast performance can be improved significantly by using shrinkage estimators based on the so-called Minnesota prior. Such a Bayesian VAR forecasts well and confirms the interdependence between Germany and The Netherlands. Variance decomposition of forecast errors and impulse response simulations strengthen the impression that the BVAR model properties are plausible.The author works at the Econometric Research and Special Studies Department of the Nederlandsche Bank. He is grateful to M.M.G. Fase, C.C.A. Winder and two anonymous referees for their useful comments and to R.B.M. Vet for his assistance in various calculations.     

What Happened to European Unemployment?

Summary  Many academic papers were still being written on mass unemployment in Europe. While, unemployment in the EU15 was falling dramatically. Not only academics, but also European workers at large did not seem to appreciate these labour market developments. I offer two explanations for this puzzling deterioration of workers perceptions of the labour market in spite of disappearing unemployment: (i) labour market risk increased, and (ii) employment growth occurred at the cost of stagnating labour productivity. This means that the new labour market offers a worse risk-return combination. Strategies to address these issues are discussed in the final section of the paper. This paper provides an extended version of the first Willem F. Duisenberg Lecture, held at the University of Amsterdam on February 28, 2008. I am particularly grateful to NIAS for this opportunity and to Petry Kievit for having greatly improved my English.     

An economic rationale for a system of loglinear asset demand functions

Summary In this paper we derived a system of asset demand functions from an expected utility maximization model, in which the utility function satisfies both the decreasing absolute risk aversion as well as the increasing relative risk aversion criteria. The rates of return are assumed to be distributed as a multivariate log-normal distribution. It is shown that a system of log-linear asset demand functions follows from the exact model as an approximation and performs better than similar types of linear asset demand functions which follow from a negative exponential utility function.I am grateful to Professor A. R. Bergstrom and Mr. R. E. Bailey for their comments on an earlier draft. Comments from the referee of this journal helped me to improve my presentation. I am also grateful to Professor R. Bandyopadhyay for his comments. I am solely responsible for any errors.     

Tinbergen's work: Change and continuity

Summary This article provides an overview of Tinbergen's economic writings, comprising well over 900 publications. Six broad areas have been distinguished to allow for the classification and discussion of Tinbergen's economic work. These six areas embody the change in Tinbergen's areas of interest apart from the shift from physics to economics early in his career. Tinbergen's work, however, is not only characterised by change of areas but also by continuity in approach. To mark this continuity four main characteristics of Tinbergen's work have been elaborated. The article concludes with Tinbergen's observations on the achievements to be expected from scientific research.J. Kol is Associate Professor of International Economics and Economic Integration at the Faculty of Economics of the Erasmus University in Rotterdam; P. de Wolff is Emeritus Professor at the University of Amsterdam and was Director of the Central Planning Bureau in The Hague as successor of J. Tinbergen. The authors are grateful to Mrs. I.M. Lageweg and Mr C.J. van Opijnen for their assistance with references.     

Income distribution as an objective in development planning

Summary In an input-output framework, income distribution among classes depends on final demand. Traditionally, it has been assumed that the policy-maker selects a distribution vector maximizing his preference function, and it has been attempted to determine this function by an interview. Here, we assume that the policy-maker does not know his preference function but constructs its relevant parts in a communication process with his adviser. This process converges to a (classwise) Pareto-optimal distribution vector and under some further assumptions, any such vector may be attained in principle. Colombian data are used for illustration.I am indebted to Dr. Jacques Melitz for improving my English and to Mr. Roland Fahrion for computational assistance. Nevertheless, I assume sole responsibility for any remaining deficiencies of this paper.     

The Economics of Health System Payment

Summary Health care takes up 10 to 15 percent of GDP in most countries. In this lecture, I consider the efficiency of the medical system, focusing on the potential for payment reform to increase efficiency. Traditionally, medical care reimbursement has been based on the quantity and intensity of the services provided. While this system encouraged valuable innovation, it failed when high quality is not achieved by increased quantity. In theory, a more efficient system could be achieved by paying for medical care on the basis of quality of care provided, not just quantity. I discuss the design of such a payment system and review the literature on how pay-for-performance systems have worked in practice. Cautious optimism about the potential for efficiency gains from payment reform is warranted. This essay was presented as the 19th Tinbergen Lecture on October 21, 2005, in Amsterdam. I am grateful to session participants for comments.     

An Activating Social Security System

Convergence to the Lisbon employment targets requires absorbing large pools of long-term jobseekers, increasing labour force participation and dealing with a sizeable informal sector, composed for the most of low-productivity jobs. The purpose of this paper is to review the main design features of an activating social security strategy reconciling shifts of these three margins with the redistributive institutions characterising the European landscape. Evidence of experimental studies is reviewed. It is argued that EU supra-national authorities should confine themselves to promoting the exchange of information about best practices in welfare-to-work policies as implementation of this approach should be done at a decentralised level. Issues related to the implementation of this activating strategy in the countries that are more distant from the Lisbon targets are also discussed. A first draft of this paper was prepared for the Dutch Presidency Conference on ‘More People at Work’, Amsterdam, 25–26 October, 2004. I am grateful to participants in that conference, Henk Don and two anonymous referees for valuable comments.     

Systemic Risk in the Financial Sector: An Analysis of the Subprime-Mortgage Financial Crisis

The paper analyses the causes of the current crisis of the global financial system, with particular emphasis on the systemic elements that turned the crisis of subprime mortgage-backed securities in the United States, a small part of the overall system, into a worldwide crisis. The first half of the paper explains the role of mortgage securitization as a mechanism for allocating risks from real estate investments and discusses what has gone wrong and why in the implementation of this mechanism in the United States. The second half of the paper discusses the incidence of systemic risk in the crisis. Two elements of systemic risk are identified. First, there was excessive maturity transformation through conduits and structured-investment vehicles (SIVs); when this broke down in August 2007, the overhang of asset-backed securities that had been held by these vehicles put significant additional downward pressure on securities prices. Second, as the financial system adjusted to the recognition of delinquencies and defaults in US mortgages and to the breakdown of maturity transformation of conduits and SIVs, the interplay of market malfunctioning or even breakdown, fair value accounting and the insufficiency of equity capital at financial institutions, and, finally, systemic effects of prudential regulation created a detrimental downward spiral in the overall financial system. The paper argues that these developments have not only been caused by identifiably faulty decisions, but also by flaws in financial system architecture. In thinking about regulatory reform, one must therefore go beyond considerations of individual incentives and supervision and pay attention to issues of systemic interdependence and transparency. Revised and expanded text of the Jelle Zijlstra Lecture at the Free University of Amsterdam on May 27, 2008. I am very grateful to the Jelle Zijlstra Professorial Fellowship Foundation for inviting me to visit the Netherlands as Jelle Zijlstra Professorial Fellow 2008 and to the Netherlands Institute for Advanced Study for providing a wonderful environment for this visit. This expanded text tries to respond to comments and questions from the discussant, Gerrit Zalm, and from members of the audience at the Lecture, for which I am very grateful. I am also grateful for comments on this text from Christoph Engel. Kristoffel Grechenig, Hans-Jürgen Hellwig, Isabel Schnabel, and two referees. As the text was being written, its subject itself has been evolving at a catastrophic pace. Some anachronisms are therefore unavoidable. However, the core of the analysis is, I believe, unaffected.     

Causes of labour supply and demand mismatches in the Dutch building trades

Summary In this paper the significance of some hypotheses on possible causes of labour supply and demand mismatches is tested on data of the Dutch building trades by means of a UV analysis. In contrast with most other UV research this study does not refer to a search-theoretical framework, but focuses on skill differences between labour supply and demand. Three significant causes of labour market frictions appear to be: the development of the skill composition of labour demand, the apprenticeship possibilities and the relatively high wages of older workers. Some other hypotheses show weakly significant results: bumping-down processes, reschooling of unemployed older workers and the development of secondary labour market segments.At the moment of writing this paper the author was working at the Department of Economics, Free University, Amsterdam, The Netherlands.The author would like to thank Professor J.A.M. Heijke, dr. N. van Hulst, Professor J.G. Knot, Professor J.J.M. Theeuwes and Professor A.J. Vermaat for their helpful comments on an earlier draft of this paper and G.A. van Pruissen for his assistance in computer work.     

Exchange rate effects on a firm's output composition

Summary Goods produced for competitive markets and goods produced for imperfectly competitive markets are likely to have interdependent production costs in the sense that an increase in the price or the quantity produced of one type of good raises the costs of producing the other. Such production costs inderdependencies are ignored in the existing literature on exchange rate effects on domestic and foreign output. This article does take these interdependencies into account and shows then that exchange rate effects may be dramatically different. In particular, it is explained why aggregate output measures may be insensitive to exchange rate changes.The idea for this paper was born during a research visit to Reading. The paper was further developed benefitting from comments by Mark Casson from the University of Reading, Henk Jager and Eelke de Jong from the University of Amsterdam, and two anonymous referees. I am most grateful for their suggestions. Any remaining errors are, of course, mine.     

Economic resilience: A two-country analysis

Summary Countries differ with regard to labour-market flexibility and animal spirits of entrepreneurs. The paper aims at an analysis of the consequences of these differences in a climate favourable to economic growth. For that purpose a two-country model is presented in section 2. Although wealth variables are taken into account, expectations are assumed to be static. Despite this simplification the model cannot be solved analytically. The role of a dynamic region (USA) versus a more passive region (Europe) is therefore studied by working through numerical examples.I am indebted to Ir. A. Markink for his invaluable assistance in all computations and to Professor S.K. Kuipers, Mr. A.B.T.M. van Schaik and Mr. J.H.M. Donders for comments on a previous version of the paper.     

Overhead labour and bounded substitutability

Summary In this paper we argue that due to the presence of quasi-fixed overhead labour, the aggregate short-run production function of the industry has the property of bounded substitutability. That is, when employing overhead labour, the industry will only be able to earn a positive quasi-rent for a bounded interval of aggregate labour intensity. This paper was written during a stay at the State University of New York at Buffalo, with financial support of the Netherlands Organization for the Advancement of Pure Research (ZWO). I am grateful to Professor K. Sato for his stimulating comments.     

The American economy in the 1980's

Conclusion There are many things that could distort or completely change the picture that has been sketched of the U.S. economy in the 1980's. War and major technological innovations are two that come immediately to mind. A quick and unexpected reversal of the trends that form the basis of the picture could also, although this seems very unlikely. Or new and unanticipated socio-psychological trends could be generated which would result in a different picture than the one presented. Perhaps it appears that I have stuck my neck out in this discussion. If you think that, you are wrong; I am in a can't-lose situation. If I am right, I can always point to my statements of 1978. Since the anticipations of this paper cannot be fully judged for at least a decade, I am safe even if I am wrong. In ten years nobody except me will remember what I said today, and even I may not. Presidential Address to the Sixth Annual Atlantic Economic Conference, October 11–14, 1978, Washington, D.C.     

The interest function approach

Summary This article reviews Frans van Winden's Ph.D. dissertation,On the Interaction between State and Private Sector: A Study in Political Economics, State University Leyden, 1981, viii+319 pages. The proclaimed objective of the book is to present a nonnormative, theoretical analysis of the interaction between state and private sector in a capitalist economy. Review of the analysis leads us to conclude that the objective is not met. I would like to thank Jean Paelinck and Rick van der Ploeg for their suggestions, and also Bernard van Praag for his apparent interest in the matter. I am particularly indebted to Professor F.A.A.M. van Winden who kindly provided extensive comments on the first draft of this review. Sloan Foundation and Netherlands Organization for the Advancement of Pure Research (Z.W.O.) grants through New York and Erasmus Universities, respectively, are gratefully acknowledged.     

Europe’s Demographic Deficit A Plea For A Child Pension System

Summary This paper considers the economic implications of the stalling birth rates and demographic development in Europe. To remedy for this it proposes a child pension system. This system allows additional pension facilities depending on the number of children raised. It should be a PAYG pension financed with an income tax. The main motivation for this is that parents have invested resources which also benefit society.18th Tinbergen Lecture, Amsterdam, October 22, 2004Ifo Institute for Economic Research at the University of Munich.I am grateful to Lans Bovenberg and Peter Cornelisse for useful conversations about the Dutch pension system and Tinbergens views on children and pensions. I thank Robert Koll, Regina von Hehl and Elsita Walter for careful research assistance, and Tobias Seidel, Michael Stimmelmayr, Martin Werding and Markus Zimmer for useful comments.