Author Archives: MIT Sloan Finance Group

Stimulus or austerity: an economist’s search for answers

New finance faculty member Jonathan Parker examines the effects of 2008 stimulus payments

Professor Jonathan Parker

In February 2008, Congress passed a $100 billion stimulus bill aimed at shoring up an an economy on the edge of freefall.

The stimulus awarded a tax rebate of up to $600 per person or $1,200 per couple in hopes that recipients would spend the money and prop up the sagging economy.

Jonathan Parker, one of MIT Sloan’s newest professors, said he believes the 2008 Economic Stimulus Act offers a promising opportunity to study a vexing question: Is household stimulus effective and good public policy?

“My research suggests that the stimulus payments did increase spending, and the extent to which they did informs us about the effects of similar policies on the economy.” Parker said. “We now have a reasonable idea about the spending responses to hitting the Fiscal Cliff or to a proposed tax change.”

“Whether the stimulus bill was good public policy, some will say ’yes,’ others will say ’no,’” he said. “That’s one of the things I’m studying.”

Parker joins MIT Sloan from Northwestern’s Kellogg School of Management, where he wrote several papers examining the impact of stimulus spending. He says at MIT he expects to continue to study stimulus spending versus austerity.

“My view is there is not a great case for either,” Parker said. “A convincing quantitative picture is still murky. A requisite for clarifying that picture is a better understanding of how firms and households behave. That’s what I’m continuously chasing.”

Parker’s path

This fall, Parker returns to MIT, where he received his doctorate in 1996. He joins an impressive roster of finance faculty at MIT Sloan, which is home to Nobel laureate Robert Merton and 2012 Time 100 honoree Andrew Lo.

“It’s a great institution with fantastic colleagues, from the grad students to the most senior faculty member,” Parker said. “It’s an exciting place to be.”

It is also a personal homecoming for Parker, who was born in Portland, Ore., but raised in the Boston suburb of Newton.

As a child, Parker couldn’t avoid being influenced by the academic life. Both parents worked at Boston University—his mother was an administrator, his father a professor of ancient Near Eastern languages and religion specializing in the ancient language Ugaritic.

While he didn’t choose economics until college, Parker’s studies began at the kitchen table.

“My mother was continuously coming up with mechanisms to make sure things were reasonably fairly divided between me and my brother,” he said. For instance, one brother sliced a piece of cake and the other brother got to pick which slice he got. “There’s something about that in economics, determining allocations in reasonable ways, understanding incentives, and thinking about how to make mechanisms that efficiently allocate resources,” said Parker.

His parents sent him to the rigorous Roxbury Latin School in the West Roxbury neighborhood of Boston. Parker went on to earn a bachelor’s in economics and mathematics from Yale University in 1988, and later a PhD in economics from MIT. The longtime headmaster at Roxbury Latin, F. Washington “Tony” Jarvis, an Episcopal priest who oversaw the school from 1974 to 2004, left a lasting impression.

“He was an inspirational figure for thinking about living for more than a house in the suburbs and the 2.5 kids and a minivan,” Parker said. “It was about doing something bigger, better, and beneficial to other people rather than measuring success in life by income.”

Work and public service

Parker studies household economics and asset pricing—the big economic questions that touch on people’s everyday lives.

After posts at the University of Michigan and the University of Wisconsin, Parker taught at Princeton University.

In 2009, while at Northwestern, Parker was tapped to join a team of economists charged with devising a way to attach values to the assets in the government’s Troubled Asset Relief Program (TARP) portfolio. It was critical to find ways to help the government pin values to assets to protect taxpayers. There were many challenges, Parker said.

“How do we value claims the government holds against AIG, Citigroup, and most of the smaller banks in the U.S.?” Parker asked. “Many of the claims on these institutions held by the U.S. government—and so taxpayers—were not traded in the marketplace, so how do you figure out their worth? Given that some may not pay the government back, and the government controls policies that influence whether they will be able to, how do you price the risk in these banks?”

Parker’s work studying the efficacy of stimulus spending started at Princeton with the tax rebates of 2001, and continued at Northwestern. There he set out in several studies to measure exactly what households did with their stimulus checks, and why, with an eye toward influencing future policy.

In 2012, Parker wrote “The Economic Stimulus Payments of 2008 and the Aggregate Demand for Consumption,” with Christian Broda of Duquesne Capital Management. The pair used consumer purchase scans to see how the tax rebates were spent.

What they learned was that after rebates arrived, households raised spending 10 percent in the first week and 4 percent in the following seven weeks, then the spending trailed away. Almost all consumer spending was by households with incomes of $35,000 or less and with two months or less of liquid assets.

Parker said it is tough to sell stimulus programs if households believe they don’t work and are costly because they add to the nation’s long-term debt.

“The $64,000 question is, ’What do we do now—with the US debt to GDP as high as it is and a perceived need to increase spending for demand?’” Parker said. “There’s a tough trade-off because household spending reflects not just cash flow, but also future concerns about who’s going to pay, and will there be a default crisis?”

His research so far doesn’t give a clear answer—stimulus or austerity. But then again, no one has the answer yet.

“Economists who get on TV and say ’I’m sure we should do more stimulus’ or claim that the only way forward is austerity, they are not getting there from the academic evidence they’ve read,” Parker said. “They’re getting there from somewhere else.”

“I’m always humbled by how little we know,” Parker said. “The world is infinitely more complex than our economic models. So we’re continuously learning. Some of the biggest questions in economics are still up for grabs.”

 

In Shanghai, charting the future of global finance

Third MIT Sloan finance forum examines interconnected finance systems and China’s role in the world economy

Professor Robert Merton

More than 200 finance professionals and MIT Sloan alumni gathered in Shanghai this month for a day of discussion on the future of modern finance, the third in a series of forums that bring MIT Sloan faculty around the world for frank discussions about finance and policy.

“[MIT Sloan] has the responsibility to lead and develop what the world needs for finance,” dean David Schmittlein told the audience at the July 19 event. “It’s important for us to develop the concepts and methods that will allow us to develop the complex, sophisticated financial systems that the world needs, with a resilience that the world also needs.”

“The world needs more smart people who understand complex financial systems,” he said. “Not less.” MIT Sloan this year launched the MIT Sloan Center for Finance and Policy.

Sound modern financial systems are built using expert knowledge to interpret vast amounts of data. To contribute to the discussion, MIT Sloan professors Deborah Lucas, Robert Merton, Jun Pan, and Stephen Ross shared their latest research on financial models and systems that address some of the challenges in modern finance.

And MIT Sloan alumni covered a range of topics in two panels. On one, two of China’s top financial professionals discussed the role of finance in emerging markets, while another group discussed ways to lead the financial organizations of the future.

Finance is becoming increasingly important for emerging markets

Shanghai, China’s financial capital and aspiring world financial center, was an apt location to discuss the role of finance in the growth of emerging markets. Leaders in emerging markets are seeking to better manage growth, gathering more knowledge and talent from the financial field than ever before.

“The era when very few Chinese financial professionals were up to date with the latest academic research findings is over,” said Haizhou Huang, managing director and head of the sales and trading department of China International Capital Corporation. There is an “ever-increasing number of Chinese financiers being educated at leading institutions like MIT Sloan,” he said.

Emerging markets are also challenging the post-2008 financial crisis system. Huang pointed out the benefit of China’s lack of heritage in finance, suggesting it gives China “an opportunity to create finance for the future, with a completely new financial system.”

Interconnectedness in finance can be a strength

Increased interconnectivity of global financial markets, a phenomenon of the modern financial system that was widely commented on during the crisis, was a key theme throughout the forum.

Professor Robert Merton, a Nobel laureate, introduced a new approach for analyzing and managing macro financial risks by leveraging the many connections between financial bodies that makes the world of finance so complex.

Merton’s goal is to “figure out ways to convey information with vast connections and numbers in a fashion that’s useful in trying to understand what’s going on.” He believes his approach will help guide finance professionals toward asking prescient questions when examining global markets.

Rather than view the complicated interconnectedness of financial systems as problematic, Merton was optimistic.

“The mere observation of growing connectedness is not in itself a suggestion of contagion or systemic risks. It may even be a reflection of the improvements in the global system,” he said.

MIT Sloan has also held finance forums in New York City and London.

Unlocking the modern financial system

Leading MIT Sloan finance faculty share research, ideas with alumni in London

Professor Robert Merton speaks at the MIT Sloan Finance Forum: Financial System 2.0

The financial system is evolving and businesses and regulators need to move quickly to keep pace with the speed of change. That was a key lesson at Financial System 2.0, a special event held in London on June 13 as part of the MIT Sloan Finance Forum series.

Some 200 alumni and friends of the School attended the event, which saw MIT Sloan’s leading academics meet with experts from across the finance industry to discuss the state of the world’s financial markets and how to shape what comes next.

Highlights of the day included:

Professor Stewart Myers look at management incentives and corporate governance. Myers discussed ways to build a functional balance between shareholder remuneration and good company management, including the idea of levying a transaction cost on shareholder intervention.

Professor Andrew Lo’s examination of how financial markets can be harnessed to help cure cancer. Lo explained that a typical cancer drug development program could cost  $200 million, with a success rate of 5 percent. However, instead of investing in one program, it might be possible to invest in 150 different ones, with diversification offering investors more than a 99 percent chance of at least two successes and a higher return on investment. The reduced level of risk resulting from diversification would allow managers of a “cancer megafund” to issue approximately $16.7 billion of debt immediately, Lo said.

“Instead of declaring war on cancer, we should put a price on its head,” said Lo.

A frank discussion, chaired by Financial Times commentator Gillian Tett, on hedge funds and how they are evolving to respond to the shifting financial landscape.

An overview of MIT Sloan’s intensive, one-year Master of Finance program. Launched in 2008, during the financial crisis, the program was developed to put highly-trained graduates to work in the financial sector. MIT Sloan’s goal is to create the next generation of global finance leaders, with a deep understanding of the profession’s potential contributions to society. Graduation data demonstrates that it is succeeding: although the finance sector has seen a general decline in interest, the number of graduates from MIT Sloan’s Master of Finance program continues to grow.

Professor Antoinette Schoar’s demonstration of how to apply insights from behavioral finance in order to mitigate credit risk, particularly in emerging markets. Schoar explained that in many emerging market countries, small businesses regularly pay late and go into default. Behavioral economics suggests small businesses and individuals in emerging economies slip into default through lack of attention to the repayment cycle, said Schoar.

Professor Andrei Kirilenko’s discussion of market evolutions and high-frequency trading. Kirilenko asked whether high-frequency trading is essentially beneficial or “legalized front­running.” He showed that a survey of market participants concluded that high frequency trading had been the cause of the May 2010 “Flash Crash” that saw the Dow Jones Industrial Average dip 9 percent only to rebound a few minutes later.

But Kirilenko shared research showing that high-frequency trading had not caused the crash.

“We should not look at high-frequency trading as being ‘good’ or ‘evil,’” Kirilenko said. “It is more productive to think of it as a trade-off between beneficial and detrimental effects.”

Kirilenko also discussed the new MIT Sloan Center for Finance and Policy, which will serve as a hub for financial analysis of public policy issues and a collaborative platform to stimulate cooperation between government, the private sector, and academia.

Professor Robert Merton’s demonstration of the role connectedness plays in the global financial markets. Merton warned that there is a need to improve integration between the different parts of government with responsibility for managing fiscal policy and promoting stability.

 

View videos from this event here