I’m neither a supporter of Bayern Munich nor of Chelsea FC. In Germany, I fiercely support the team from the city I was born. Here in England I support the one that plays in the district where I live.

Hence, with regard to this years Champions League final, I’m perfectly neutral.

However, I’m also an economist. And based on my professional background I’m rather confident that Bayern Munich will beat Chelsea this weekend.

This forecast is not based on the fact that Bayern will play on its home turf. It is rationally derived from purely economic arguments: Judged by the current market value of the individual playes, Bayern will have the stronger and more powerful squad on the ground.

On Friday, the German football magazine “kicker” published the most probable formations of Bayern and Chelsea. Judged by the current market value of the player – estimated by the football website Transfermarkt – the German XI will be about 30 percent stronger than the English one.

The Bayern XI will be worth 290.5 million Euro while Chelsea’s players are just worth 202.5 million Euro. Even if the ageing forward Didier Drogba would be replaced by the expensive (and mostly useless) Fernando Torres, Chelsea’s value would only climb to 235 million Euro.

The most striking difference between both teams is in the midfield and in the attacking units. The six Bayern players Sebastian Schweinsteiger, Toni Kroos, Arjen Robben, Thomas Müller, Franck Ribery and Mario Gomez have a combined market value that is higher than that of all eleven Chelsea players. They are worth 212 million Euro.

The goalies are a much closer match: Manuel Neuer is better than Petr Cech, but the difference is rather tiny (30 million Euro vs. 25 million). Chelsea’s defensive unit is slightly stronger than Bayern’s. The four defenders of the British team are worth 62,5 million Euro while Bayern’s would cost 48.5 million.

The idea to use the transfer value of the individual players as a forecasting tool traces back to Gert Wager, a Professor of Economics at the Berlin University of Technology, and Jürgen Gerhards, a professor of Sociology at the Free University of Berlin.

Their track record is rather impressive. Wagner and Gerhards were able to successfully predict the winning teams of the World Cup in 2006 and 2010 as well as the Euro 2008. “Our method confirms the idea that simple models quite often work as precisely as more complex and intricate forecasting tools”, says Gerhards.

However, they also concede that pure happenstance often plays the decisive role in football. In a single match, this factor might be much more important than in a tournament where teams play several games.

According to the German sport scientist Roland Loy, about 50 percent of all goals are happening by chance, for example because of outright errors by the goalie or the referee or because the ball was deflected in a completely unpredictable way. Loy’s assessment rests on the detailed analysis of more than 3000 professional football games.

Hence, in fact anything can happen in Munich. This is why I really look forward to watching the game.

Now, the editors of the Journal of Finance and five other Finance journals have teamed up. In a joint statement, they condemn the practise and stress:

“[We] hereby affirm that it has been, and will continue to be, our policy to avoid coercive citation practices.

While we retain professional discretion to suggest that authors cite particular papers, we will do so only when scientifically appropriate, and without regard to the journal where the cited paper is published.”

This statement is signed by the editors of the following journals: Journal of Finance, Journal of Financial and Quantitative Analysis, Journal of Financial Economics, Review of Asset Pricing Studies, Review of Corporate Finance Studies and Review of Financial Studies.

I think this is an important move. Let’s hope that other journals will follow suit.

After all, the University of Zurich gets tough against Bruno Frey.

The faculty has decided to force him into retirement. The current contract with Bruno Frey, which is going to run out at the end of July 2012, will not be renewed.

Probably as a matter of retaliation, Bruno Frey has severely criticised his faculty in an op-ed he published in a major Swiss daily. Between the lines, he urged the Swiss government to cut the funding for the economics department of the University of Zurich.

After weeks of unconfirmed rumours about the decision, the University of Zurich on Sunday officially announced that they won’t prolong Frey’s contract.

The press office declined to explain the reasons for this decisions pointing to the fact that HR affairs are confidential.

However, as sources at the university explained to me, Frey’s dodgy academic conduct is at the core of the ruling.

“The discussions about Bruno Frey’s self-plagiats have severely harmed the international reputation of the faculty”, an insider told me.

Last summer, the blogger Economic Logician and others discovered that Bruno Frey published an article about the sinking of the Titanic in four different academic journals without cross-referencing to the other papers.

The “Journal of Economic Perspectives” and other effected journals publicly rebuked Frey. He sincerely apologised and tried to frame the missing citations as a one-off thing.

However, numerous similar cases were revealed by the FreyPlagWiki and by this blog: Bruno Frey systematically published similar papers in a number of journals without citing the related work.

This is a clear violation of the submission guidelines of most affected journals and at odds with commonly agreed ethical standards of the academic profession.

However, last month it looked like Bruno Frey was getting away with a slap on his wrist by the University of Zurich. An external commission that examined the Titanic papers came to the conclusion that the missing cross-references were “improper” and violated the integrity of the academic research.

They recommended that Frey should be reprimanded but also came to the conclusion that no further action was necessary. The University of Zurich followed this advise. Frey was rebuked and the procedure closed.

But that is only half of the story – as it has become clear recently.

Formally, the decision not to renew his employment contract is not related to the investigation. Frey, who is 70 years old, was officially retired in 2006 when he celebrated his 65 birthday. However, based on a special arrangement applicable for outstanding researchers, the university extended his employment with temporary contracts that had a duration of two years. The current one runs out at the end of July 2012.

In a very unusual step, Bruno Frey, who is also a Distinguished Professor of Behavioural Science at Warwick Business School, lambasted the economic department at the University of Zurich. In an op-ed for the Swiss daily “Tages-Anzeiger”, he claimed that most economists of the University of Zurich were only focussing on producing scientific publications and were not interested in influencing economic policy anymore. He wrote:

“A lot of economists at universities are only aiming at publishing as much as possible in academic journals. They are only marginally or not at all interested in what’s going on in the real world.

Hence, there are only a few economists left who take a stand on the economic problems of this country. Positive examples are Monika Bütler (University of St. Gallen) and Christoph Schaltegger (University of Luzern).

Almost without any exception, however, the economists of the University of Zurich, are not visible at all in the economic and financial discussions.

They are only interested in publishing in academic journals. If at all, those publication are only acknowledged by a few number of other academics. Quite often, nobody at all takes note of them. The economic and socio-political debate surely is not influenced by this. Sooner or later, this should be realised by the tax payers who are funding the university.”

Such a rant against a faculty where Frey has been working since 1977 is quite a unique thing. I don’t think it is either fair or justified.

This rampage hurts Frey much more than his old colleagues (who, ironically, announced that they will receive a donation of 100 million Swiss Francs from UBS a few days after Frey published his piece.)

Question: Professor Sen, do you have the impression that economists and economic policy makers are learning the right lessons from the most severe economic and financial crisis since the Great Depression?

Answer: I don’t think that at all. I’m quite disappointed by the nature of economic thinking as well as social thinking that connects economics with politics.

What’s going wrong?

Several features of policy making are worrying, particularly in Europe. The first is a democratic failure. An economic policy has to be ultimately something that people understand, appreciate and support. That’s what democracy is all about. The old idea of “no taxation without representation” is not there in Europe at the moment.

In which respect?

If you are living in a southern country, in Greece, and Portugal and Spain, the electorates views are much less important than the views of the bankers, the rating agencies and the financial institutions. One result of European monetary integration, without a political integration, is that the population of many of these countries has no voice. Economics is de-linked from the political base. That I think is a mistake and it goes completely against the big European movement that began in the 40s and fostered the idea of a democratic, united Europe.

Cutting back public debt has become the priority of policymakers in Europe. A lot of  economists in Germany appreciate this.They argue that public finances have been on an unsustainable track.

Public debt in Europe has to come down, there is no question about that. However, I think the timing is wrong. At the moment the official priority seems to be to cut debt first and think about growth later. To me, this seems to be a big mistake.

Why’s that?

Economic history shows that public debts are much more easily paid back in periods of high growth rates. This is true for the years following the second world war as well as for the United States during the Clinton administration, or Sweden in the 1990s.

What’s the alternative?

One has to bear in mind the role of the state, which includes not only providing support to vulnerable people and a social safety net, but also regulating the market economy. Right now, well directed stimulation is needed, rather than drastically cutting down the state.

Since the crisis broke out the economics profession in general and mainstream economics in particular have been severely criticised. Do you think this is justified?

The criticism of mainstream economics is justified to a limited extent. It is certainly true that the focus of attention in mainstream economics has tended to be on assuming the market to be working perfectly and there being no need for regulation. However, while this view has been a very dominant part of mainstream economics, you have to bear in mind that mainstream economics is not all centered around one unified theme. I don’t think all of mainstream economics should be held responsible.

Do you think that neoclassical macro economists should bear the brunt of the blame?

This would be an oversimplification. Neoclassical economics has many different paths. There are mainstream neoclassical economists who have been very critical of the complete reliance on the markets.

For example?

Take Arthur Cecil Pigou. Often, he is described as an important intellectual antagonist to John Maynard Keynes. On the other hand, Pigou talked a lot about the state, income distribution, and poverty. But at the same time, he was very much a neo-classical economist. Keynes was far less concerned about inequality and poverty than Pigou was.

Putting a lot of faith in the functioning of free markets has a long tradition in economics. Take Adam Smith for example. The work of Adam Smith was much more diverse than is currently appreciated.

Smith described how the market economy works very well. However, he also pointed out why we need the state and well-reasoned regulation. He was also very much concerned about redistributional issues as well as issues of poverty. In fact, nothing engaged Adam Smith more than the issue of poverty.

Why is our view of Smith so biased?

Parts of the economics profession took only the first part of his work seriously but disregarded the other part. I think what has happened is that mainstream economics fell prey to a biased reading of the tradition that it had inherited.

Why did that happen?

I think a lot of economists were deeply impressed by the elegance of their models. These models describe an imagined economy where the markets functioned perfectly. In such an environment, the market achieves very good results and does not need any kind of state intervention. That’s a very elegant model. It was something which Adam Smith did discuss, but he discussed it along with all the limitations that must be borne in mind. Other early economists who used simplified models of this kind also stressed the importance of noting that the world isn’t anything like that. Edgeworth did that, Walras did that, Wicksell did that. Many modern economists take their simplified models too seriously.

In which ways do you think new economic thinking is necessary and how should it look like?

I think we need a bigger, more integrated view that economists tended to look for, in the past. We have to see the totality of the concerns that make human beings want a good economy. The kind of economic thinking that I would like to see pays a lot more attention to issues of human freedom. What I have in mind is real freedom, not just formal liberties but also what kind of lives people manage to achieve, what they can do with their lives, and what help of the state they need for more substantive freedom. The basic question economists should ask themselves is: What can we do to have a decent society where people get much more freedom to live the kind of lives of which they would have reason to be proud and happy.

You make a lot of references to old economic thinkers like Smith, Keynes and so on. However, if you look at the current economic research that is published in the journals and taught at universities, the history of economic thought does not play a big role anymore…

Yes, absolutely. The history of economic thought has been woefully neglected by the profession in the last decades. This has been one of the major mistakes of the profession. One of the earliest reminders that we are going in the wrong direction has come from Kenneth Arrow about 30 years ago when he said: These days, I get surprised when I find the students don’t seem to know any economics that was written 25 or 30 years ago.

Is there any hope that this trend can be reversed?

Yes, I’m quite optimistic in this regard. I get the impression that this seems to be getting corrected right now. I’m particularly delighted that the corrective has come to a great extent from student interest. I’m very struck by the fact that at the university where I teach – Harvard – the demand for more history of economic thought has mostly come from students. As a result there is a lot more attempt by the department of economics as well as history and government to look for the history of political economy. Last year, along with my wife Emma Rothschild, I offered a course on Adam Smith’s philosophy and political economy. It drew a lot of interest and we got some of the finest students at Harvard.

Do you think the focus on mathematics in current economics is the flip side of the neglect of the history of economic thought?

I don’t think that there is any conflict between mathematical reasoning and being interested in the history of thought. Many of our early thinkers were quite mathematical. The connection between mathematics and economics is very strong, and there is no reason to be ashamed of it. What is to be avoided is to be concentrated only on mathematical economics. We must not neglect the insights that come from parts of the subject where mathematics is not sensible to use and different kinds of reasoning are useful. I don’t think the conflict is between mathematics and other kinds of methods. The conflict is between taking an integrated, broad, comprehensive view as opposed to a narrow view whether it is mathematical or anti-mathematical.

In a single case, he was formally reprimaned by the university but no other actions were taken. This means that the rebuke is purely symbolic.

The external commission, consisting of  Richard Layard, Christopher Pissarides (both: London School of Economics)  and Georg Winckler (University of Vienna) apparently just looked at the papers dealing with the sinking of the Titanic and ignored the numerous other cases of self-plagiarism by Frey.

With regards to self-plagiarism, the commission

“rates the behavior by Frey et al. as improper. As universities are responsible for fostering research integrity, it recommends to reprimand Frey et al, although without any further action, expecting that this event remains a one-off event.”

The University of Zurich followed suit. They reprimanded Frey and closed the procedure.

The assessment that the self-plagiarism by Bruno Frey “remains a one-off event” is, amazing, to say the least.  In fact it never was a “one-off event” but just the tip of the iceberg.

As discussions on the website “Freyplag Wiki”  and an investigation by this blog have shown, there are numerous other cases of self-plagiarism by Bruno Frey and several of his co-authors.

Some older cases are much more drastic than the Titanic example. In at least two instances, Frey published a nearly identical paper under a different title for a second time  in a different journal without any reference to the earlier paper. Here is a detailled comparasion of some known cases.

Given Frey’s track record,  the assessment that the missing cross references in the Titanic papers are a one-off event are just embarrassing for the commission as well as for the University of Zurich. Either the commission worked very sloppily or Layard, Pissarides and Winckler were suffering from willfull blindness.

The blogger Economic Logician has a different explanation. He reports that

“the mandate was formulated in such a way that only the articles about the Titanic could be analyzed. The experts came to the obvious conclusion that unethical behavior was at play for this case. They could not mention the others and thus the University concluded that this was a one off miss-step. The University gave Frey a verbal admonishment, which does not go on his record, and did not release the report.”

If this really was the case the Layard, Pissarides and Winckler should not have accepted the mandate in the first place. Their verdict is damaging the credibility of all parties involved. In essence, it means that Frey’s self-plagiarism is tolerated by his employer and his peers.

It remains to be seen if the University of Zürich renews its contract with Bruno Frey. The current contract is supposed to expire in the summer.

According to these reports, in a letter to Mario Draghi Weidmann urged the ECB to beef up the Target2 liabilities of countries like Greece, Ireland, Spain and Portugal with additional collateral.

“Euro Intelligence” even claimed that Weidmann labeled the Target2 imbalances as a “major concern”. The website also suggested that the Bundesbank has taken up proposals initially made by Hans-Werner Sinn to fix the imbalances in the Target2 system. (Sinn himself shares this impression.)

If all this really was true, it would be a complete U-turn by the Bundesbank. For one year, the German central bank has been arguing that Target2 liabilities do not constitute any additional risks neither for the German central bank nor the Euro system. For example, in February 20111 a press release asserted:

“The size and distribution of the Target2 balances across the Eurosystem central banks are, however, irrelevant to their risk exposure from the provision of funds by the Eurosystem: Target2 balances do not pose specific risks to individual central banks.”

As the Bundesbank pointed out in these days, Target2 balances do

“not create any new specific risk not already contained in monetary policy refinancing operations”.

Similar statements were made in Bundesbank’s March 2011 monthly bulletin as well as in a piece by Bundesbank staff published in the CESifo bulletin. (Note that the ECB made similar points in its October 2011 monthly bulletin and that the former chief economist, Jürgen Stark, strongly opposed the claims of Hans-Werner Sinn.)

If Weidmann now really considered the Target2 claims by the Bundesbank as a “major concern”, this would undermine the credibility of the German central bank.

It would either imply that the central bank tried to hoodwink the public into thinking that the Target2 imbalances were harmless while they were in fact risky.

An alternative explanation, put forward by Karl Whelan, is that Weidmann was just talking rubbish. As Karl puts it:

“I suspect most of us have worked for bosses that say things in public that are just plain wrong and I would guess that the sober Bundesbank officials that approved of the monthly bulletin piece on Target2 are fairly disgusted that Weidmann is adopting an approach in public that they know is ungrounded.”

Well, there is a third possible explanation which – from my point of view – is the most likely one. It’s just a misunderstanding. Almost nobody who publicly talks about the Weidmann letter has ever seen it.

Even “Frankfurter Allgemeine Zeitung”, the newspaper which broke the story about Weidmann’s letter to Draghi, did not give a single verbal quote.

In background conversations, sources close to the matter pointed out to me that the Bundesbank by no means changed their mind about the Target2 balances. They are still concerned about the additional risks taken up by the loose collateral requirements, not by the Target2 balances in themselves.

My colleague Mark Schieritz, Frankfurt correspondent with the German weekly “Die Zeit”, apparently also had a glance at the letter. In last week’s edition of “Die Zeit”, he also suggested that the Target2 views of the Bundesbank were misrepresented. According to Mark, Weidmann’s letter pointed out

 ”that the Bundesbank also is sceptical with regards to caps on Target2 balances. Weidmann asserts that the risks on the ECB’s balance sheet are caused by the fact that the central bank provides a lot of liquidity. This liquidity is distributed unevenly in the Euro area.

However, Weidmann solely urged to “further analyse” if the risks could be mitigated by tweaking the Target system, for example through the pawning or transfer of assets to the ECB.

However, according to Weidmann, it would make more sense to originate less risky credit in the first place. “Decisions by the government council must not perpetuate the situation of mounting risks,” asserts Weidmann.”

An op-ed piece written by Jens Weidmann in Tuesday’s edition of “Frankfurter Allgemeine Zeitung” confirms the impression that the general stance of the Bundesbank towards Target2 did not change at all.

In this piece, made available in English today by the Bundesbank, Weidmann did not ask for any “pawning” of collateral. He did not urge for the transfer of assets to the ECB either. Instead, he asserted:

“If euro-area monetary policy were centralised at the ECB, there would not be any Target2 balances; however, this would not inherently alter the risks associated with providing liquidity. (…)

Weidmann stresses that he does not share the criticism with regards to Target2:

“An increase in Target2 balances may thus mirror a bona fide monetary policy response to a looming liquidity crisis within the bounds of its mandate. To that extent – as the Bundesbank has repeatedly pointed out – criticism of the Target2 balances per se is misplaced.

As I see it, the Bundesbank’s Target2 claims do not constitute a risk in themselves because I believe the idea that monetary union may fall apart is quite absurd. Whether and to what extent losses arising from liquidity provision actually impinge on the Bundesbank’s balance sheet does not depend on the volume of the Bundesbank’s Target2 claims. This is also true for the hypothetical scenario, which has sparked much public debate, of a member state with a negative Target2 balance potentially exiting monetary union.

Even in such a case – which I consider to be highly unlikely – the risk remains rooted in the nature and volume of the liquidity provision. This might result in partial defaults on the ECB’s claims. However, any losses sustained by the ECB would have to be borne jointly by all Eurosystem central banks, irrespective of the size of their Target2 balance.”

As Weidmann points out, the debate should focus on the quality of the collateral used in the refinancing operations, not on the Target2 balances:

“In the Eurosystem, however, there is broad agreement that the non-standard monetary policy measures are limited and temporary, and that they may on no account be used as a pretext to postpone necessary financial and economic policy reforms. It is an uppermost concern of mine to ensure that this does not give rise to any stability risks, such as would be the case if the public were to believe that monetary policy were being held hostage by fiscal policy.”

The bottom line is that the Bundesbank in fact did not change its general perception about the Target2 imbalances and they do not subscribe to the views of the usual Target2 critics.

This seems to be a severe misinterpretation of the Bundesbank’s view, probably fostered by some interested parties in the debate.

Jens Weidmann, President of Deutsche Bundesbank: "I believe the idea that monetary union may fall apart is quite absurd."

Target2 has recently been subjected to critical scrutiny in connection with the Eurosystem’s role in containing the sovereign debt crisis. But what does this ominous term, which many people equate with additional risks for the taxpayer, actually mean?

Target2 is, in effect, a European money grid through which liquidity circulates in the euro area. It is a payment system used for the cross-border transfer of central bank money between euro-area national central banks (NCBs). This liquidity arises in the individual countries predominantly as a result of the NCB’s refinancing operations with commercial banks.

Liquidity is transferred whenever central bank money is transmitted from one country to another. This results in claims on and liabilities to the European Central Bank (ECB), which acts as a kind of clearing house. The transferring central bank records a liability – a negative Target2 balance. The recipient central bank is credited with a claim – a positive Target2 balance. If euro-area monetary policy were centralised at the ECB, there would not be any Target2 balances; however, this would not inherently alter the risks associated with providing liquidity.

Prior to the financial crisis, these balances more or less offset each other. The NCBs provided banks with liquidity via refinancing operations, chiefly to enable them to meet their minimum reserve requirements and to put cash into circulation. Banks’ cross-border funding requirements were generally met via private capital flows, for instance through interbank lending and borrowing.

With the onset of the financial crisis, and especially following the emergence of the sovereign debt crisis, confidence in public finances and national banking systems started to shrink in a number of countries. Private sources of funding, including the interbank market, contracted, were regarded as too costly or all but dried up. To fund their liquidity needs resulting, for instance, from the sale of goods or capital outflows, banks turned increasingly to the Eurosystem.

This was possible because the Eurosystem has progressively expanded its provision of liquidity since the onset of the financial crisis, now providing unlimited amounts (full allotment), at low interest rates and for significantly longer maturities. At the same time, the Eurosystem has perceptibly lowered its collateral standards, eg for ratings.

This has considerably changed the Eurosystem’s role as a liquidity provider. Whereas before, it provided only the bare minimum of central bank money, the Eurosystem has now largely taken over the liquidity functions of the interbank market and other cross-border capital flows.

The total volume of refinancing transactions has risen from approximately €460 billion on the eve of the financial crisis to over €1,100 billion at last count, and the average maturity of the transactions has spiralled from a few weeks to almost three years. The share of euro-area peripheral countries in the volume of refinancing operations has concurrently climbed from one-sixth to around two-thirds. The continued net outflow of liquidity from the peripheral countries has caused them to accumulate combined Target2 liabilities in excess of €750 billion.

It is the Eurosystem’s task to provide central bank money – to solvent banks in return for sufficient collateral and without endangering price stability. This ensures the provision of credit to the economy, and can also strengthen financial market stability. However, it is essential to keep monetary policy and fiscal policy strictly segregated and, in particular, to stringently observe the prohibition on the monetary financing of governments.

Neither providing life support to ailing banks nor propping up the solvency of sovereigns falls under the remit of monetary policy. Decisions relating to the redistribution of major solvency risks of banks or governments among taxpayers across the euro area is the sole responsibility of elected governments and parliaments.

Admittedly, it is not always possible to clearly differentiate between liquidity shortages and solvency risks of banks and, precisely in times of crisis, a certain degree of flexibility is appropriate for a short time. However, this can also inflate risks on central banks’ balance sheets, and moral hazard may assume a critical dimension.

An increase in Target2 balances may thus mirror a bona fide monetary policy response to a looming liquidity crisis within the bounds of its mandate. To that extent – as the Bundesbank has repeatedly pointed out – criticism of the Target2 balances per se is misplaced.

As I see it, the Bundesbank’s Target2 claims do not constitute a risk in themselves because I believe the idea that monetary union may fall apart is quite absurd. Whether and to what extent losses arising from liquidity provision actually impinge on the Bundesbank’s balance sheet does not depend on the volume of the Bundesbank’s Target2 claims. This is also true for the hypothetical scenario, which has sparked much public debate, of a member state with a negative Target2 balance potentially exiting monetary union.

Even in such a case – which I consider to be highly unlikely – the risk remains rooted in the nature and volume of the liquidity provision. This might result in partial defaults on the ECB’s claims. However, any losses sustained by the ECB would have to be borne jointly by all Eurosystem central banks, irrespective of the size of their Target2 balance.

In the Eurosystem, however, there is broad agreement that the non-standard monetary policy measures are limited and temporary, and that they may on no account be used as a pretext to postpone necessary financial and economic policy reforms. It is an uppermost concern of mine to ensure that this does not give rise to any stability risks, such as would be the case if the public were to believe that monetary policy were being held hostage by fiscal policy.

The risks that the Eurosystem is assuming are, to a certain extent, unavoidable, but we are making every possible effort to ensure that these remain within justifiable bounds. This will be aided by Eurosystem efforts to speedily devise a plan for central banks to scale back the extensive provision of liquidity in a timely manner so as to preclude the danger of inflation. At the end of the day it is the member states, and not the central banks, that hold the key to resolving the crisis.

This is the English version of an op-ed by Jens Weidmann, the President of Deutsche Bundesbank, which was published earlier in “Frankfurter Allgemeine Zeitung” and “Het Financieele Dagblatt”. The translation was provided by Deutsche Bundesbank and is also available on its website.

The authors reveal that editors frequently and deliberately force researchers to quote articles that originally have not been considered relevant by them. Usually the editors them them to refer to articles which were published in the very same journal the authors submitted their work to. However, some editors even try to push the citation of individual articles and researchers. Says Eric A. Fong:

“This type of behavior hurts all of academia and affects the integrity of academic publications.”

Among the worst offenders are a number of leading management journals: the “Journal of Business Research”, the “Journal of Retailing” and “Marketing Science” top the ranking of rogue journals (see page 40 of this document) compiled in the paper entitled “Coercive Citation in Academic Publishing”.

Two journals in Economics and Finance also make it to the infamous Top 10 list: “The Journal of Banking and Finance” and “Applied Economics”.

The results, recently published in “Science”, rest on the answers of almost 6700 researchers who took part in an online survey. The general picture is rather unsettling, as Wilhite and Fong conclude:

 “We find that coercion is uncomfortably common and appears to be practiced opportunistically. As editors game the system and authors acquiesce, the integrity of academic publications suffers. (…) Additionally, some editors seem to target specific articles and authors.”

The most juicy part of the study is buried on the last page of the online appendix: the list of the worst offenders. Here’s the Top 10 ranking:

1. Journal of Business Research
2. Journal of Retailing
3. Marketing Science
4. Journal of Banking and Finance
5. Information and Management
6. Applied Economics
7. Academy of Management Journal
8. Group and Organization Management
9. Journal of Consumer Psychology
10. Psychology and Marketing

With this dodgy conduct, journals can artificially inflate their impact factors which are the hardest currency when it comes to measure academic influence and reputation. It counts how often the average article of a specific journal is quoted by other researchers.

As a rule of thumb, it is assumed that the best papers are cited more often and the best journals publish the most influential papers.  The higher the impact factor of a journal, the more attractive is it for academics to publish their work in this outlet. However, the practise of coerced citation seriously questions the validity of impact factors.

The extend of manipulation is amazing. For example, according to figures published by the Managing Editor of the “Review of Finance“, the impact factor of the “Journal of Banking and Finance” – the fourth worst offender according to the study by Wilhite and Fong - dwindles if self-citations are excluded. While the raw impact factor of the journal is 2.731, the one without self-citations is just 0.748.

Says Thorsten Beck, the director of the European Banking Center at the University of Tilburg:

“Among the finance journals, the ,Journal of Banking and Finance’ stands out as one of the journals that explicitly insists on including a minimum number of references to papers published in recent issues of the same journal. This seems to have become an explicit editorial policy in recent years and seems to be driven by the attempt to artificially increase the impact factor.”

Wilhite and Fong give two concrete examples how coerced citation looks like:

“Recently a friend had an article accepted for publication. Two weeks after that acceptance the editor sent another letter asking the author to add citations from his journal. Specifically the editor wrote, ,you only use one (name of my journal) source which is unacceptable. Please add at least five more relevant-(name of my journal) sources.’

Another colleague had a similar experience at the submission stage; the editor asked her for three more citations to his journal before he would send her manuscript out for review. Note, these citation requests did not mention omitted content or shortcomings in the manuscript’s analysis; they simply asked authors to cite related articles in the editor’s journal.”

The vast majority of academics polled by Wilhite and Fong considers coercion as inappropriate (86%). 81% are convinced that in the long run the reputation of a journal suffers. Nonetheless, 57% would be willing to bite the bullet and add superfluous citations if the acceptance of an article hinges on that. Only a tiny minority of 7 % expects that their colleagues would reject such a request.

The authors of the study predict that things will get worse because competition among journals and researchers is ever-increasing. They suggest that academic associations should come to act:

“Without action, the situation is likely to deteriorate. (…) Academic associations could help by officially condemning the practice. Their action would raise the cost of coercion to editors and might help persuade organizations that promote impact factors to remove self-citations from those calculations, which would eliminate the coercive motive.”

The new codex could be modelled on the disclosure guidelines the American Economic Association has recently agreed upon. Every researcher who submits an article to a journal published by the AEA will have to disclose his sources of funding and possible conflicts of interest.

In a similar manner, the AEA could state that their editors must not coerce authors into adding superfluous references. Although according to the results by Wilhite and Fong this practise seems not to be common in the AEA journals, this would send a strong signal to the entire academic community.

In general, the paper by Wilhite and Fong supports the view of Dennis Snower, director of the Kiel Institute of World Economics and editor of the open access journal “Economics”. In an interview with me, he recently asserted (in German) that the current editorial process gives way too much power to the editors:

 “Those people can play God. We’ve lost the ethical values that should be at the core of the academic community.”

Dennis Snower proposes an open assessment of submitted articles. “Economics” publishes every referee report on its website and the discussion about a paper is open to everyone.

(Here’s a press release about the paper by Wilhite and Fong.)

Try your luck at the big rating gamble. (c) Klaus Meinhardt, 2012

Christian Noyer is usually a calm and sober-minded central banker. Last December, however, the president of the Banque de France was unusually outspoken and indulged himself in a vitriolic rant against credit rating agencies. According to Noyer, their assessments had become nothing less than “incomprehensible and irrational”. Some decisions “do not seem to be justified on the basis of economic fundamentals,” Noyer complained.

A new study by two economists now provides empirical evidence for this drastic view. Jens Hilscher (Brandeis University International Business School) and Mungo Wilson( Saïd Business School, University of Oxford) come to the conclusion that credit ratings do not contain much information about actual default probabilities. “The informational value of credit ratings is surprisingly low,” says Hilscher in summarising the key findings of the paper entitled “Credit Ratings and Credit Risk.”

More often than not a rather simple analysis of publicly available data easily beats the assessments of the credit rating agencies and gives a much better picture about the actual default risks, the researchers observe. “The judgements of the credit rating agencies are significantly over-rated ,“ concludes Hilscher.

These results are directly challenging the pivotal role credit agencies currently play on world financial markets. The agencies largely enjoy their dominant position thanks to the decisions of financial regulators. For instance, a lot of investment funds are only allowed to hold assets with a certain minimum rating. The equity buffers that banks have to put aside to protect themselves against potential losses in the current regulatory framework also hinge on the assessment of S&P, Moody’s and Fitch.

Since the financial crisis broke out, these privileges have been under attack. Critical researchers take the new paper by Hilscher and Wilson as a confirmation of their views. “My personal view is that credit ratings have many problems, and should not be used for regulatory policy,“ says Robert Jarrow, Professor of Investment Management at the Johnson Graduate School of Management, Cornell University. Jarrow feels vindicated by the Hilscher/Wilson paper. „I think the paper’s results are correct and should be taken very seriously.“

John Campbell, professor of economics at Harvard, also has a high opinion about the paper: “I do think Jens and Mungo’s work is convincing and methodologically sound.”

At the core of the paper are corporate bond ratings by Standard & Poor’s. Hilscher and Wilson look at all assessments that have been given between 1986 and 2008. Additionally, they constructed an alternative indicator that is meant to gauge the default risk of the bond issuers. The economists only use publicly available information for this “failure score”, mainly balance sheet data like profitability, leverage and cash holdings.

Hilscher and Wilson compare the S&P ratings and their own failure score with actual defaults and come to a straightforward conclusion: Their simple indicator delivers much better predictions about expected defaults than the verdicts of the rating agencies. According to the paper, the failure score is almost twice as reliable:

“We find that this measure (…) is substantially more accurate than rating at predicting failure at horizons of 1 to 10 years. The higher accuracy in predicting the cumulative failure probability is driven by a much higher ability of failure score at predicting marginal default probabilities at horizons of up to 2 years and the fact that credit rating adds little information to marginal default prediction at horizons up to 5 years.”

This leads Hilscher and Wilson to a straightforward conlusion that is rather inconvenient for the suppliers and users of credit ratings: “ratings are in fact a poor predictor of corporate failure.”

As Jens Hilscher explains, those findings probably also apply to sovereign bonds. As a piece of evidence, Hilscher refers to a paper co-authored with Yves Nosbusch in 2010. Both economists analysed the bond spreads of emerging market sovereigns and show that publicly available data about the macroeconomic situation of the borrowers can explain them much better than the verdicts of rating agencies.

The rating agencies rebuff the findings of Hilscher and Wilson. “The research is criticising ratings for missing goals that we do not try to achieve,” asserts Albert Metz, Managing Director Credit Policy Research with Moody’s:

“The objective of our ratings is not to predict absolute default probabilities of individual firms. Such ratings would be more volatile and highly cyclical. The purpose of Moody’s ratings is to produce a stable indicator of relative credit risk.”

At a given point in time, two companies that have a similar rating should have a similar expected loss profile. “That’s our aspiration,” says Metz.

However, according to the paper by Hilscher and Wilson, even this goal is frequently missed: According to their findings, the ratings for different firms prove to be quite inconsistent at a given point in time:

“Firms with the same rating often have widely different default probabilities and firms with very different ratings often have very similar default probabilities. (…) In fact, the 75th percentile AA-rated issuer (two notches below AAA) is more likely to default than the median issuer rated BBB-, the last rating before reaching junk status.”

S&P fundamentally questions the design and the approach of the paper. “If the intention of this study is to assess the track record of credit ratings, then its methodology is flawed and many of the assumptions it makes about the meaning and basis of ratings are wrong”, says Martin Winn, Vice President Communication with S&P.

Winn asserts that a close correlation between ratings and defaults in fact exits. As an example, he refers to the track record of the company since 1980. Only around 1% of corporates that were rated investment grade (BBB- or above) defaulted within 5 years, compared with around 20% of companies rated speculative grade (BB+ or below).

Hilscher and Wilson reply that they do not claim that ratings have no informational content whatsoever. Having a S&P rating was certainly better than no information at all, stresses Hilscher.

However, according to their findings ratings only prove meaningful with regard to the question how a company will fare in bad economic conditions. Higher  rated firms are more likely to survive an economic downturn, the researchers observe: “Ratings reflect sensitivity of credit risk to bad times and, therefore, (..) rating may at least partly capture systematic risk of default.”

However, this does not change the basic findings that a simple failure score based on publicly available information easily beats the ratings when it comes to the assessment of absolute and relative default risks of borrowers. The key question according to Hilscher is: “Why are their measures not more accurate if more accurate information is easily available?”

“adopt a code of ethics that requires disclosure of potential conflicts of interest that can arise between economists’ roles as economic experts and as paid consultants, principals or agents for private firms”.

More than 300 economists signed the letter, among them Nobel laureate George Akerlof and Christina Romer, a former advisor to US president Barack Obama.

Almost exactly one year later, the American Economic Association in fact agreed on a new disclosure codex. (Luigi Zingales also presented an interesting paper on the “Capture of Economists”.)

What do the authors of the open letter make of the new guidelines? I did an interview with Gerald Epstein, who wasn’t involved in the discussions about the new rules.

Olaf Storbeck: Gerald, what do you think about the new AEA disclosure guidelines? Are you satisfied?

Gerald Epstein:  I think the AEA guidelines are a very big step forward. They make very clear the importance of disclosure of potential conflicts of interest by economists and set out in detail the types of conflicts that should be disclosed. In some ways these guidelines are stronger than i had expected.

For example?

They require disclosure with respect to publication in AEA journals, rather than just recommend it. And they require such disclosure with respect to a broad range of possible conflicts including those connected to groups that might have an ideological interest in the outcome of the article and not just material or financial. While this cuts a broad area, I think it is healthy.

The guidelines also suggest that these same criteria for disclosure apply to all other publications, including non academic publications, media appearances and testimonies. By suggesting their application to these areas, as well as by requiring such disclosures for AEA publications, these guidelines will help to set norms of behavior that colleagues, the press, students and citizens can help hold economists accountable to.

Is there anything missing?

One could quibble about the $10,000 limit. For an economist who makes a low salary, smaller amounts would have a significant impact. Still, I think that as a bench mark, the $10,000 figure is fine since it will catch most of the economists for whom such kinds of activities are an important part of their work.

What should happen next?

These guidelines should be widely promoted and reported on in the press and it would be important for journalists, students and others to try to see if such guidelines can be broadly implemented for other publications, TV and radio appearances, etc. The point would be to make such guidelines a broad norm that are widely implemented .

Will these guidelines have any impact?

I do think they will have an impact in terms of providing information to the public. it is very difficult to predict whether it will have an impact on the professional activities of economists. It will take five  years or so to see that.

Would you recommend economic associations abroad to adapt similar guidelines?

Yes. Absolutely. I think this would be a good starting point for other associations. If they do not have publications, then they could still recommend the broad guidelines as indicated in point 7 of the guidelines. In fact it would be good to start with point 7 and then if they have publications, then require that they apply to the organizations’ publications.