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Politics : Idea Of The Day

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To: IQBAL LATIF who wrote (44813)	10/17/2003 4:00:21 AM
From: IQBAL LATIF	Read Replies (1) of 50167

A great debate.. Krugman in today's NYT: Lehman Brothers has a mathematical model known as Damocles that it calls "an early warning system to identify the likelihood of countries entering into financial crises." Developing nations are looking pretty safe these days. But applying the same model to some advanced countries "would set Damocles' alarm bells ringing." Lehman's press release adds, "Most conspicuous of these threats is the United States." First misrepresentation: Damocles is not a mathematical model but a very simple index of ten "selected" indicators. Second misrepresentation: genuine mathematical models, like the Yale multi-country trade and US macroeconomic models are definitely not predicting that a "crisis could erupt at any time." (Far from it, they're predicting a robust recovery even in the face of Iraq reconstruction costs!) Third misrepresentation -- when we look at the original article on which the editorial was based, we find Krugman left something out: Subbaraman said that the biggest risk to emerging economies was the developed world, where many countries were exhibiting imbalances "that would set Damocles' alarm bells ringing". Most conspicuous of these threats is the United States, where any financial crisis could cause considerable spillover effects to the rest of the world. However, Lehman Brothers cautions that Damocles could not be used alone to grasp a country's full financial picture. (Emphasis added.) ----------------- Also from the original press release we learn Damocles measures: foreign reserves as a ratio of imports foreign reserves as a ratio of short-term external debt external debt as a percentage of GDP short-term external debt as a percentage of exports current account as a percentage of GDP 'broad' money supply as a ratio of foreign reserves domestic private credit as a percentage of GDP real short-term interest rate stock market index real trade-weighted exchange rate There are many macroeconomic models that use these and additional data in a far more sophisticated way than Damocles, which simply assigns made-up numerical weights to each and then adds them up.

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