Equilibrium

Teaching Supply with Video

2012 St. Louis Fed Video Competition

National Economic Education video competition

RIP: Toxie

Mankiw on NPR

James Bullard on CNBC

St. Louis Fed | Education Resources | For Students | Podcasts

Check out the newest episode in the podcast series - The Economic Lowdown - The Role of Competition and Self-Interest in a Market Economy.

St. Louis Fed | Education Resources | For Students | Podcasts

Keynes Vs. Hayek

St. Louis Fed | Education Resources | 'In Plain English' Video

"In Plain English" is an excellent video about the Federal Reserve - check out the live stream here:

St. Louis Fed Education Resources 'In Plain English' Video

St. Louis Fed | Education Resources | For Students | Podcasts

This is my first podcast - Opportunity Cost.

St. Louis Fed Education Resources For Students Podcasts

St. Louis Fed | Education Resources | For Students | Podcasts

Check out my second podcast - The Factors of Production.

St. Louis Fed Education Resources For Students Podcasts

The Fed Explained

Letter to Santa

Love this letter to Santa found here.

Dear Santa

It is with regret that I am serving you with a Section 415 Cease and Desist order in the matter of delivery of gifts and/or presents on the occasion of the Night Before Christmas on behalf of Mr. and Mrs. Dean (hereafter “My Parents”).

My Parents note the following violations of international trade rules which constitute a prima facie case of unfair competition in the delivery of but not limited to balls, teddy bears and games:

• Anti-Dumping. The low price of zero dollars you charge is clearly below marginal cost. This seems to be a flagrant attempt to attain market share. No doubt you have your eyes fixed on Easter and Halloween, to say nothing of birthdays.
• Labor standards. You have never accepted international standards for your workforce. Your elves toil for impossibly long hours and appear to subsist entirely on leftover cookies. My Parents have serious concerns about the long-term health effects of the “magic dust” which you pump into your workshops to enhance productivity.
• Environmental standards. Your production methods are extremely carbon-intensive. My Parents are not convinced that your base in the North Pole is sustainable given the long-term decline in Arctic sea ice.
• Intellectual Property. Santa-brand Tickle-Me-Elmo dolls are an unauthorized reproduction of the real thing.
• Transportation costs. We regret your genetic modification of reindeer in respect of flight, and, in at least one case, red noses.

In light of these concerns, it is My Parents’ view that I would be better off without any such “free” presents and that my arguments against such were “naive.”

Merry Christmas.

Yours

Johnny (aged four and three quarters)

Bernanke

How Do Economists Feel About Fed Independence?

The talk about oversight and audits of the Fed have many academic economists worried about Fed independence. Here's an interesting development:

A group of academic economists — including several Nobel Prize winners, leaders of respected economic journals and former Fed officials — is dialing up its call for lawmakers to drop plans to subject the Federal Reserve to more scrutiny by the Government Accountability Office, an investigative arm of Congress.

In a letter to leaders on the Senate Banking Committee and House Financial Services Committee, the economists say a bill proposed by Rep. Ron Paul (R., Tex.) and Alan Grayson (D., Fla.) to let the GAO review Fed monetary policy would do “serious harm to the economy.” They warn increased congressional oversight would harm the Fed’s independence and ability to fight inflation.

Mr. Paul has built a popular movement in part on his attacks against the Fed and won large support in the House for his bill. Ben Bernanke, Fed chairman, has a growing body of academics on his side. Some 270 economists have signed the letter, including Edward Prescott, Myron Scholes, Daniel McFadden, Fynn Kydland, Roger Myerson and Robert Engel, all Nobel winners.

The academics sent a similar letter to Congress in November, but are trying to dial up their campaign now that Mr. Paul’s bill has been approved by the House Financial Services Committee.

Supporters of Mr. Paul argue that the organizers of the letter-writing campaign are too close to the Fed to be objective — some are former Fed officials or have served as advisers to the Fed. Mr. Bernanke, a former academic, is also friends with many of them.

The academics say the charge isn’t fair. “Hundreds of people signed the petition and most have little, if any connection to the Federal Reserve,” counters Anil Kashyap, a professor at the University of Chicago Booth Business School and a lead organizer of the campaign. Signatories to the letter include some critics of Fed policy, such as Allan Meltzer, a Carnegie Mellon University professor.

Are Federal Reserve Banks Private?

A question I have been asked very often, this is the source.

The Federal Reserve Banks, created by an act of Congress in 1913, are operated in the public interest rather than for profit or to benefit any private group.

Commercial banks that are members of the Federal Reserve System hold stock in the Reserve Bank in their region, but they do not exercise control over the Reserve Bank or the Federal Reserve System. Holding stock in a regional Reserve Bank does not carry with it the kind of control and financial interest that holding publicly traded stock affords, and the stock may not be sold or traded. Member banks do, however, receive a fixed 6 percent dividend annually on their stock and elect six of the nine members of the Reserve Bank's board of directors.

Although they are set up like private corporations and member banks hold their stock, the Federal Reserve Banks owe their existence to an act of Congress and have a mandate to serve the public. Therefore, they are not really "private" companies, but rather are "owned" by the citizens of the United States.

The Emmy goes to... Bernanke.

Dr. Bernanke can add Emmy award winner to his resume according to this story.

CBS News”s “60 Minutes” program won an Emmy yesterday for its profile of Ben Bernanke, titled “The Chairman,” aired in March from Mr. Bernanke’s hometown of Dillon, South Carolina and from inside the Fed’s marble hallways in Washington.

Fed chairmen used to live in a secretive world. But Mr. Bernanke decided he needed to open up a little amid the growing backlash against the Fed in the wake of the financial crisis. In a first for TV, he brought CBS’s Scott Pelley into his world to explain what the Fed has been doing and to convince the country he was a regular guy who could be trusted. Congrats to CBS for a nice piece. As for Mr. Bernanke, well, the backlash has just kept growing.

To see the interview, see my earlier post.

Economic Development vs. Negative Externalities

If Gretzky Were a Central Banker

Nice analogy (click here for the full story):

Hockey great Wayne Gretzky was once asked about his success on the ice. He responded by saying, “I skate to where the puck is going to be, not to where it has been.” He didn’t chase the puck. Instead, Gretzky wanted his hockey stick to be where the puck would be going next. He scored many goals with that strategy, and I believe monetary policymakers can better achieve their goals, too, if they follow the Gretzky strategy.

Good monetary policymakers, like good hockey players, must be forward-looking in their actions. Setting policy that is appropriate for where the economy is today, or has recently been, is not likely to deliver the kind of economic outcomes we desire. … Gretzky, like all great hockey players, excelled, in part, because of his ability to anticipate. That does not mean he always anticipated accurately. Sometimes his forecast turned out to be wrong and the puck went in another direction. But that does not mean that his strategy was wrong, only that his execution needed improvement. The more you understand the game or the economy, the better your forecasts will be. Monetary policymakers similarly must be forward-looking despite the difficulties, uncertainties, and challenges that entails.

Minneapolis Federal Reserve

The Federal Reserve Bank of Minneapolis said Narayana Kocherlakota will succeed Gary Stern as the bank’s president and chief executive.

Kocherlakota is currently a professor of economics at the University of Minnesota, and has worked as a consultant for the Minneapolis Fed. Kocherlakota entered Princeton University at age 15 and he received his Ph.D. in economics from the University of Chicago in 1987 on the topic of pricing financial assets, incorporating new kinds of consumer preferences and analyzing how risky payoffs influence attitudes.

He has big shoes to fill, succeeding Stern, the Fed’s resident expert on the too-big-to-fail problem. Stern literally wrote the book on the issue. He retired from the Minneapolis Fed on Sept. 1.

Kocherlakota begins his new job Oct. 8.

Here is the story source.

Alchian on Golf, Capitalism and Socialism

I recently happened upon a great essay by Armen Alchian on Golf, Capitalism, and Socialism. The piece was written in 1977 so you will find references to the communist bloc that may seem out of place.

A puzzle has been solved. Despite their intense interest in sports, no golf courses exist in the Socialist-Communist bloc. Why is golf solely in capitalist societies? Because it is not merely a sport. It is an activity, a lifestyle, a behavior, a manifestation of the essential human spirit. Golf’s ethic, principles, rules and procedures of play are totally capitalistic. They are antithetical to socialism. Golf requires self-reliance, independence, responsibility, integrity and trust. No extenuation is granted misfortune, mistake or incompetence. No second change. Like life, it is often unfair and unjust, with uninsurable risks. More than any other sport, golf exploits the whole capitalist spirit.

Here is the whole essay, its worth a read.

Back from the Brink

Christina Romer, the current chair of the Council of Economic Advisers, concludes her paper Back from the Brink this way:

There is no question that the economic crisis that began in earnest last fall has been unlike any since the Great Depression. As I have described today, the key reason that we begin this fall with a sense of hope rather than dread of a second Great Depression is because the policy response in 2008 and 2009 has been fast, bold, and effective.

But, now is not the time for a victory lap. To turn that sense of hope into reality for the millions of Americans without a job will require continued vigilance and the courage to stick with programs that are working until their work is truly done. And, to turn the pain of the last year into more than just a bad memory, we have to use it to spur fundamental improvements in our regulatory structure. Only by building a new regulatory framework for the twenty-first century can we help ensure that our children and grandchildren will not have to walk their economies back from the brink, as we have had to do this past frightful year.

Economic Myth Busters - Immigration

Minneapolis Federal Reserve economist Toby Madden turns his myth busters series toward the issue of immigration. Click here to read the article.

You often hear this myth: "Immigration is bad for native-born workers”

Madden responds: "...this myth stems from the idea that the number of jobs in America is fixed, and every job taken by an immigrant reduces the total number of available jobs, always to the detriment of native-born workers. This overlooks some valuable economic contributions from immigration on both the supply of and demand for labor.

That’s not to say immigration has no downside. Setting aside the controversy of legal versus illegal immigration, both economic theory and practical evidence suggest that immigration does affect native-born workers. When an individual immigrates to the United States, native-born workers face additional competition for available jobs and may find it harder to get a job. The increase in regional labor may also drive wages down by a marginal amount.

Most immigrants take low-skill jobs; thus, the burden of displacement and lower wages falls disproportionately on low-skilled, minimally educated workers. However, most economists find very modest impacts on wage levels: A 2008 National Bureau of Economic Research study estimated that the positive immigration effect on wages of U.S.-born workers with at least a high school degree offsets the small negative effect on wages of U.S.-born workers with no high school degree.

Economists also see supply-side benefits from immigration. For starters, increased labor competition, and any dampening effects on compensation, helps employers spend less time and money filling labor needs. Increased labor competition also provides incentives for native-born workers to improve their skills through additional education or other training. Such an outcome is good for native workers, who should see their wages increase, as well as employers, who benefit from a higher-skilled workforce.

Equally important, and often overlooked by opponents in this debate, are the positive, demand-side effects of immigration. Immigrants spend money on food, shelter, and other goods and services. This spending raises the overall level of economic activity in the community, leading employers to create more jobs in response to increased demand. There is some empirical evidence that immigrants create more jobs than they fill—thereby increasing overall employment.

Meanwhile, changes stemming from increased demand accrue to a wide swath of participants in the economy. In 1997 the National Research Council estimated that immigrant labor conferred net benefits of anywhere from $1 billion to $10 billion per year on the native-born population. Immigrant workers contribute taxes to governments at all levels. Studies suggest that the majority of foreign-born laborers will generate more in tax revenue than they generate in public costs through the use of social programs.

Part of the net public benefit stems from more taxpayers shouldering the cost of government, whether it be for interest payments on national debt or for public goods and services; without immigrants, who generate most of the population growth in the United States today, costs per taxpayer would be higher. However, costs may be concentrated in the short run and borne by specific local governments. For example, education expenses are shouldered by local school districts with high numbers of immigrants, while benefits (including returns from that education) are often more dispersed over time and geography."

Larry Summers on Keynes, Smith, and Schumpeter

Larry Summers takes to the White House blog to tout the administration’s economic policies.

“During the past two years, the ideas propounded by John Maynard Keynes have assumed greater importance than most people would have thought in the previous generation. As Keynes famously observed, during those rare times of deep financial and economic crisis, when the “invisible hand” Adam Smith talked about has temporarily ceased to function, there is a more urgent need for government to play an active role in restoring markets to their healthy function. The wisdom of Keynesian policies has been confirmed by the performance of the economy over the past year. After the collapse of Lehman Brothers last September, government policy moved in a strongly activist direction. As a result of those policies, our outlook today has shifted from rescue to recovery, from worrying about the very real prospect of depression to thinking about what kind of an expansion we want to have. An important aspect of any economic expansion is the role innovation plays as an engine of economic growth. In this regard, the most important economist of the twenty-first century might actually turn out to be not Smith or Keynes, but Joseph Schumpeter. One of Schumpeter’s most important contributions was the emphasis he placed on the tremendous power of innovation and entrepreneurial initiative to drive growth through a process he famously characterized as “creative destruction.” His work captured not only an economic truth, but also the particular source of America’s strength and dynamism.”

Scarcity of Healthcare Resources

The healthcare debate has so many angles and issues that it is difficult to grasp. I have recently been reading Easterly's The White Man's Burden about economic development. I have been thinking that the current debate has been dominated by those that Easterly calls planners and not the searches. In this case, planners fail because they lack the information necessary to reform an industry as large and as important as healthcare.

Mankiw has been thinking about healthcare too. Click here to see his NYT article.

Protectionism Revisited

A classic tit-for-tat trade situation seems to be developing. Lets hope the Obama administration decides to re-embrace free trade. For an update click here.

President Obama approved the tariffs Friday to slow the rapid growth of U.S. imports of Chinese-made tires that have been blamed for the loss of thousands of American jobs. That drew an accusation of trade protectionism from Beijing.

Yao's statement called on other governments to oppose protectionism.

The White House says Obama acted under a provision in the U.S.-Chinese agreement on Beijing's WTO membership that allows Washington to slow the rise of Chinese imports to allow American industry to adjust.

Obama's order Friday raised tariffs for three years on Chinese tires — by 35% the first year, 30% the second and 25% the third.

College Majors That Lead to High Salaries

Notice Economics in the rankings. Read more here.

The Fed's Exit Strategy

This Op-ed by Federal Reserve Chairman Ben Bernanke does an excellent job explaining the Fed's strategy for avoiding the inflation than many fear as we exit recession. I found the discussion on the Fed's relatively new practice of paying interest on deposits rather fascinating.

Congress granted us authority last fall to pay interest on balances held by banks at the Fed. Currently, we pay banks an interest rate of 0.25%. When the time comes to tighten policy, we can raise the rate paid on reserve balances as we increase our target for the federal funds rate.

Banks generally will not lend funds in the money market at an interest rate lower than the rate they can earn risk-free at the Federal Reserve. Moreover, they should compete to borrow any funds that are offered in private markets at rates below the interest rate on reserve balances because, by so doing, they can earn a spread without risk.

Thus the interest rate that the Fed pays should tend to put a floor under short-term market rates, including our policy target, the federal-funds rate. Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed.

Considerable international experience suggests that paying interest on reserves effectively manages short-term market rates. For example, the European Central Bank allows banks to place excess reserves in an interest-paying deposit facility. Even as that central bank’s liquidity-operations substantially increased its balance sheet, the overnight interbank rate remained at or above its deposit rate. In addition, the Bank of Japan and the Bank of Canada have also used their ability to pay interest on reserves to maintain a floor under short-term market rates.

A Random Walk

Indexing is one of my favorite blogging topics when it comes to investing, so this article about Burton Malkiel caught my eye. Malkiel is a Princeton Economics Professor who literally wrote the book on index investing. Here is a notable blurb from the interview:

We have a lot of information about how index funds have done, as well as the typical actively managed mutual fund. I find that consistently two-thirds of active managers are beaten by the indexes, and those that beat the index in one year are not necessarily the ones who beat it the next year.Over a very, very long period, sure, there are a few people who have outperformed the index. But you can almost count them on one hand. I still believe -- even more strongly than I did in 1973 -- that most investors would be much better off having at least the core of their portfolio in a low-cost index fund.

And on the most frequent criticism of indexing:

There is no question that it is a rap on indexing -- that at the peak of the market in 2000, you had more Internet stocks than you should have had, in retrospect. But active managers had an even a greater proportion than did the index funds.

Similarly, you could say that with an index fund at the end of 2007 and the beginning of 2008, you had too much in financial stocks, absolutely. But that's what killed all the value managers who had done so well for so long.

So you are quite right that, with an index fund, you will be invested in what turns out to be the most overvalued part of the market. But you will also be invested in what turns out to be the most undervalued part of the market.

Yellen's Implicit Inflation Target

Janet Yellen, President of the San Francisco Federal Reserve Bank, who previously preferred an inflation objective of 1.5% in the long run, has changed her preference to 2%. A higher inflation preference is interesting coming off a period of history economists called "The Great Moderation" - a glorious time of low inflation, low unemployment, and steady growth. The higher inflation preference of Ms. Yellen is meant to give the Federal Reserve more room to respond to shocks. Indeed, the current deflation fears has caused the Fed to lower the Fed Funds Rate target to a range of 0% to 0.25%, which leaves little room to maneuver if the economy were to continue to deteriorate. A higher long run objective would give the Fed more room to cut. In Ms. Yellen's words:

“Thus, an analysis of the zero bound needs to incorporate greater volatility than experienced over the past quarter century. With respect to the equilibrium real interest rate, the global savings glut that helped restrain real interest rates may persist or even intensify after the recession is over, leaving us with only a small cushion against reaching the zero bound.”

Economic Myth Busters - Spending vs. Saving

vs.

There has been much talk recently about the benefits of spending during times of recession. The message that is often communicated is that spending causes growth and is good for the economy while saving does not cause growth. Even Nobel Laureate Economist Paul Krugman makes this claim...

If the money the government lays out doesn't get spent—if it just gets added to people's bank accounts or used to pay off debts—the plan will have failed.
—Paul Krugman (New York Times, Jan. 25, 2008)

Tobias Madden, an economist at the Minneapolis Federal Reserve, does a nice job of busting this myth. Madden says that saving does have economic benefits...

Saving provides an important source of capital to banks and companies. In particular, banks utilize consumer savings to make loans to individuals or companies, and public companies use consumer investments to build factories, hire new employees, research new products and so on. Saving drives all of the above. If an individual wants to take out a loan to buy a car, the bank can use the savings of consumers to make a loan to that individual. When a bank makes a loan, the person or business receiving the loan will spend the money, which is the secondary spending that takes place to aid economic growth. However, it may take time to make this investment and for the effects of the investment to roll through the economy.

Saving in the present creates stronger spending in the future. When consumers save, they earn interest on their savings and experience appreciation on their investments. When interest is received and profits are made, consumers have more income to spend than they had prior to the investment. When U.S. taxpayers received their tax rebate checks, spending them immediately may have had the greatest effect at the present; however, saving that check would have accrued interest and appreciation, creating greater spending power in the future.

University of Delaware Commencement

I was in Newark, Delaware over the weekend attending my graduation from the University of Delaware. I finished my M.A. in Economics and Entrepreneurship for Educators. Thomas Friedman gave the commencement address and did a nice job.

There were 3400 graduates at the ceremony and I was happy to be there.

Don't Buy Stuff...

Bernanke on the Difficulty of Economic Forecasting

In a commencement address at Boston College Ben Bernanke gave more insight into his childhood as a brilliant child from a working class family in South Carolina and the importance of education. He also gave this description of the difficulty of economic forecasting:

Like weather forecasters, economic forecasters must deal with a system that is extraordinarily complex, that is subject to random shocks, and about which our data and understanding will always be imperfect. In some ways, predicting the economy is even more difficult than forecasting the weather, because an economy is not made up of molecules whose behavior is subject to the laws of physics, but rather of human beings who are themselves thinking about the future and whose behavior may be influenced by the forecasts that they or others make.

Economist Robert Frank on the Consumption Tax

Robert Frank describes how replacing the current income tax with a consumption tax might help avoid future problems in the financial sector:

...What's the solution in the financial world?

To start, you can regulate the amount of leverage asset managers could offer. But if you really want to blunt the incentive for investors to squeeze out ever higher returns, scrap the income tax and shift to a much more steeply progressive consumption tax. You would report people's income and savings to the IRS each year. The difference between those numbers is how much they consume.

Tax that instead of taxing people's income, and the government would strengthen the incentive to save and invest, and weaken the incentive to build bigger houses. If other people were building smaller houses, each investor would feel less compelled to take greater risks to keep up.

Wouldn't a consumption tax, which reduces consumer spending, be a drag on economic growth?

The tax should be phased in gradually after the economy recovers. The capital market would direct consumers' extra savings to investors, who would spend the money on capital goods. So total spending would remain the same - and it's total spending that determines output and employment.

The Heavy Hand of Energy Policy

Economists often describe government policy implementation as either heavy handed or light touch. Heavy handed policy is accomplished through government mandate and often has adverse economic effects and sends inaccurate information to markets by way of bad price signals. Examples of heavy handed policies would be rent control (price ceiling) and minimum wage laws (price floor). The light touch approach takes economic incentives into consideration and uses markets and price signals to accomplish the intended goals.

The Obama administration aims to accelerate higher gas-mileage rules using the heavy handed approach. This idea is an easy sell to the public because the perception is that the automotive companies will bear the cost of the mandate, without realizing that the costs are passed on to the consumer. The same goals could be accomplished much more effectively and efficiently by using a simple gas tax as proposed by Greg Mankiw and his Pigou club.

Inflation and Zimbabwe

"Inflation is always and everywhere a monetary phenomenon."
- Milton Friedman

This from The Wall Street Journal about hyper-inflation in Zimbabwe. It seems they have solved the problem by adopting a stable currency: the U.S. Dollar.

Zimbabwe topped that record for economic mismanagement last year. The country’s annual rate peaked at 489 billion percent in September 2008, the International Monetary Fund reported, and for the full year averaged 56 billion percent. The Zimbabwe dollar became literally worthless, the IMF said, and by November 2008 it “virtually disappeared from circulation.”

Fed up, locals started using U.S. dollars, which put a sharp lid on inflation. This year, the IMF estimates that inflation will descend from hyper-stratosphere and average 6.9%, when measured in dollar terms.

Labor Mobility and Unemployment

This story in BusinessWeek is very enlightening. Some parts of the country are mired in recession with high unemployment while others (like my hometown of Minot, North Dakota) are struggling to find enough workers to fill positions. While the incentives created by generous unemployment benefits might be having some negative effect, as well as a mismatch between the job openings and the job skills of the unemployed, the most interesting observation is the sad state of the housing market. People are finding it difficult to move to more attractive markets because they are finding it difficult to sell their homes.

One reason the jobs misery index is so high: The housing bust has reduced Americans' mobility. The Census Bureau reported on Apr. 22 that the percentage of the population that moved was the lowest since recordkeeping began in 1948. Home-owners, the Census found, were only one-fifth as likely to move as renters.

Meltzer on Inflation and Deflation

In this article in the NY Times, Economist Allan Meltzer ponders inflation and deflation. Meltzer thinks that inflation lies ahead...

When will it come? Surely not right away. But sooner or later, we will see the Fed, under pressure from Congress, the administration and business, try to prevent interest rates from increasing. The proponents of lower rates will point to the unemployment numbers and the slow recovery. That’s why the Fed must start to demonstrate the kind of courage and independence it has not recently shown.

Milton Friedman often said that “inflation was always and everywhere a monetary phenomenon.” The members of the Federal Reserve seem to dismiss this theory because they concentrate excessively on the near term and almost never discuss the medium- and long-term consequences of their actions. That’s a big error. They need to think past current political pressures and unemployment rates. For the next few years, they cannot neglect rising inflation.

Making Lemonade From Lemons

GDP contracted by 6.1% in the first quarter of 2009 and the stock market rallied. Why? The light at the end of the tunnel has appeared. This is from the Wall Street Journal.

The U.S. economy shrank sharply in the first quarter, capping its worst six-month performance in 51 years, the government said Wednesday. But a large decline in inventories and an uptick in consumer spending suggest the economy is closer to the day when it resumes growing.

Federal Reserve Economic Forecast

Release Date: April 29, 2009

Information received since the Federal Open Market Committee met in March indicates that the economy has continued to contract, though the pace of contraction appears to be somewhat slower. Household spending has shown signs of stabilizing but remains constrained by ongoing job losses, lower housing wealth, and tight credit. Weak sales prospects and difficulties in obtaining credit have led businesses to cut back on inventories, fixed investment, and staffing. Although the economic outlook has improved modestly since the March meeting, partly reflecting some easing of financial market conditions, economic activity is likely to remain weak for a time. Nonetheless, the Committee continues to anticipate that policy actions to stabilize financial markets and institutions, fiscal and monetary stimulus, and market forces will contribute to a gradual resumption of sustainable economic growth in a context of price stability.

In light of increasing economic slack here and abroad, the Committee expects that inflation will remain subdued. Moreover, the Committee sees some risk that inflation could persist for a time below rates that best foster economic growth and price stability in the longer term.

Socialism in the Classroom

My father-in-law sent me this in an e-mail.

An economics professor at Texas Tech said he had never failed a single student before but had, once, failed an entire class. That class had insisted that socialism worked and that no one would be poor and no one would be rich, a great equalizer. The professor then said ok, we will have an experiment in this class on socialism.

All grades would be averaged and everyone would receive the same grade so no one would fail and no one would receive an A. After the first test the grades were averaged and everyone got a B. The students who studied hard were upset and the students who studied little were happy. But, as the second test rolled around, the students who studied little had studied even
less and the ones who studied hard decided they wanted a free ride too; so they studied little..

The second test average was a D! No one was happy. When the 3rd test rolled around the average was an F.

The scores never increased as bickering, blame, name calling all
resulted in hard feelings and no one would study for the benefit of
anyone else.

All failed, to their great surprise, and the professor told them that
socialism would also ultimately fail because when the reward is great, the effort to succeed is great; but when government takes all the reward away; no one will try or want to succeed.

Could not be any simpler than that....

Index Investing, EconTalk, and John Bogle ... Hat Trick!

Continuing my theme of the last few days on index investing, listen to this podcast on EconTalk with John Bogle where he describes his personal journey and why indexing works.

Bogle on Investing

This is an addition to my post yesterday on index investing from the index master John Bogle. If you have trouble follow this link.

A Random Walk Down Wall Street

Being an economics teacher, I get a lot of questions about where people should invest their money. Some of this arises from the misconception that all we "econ people" do is talk about the stock market. People who ask are usually expecting a hot stock pick. People are often surprised that I am not an active stock picker. In fact, I'm not even an active fund picker. I am a boring index fund investor. Why? This too comes back to my faith in the efficiency of markets. The basic idea behind what is called the efficient market hypothesis is that markets respond to new information almost immediately, so trying to pick stocks based on new information is futile. Therefore, only way to beat the market is to have access to information before the public knows (read: insider trading) or have the ability to divine future events. If interested read A Random Walk Down Wall Street. The data continue to support the strategy of index investing, check out this story in the Wall Street Journal.

Investors in actively managed mutual funds for the past five years have reason to wonder what they have been paying for: A new study from Standard & Poor's finds that 70% of large-cap fund managers who use the S&P 500-stock index as a benchmark for comparison have failed to match the performance of the index over that time....The failure of active management is replicated across almost all categories, not only U.S. stock funds but also bond funds and even emerging-markets funds. What's more, those numbers are similar to the previous five-year cycle.

Thanks to Mankiw's blog for the link.

Health Care Markets

In the current debate over rising health care costs, we market lovers cringe when we hear of government health care. The proponents of change say that the current market system is not working. I would agree. The problem is not with markets, but with the market conditions of health care. In order for markets to work effectively people must be aware of prices, there must be true competition, and consumers must bear the cost of their decisions. All these aspects of an effective market are missing for most health care consumers. This article contains this quote:


Ask most Americans how much it costs to visit a doctor and they probably do not know.

Ask doctors what their fees are and they're not likely to know that either.

Health care prices - both physician fees and prices of medical procedures - have been cloaked in mystery for decades.

Why I Dig Adam Smith...

I have been reading Adam Smith of late and have found it refreshing and disturbing at the same time. I have found it refreshing to read Smith's very clear descriptions of what makes the market system work, and also his clear defense of economic freedom. The disturbing part is not due to Smith or his arguments, but in the lack of progress that we in the business of economic education have made in conveying the ideas that Smith published in 1776 - ideas that are considered to be the bedrock of orthodox economics. Smith largely wrote in response to the merchantilist ideas of his day. We are still fighting a battle of ideas that have their roots in merchantilism. We have convinced the population that the world is round and germ theory, why is comparative advantage so difficult? I would enjoy your comments. The following is one of my favorite Smith quotes:

It is the maxim of every prudent master of a family, never to attempt to make at home what it will cost him more to make than to buy. The tailor does not attempt to make his own shoes, but buys them from the shoemaker. The shoemaker does not attempt to make his own clothes, but employs a tailor. The farmer attempts to make neither the one nor the other, but employs those different artificers. All of them find it for their interest to employ their whole industry in a way in which they have some advantage over their neighbors, and to purchase with a part of its produce, or what is the same thing, with the price of a part of it, whatever else they have occasion for.

What is prudence in the conduct of every private family, can scarce be folly in that of a great kingdom. If a foreign country can supply us with a commodity cheaper than we ourselves can make it, better buy it of them with some part of the produce of our own industry, employed in a way in which we have some advantage.

- Adam Smith
Wealth of Nations

Here and here are a couple of other posts on trade I made early in my blogging career on trade.

Go jump off a supply curve!

The new issue of BusinessWeek has a feature story: What Good Are Economists Anyway.

Economists mostly failed to predict the worst economic crisis since the 1930s. Now they can't agree how to solve it. People are starting to wonder: What good are economists anyway? A commenter on a housing blog wrote recently that economists did a worse job of forecasting the housing market than either his father, who has no formal education, or his mother, who got up to second grade. "If you are an economist and did not see this coming, you should seriously reconsider the value of your education and maybe do something with a tangible value to society, like picking vegetables," he wrote on patrick.net.

Take that, you pointy-headed failures! Go jump off a supply curve!

Of course predicting the future is always difficult, especially when it involves human behavior. To be fair, there were economists who spoke frequently about the unsustainable increase in housing values - the word bubble was used frequently. While no one really saw the extent to which the toxic mortgages would plug up the financial system, there were voices of concern about lending practices and the savings rate of individuals. As for the disagreements among economists, macroeconomics is a still developing field and the models have been refined dramatically since The Great Depression when it started to evolve out of microeconomics. I suspect that the next decade will see another stage in the evolution as this recession again refines the models.

Econ Quiz

Take an Econ Quiz here.

A Change in Consumer Expectations...

The current issue of Time Magazine is about the "New Frugality" - being a truly frugal person (I'm a real cheapskate) I was drawn to the article. The part of the article quoted below caught my attention as a great example of a change in demand due to a change in consumer expectations. Consumers expect the current administration to change gun ownership laws, so people are buying - especially handguns. There is also hoarding behavior due to speculation of a future tax on handgun ammunition - can't find a box of 9mm or .357 magnum ammo anywhere. Here's the segment:

Jody Windschitl, 49, Missouri Valley, Iowa

Our sales are up about 33% this year compared with last. As an industry, they say it's the "Obama effect." We have never been in business when the Democrats are in office. We've been told that gun sales go through the roof, and they weren't kidding. We can't even get stuff. Ammunition has just dried up all over the country. Right now we're so busy, we've had to hire one person. People are afraid also of the Democrats' putting a ban on firearms — that's the biggest fear factor.

Dilbert

Economists too often use of phrases like "it depends" and "one the one hand...one the other hand" - this comic pokes good fun at this habit.

The Great Recession...?

More and more I am seeing the current recession referred to as a "Great Recession". It will be interesting to see if this label sticks. This is legendary Fed Chairman Paul Volcker using the term:

Former Federal Reserve Chairman Paul Volcker on Saturday warned that while the severity of the recession may be waning, the U.S. faces a “long slog” toward recovery.

Volcker also said that the Fed’s recent interventions into credit markets will inevitably lead to a review of the Federal Reserve Act, and urged patience in addressing financial regulation.

In comments to a Vanderbilt University ... Volcker said that while the current downturn isn’t like the Great Depression of the 1930s, “we’re in a Great Recession for sure.”

“It does look like rather a long slog in terms of recovery…though the rate of decline is going to slow,” Volcker said.

Vertical Integration and Derived Demand

This story segment from the local Hibbing Tribune newspaper about the demand for steel and therefore the derived demand for workers in the steel industry is relevant to the local labor market, but also a great example of market signals and responses. As it turns out the vertical integration within the steel industry has allowed market signals to be read more quickly and labor markets are responding more quickly as well.

More precisely, they’re saying that mining companies can adapt more quickly to market conditions than they could in the past, and the reason is the iron mining and steel industries have become “vertically integrated.” That is, mining companies have been folded into larger corporations that control multiple steps in the sequence from mining to the production of finished steel. Barry D. Lesar, St. Louis County’s inspector of mines, said that when demand for steel plummeted, mining companies in the region reacted quickly. Mines throughout northeastern Minnesota have sharply cut production. Since December, workers at Hibbing Taconite, Keewatin Taconite and Minntac in Mountain Iron — hundreds of workers in all — have been laid off. That’s the bad news. The good news, Lesar and others say, is that when the market for steel revives, those workers could be put back to work with equal speed.

100 Trillion Dollar Note

I ordered a Zimbabwe 100 Trillion Dollar Note to use as an example of hyperinflation in class. How much? I bought the 100 Trillion Dollar note 0n Ebay for $5 + $1 shipping.

The Dismal Scientist

Tax Day

This story:

WASHINGTON – On the day of the deadline for Americans to file their tax returns, President Barack Obama will talk about restoring fairness to the tax code and providing tax relief to working families.

Of course "fairness" is a loaded word. I might consider fair to be smaller marginal rates for people who make under $100,000 and an increase in the teacher tax deduction. As long as we are at it, why not include a big tax credit for teachers who want to pursue more education - I might like to pursue a MBA or PhD. Of course scarcity means that in order to raise the same amount of revenue, a reduction in taxes for one household means a tax increase for someone else. The "tax relief to working families" would imply that President Obama is pursuing policy that would make the tax code more progressive - no real surprises there.

After doing my taxes again this year, I think tax simplification might be a more noble cause to pursue.

Update : It looks like President Obama is at least interested in tax simplification, according to this story:

Seeking to tap into public exasperation with the tax system, Obama said: "We need to simplify a monstrous tax code that is far too complicated for most Americans to understand, but just complicated enough for the insiders who know how to work the system."

"It will take time to undo the damage of years of carve-outs and loopholes. But I want every American to know that we will rewrite the tax code so that it puts your interests over any special interest. And we will make it quicker, easier and less expensive for you to file a return, so that April 15 is not a date that is approached with dread each year," he said.

Of course the difficulty of passing tax reform is monumental. Example - when President Bush's panel on tax reform suggested eliminating or reforming the mortgage interest tax deduction - the realtor's lobby group went wild and struck fear into the hearts of every homeowner.

What I Have in Common with Larry Summers

I like this Larry Summers quote from Wikipedia. It turns out Larry and I have something in common - Milton Friedman is a hero to both of us.

Upon the death of his hero, libertarian economist Milton Friedman, Summers wrote an Op-Ed in The New York Times entitled "The Great Liberator" arguing that "any honest Democrat will admit that we are now all Friedmanites." Summers wrote that while Friedman made real contributions to monetary policy, his real contribution was "in convincing people of the importance of allowing free markets to operate."

Fed Funds Rate 1990-2008

Alan Greenspan's time at the Fed was revered as the wonder years a few years ago when all the talk was about the "great moderation" - now the mantra is "too low for too long".

Bernanke part 1 & 2

Watch CBS Videos Online


Watch CBS Videos Online
Bernanke vowed to bring more transparency to the Fed. Watch this historic interview with a sitting Fed Chairman. Bernanke may well go down as our most powerful Fed chief to day.

Don't Forget to Invest in Human Capital

Taking the hot dog stand from Marketplace on Vimeo.

Chris Farrell reminds us that working can be healthy and that many people are going to end up working for a longer period of time than they had planned.

The Debate Goes on...

Progress

To Save or to Spend...

To save or to spend, that is the question from Marketplace on Vimeo.

SNL and the Financial Crisis

Mankiw and Blinder on Consensus

There are many jokes about economists not agreeing on policy, or giving an "it depends" answer. Greg Mankiw's textbook and blog lists some things that economists agree on:

I include a table of propositions to which most economists subscribe, based on various polls of the profession. Here is the list, together with the percentage of economists who agree:

1. A ceiling on rents reduces the quantity and quality of housing available. (93%)
2. Tariffs and import quotas usually reduce general economic welfare. (93%)
3. Flexible and floating exchange rates offer an effective international monetary arrangement. (90%)
4. Fiscal policy (e.g., tax cut and/or government expenditure increase) has a significant stimulative impact on a less than fully employed economy. (90%)
5. The United States should not restrict employers from outsourcing work to foreign countries. (90%)
6. The United States should eliminate agricultural subsidies. (85%)
7. Local and state governments should eliminate subsidies to professional sports franchises. (85%)
8. If the federal budget is to be balanced, it should be done over the business cycle rather than yearly. (85%)
9. The gap between Social Security funds and expenditures will become unsustainably large within the next fifty years if current policies remain unchanged. (85%)
10. Cash payments increase the welfare of recipients to a greater degree than do transfers-in-kind of equal cash value. (84%)
11. A large federal budget deficit has an adverse effect on the economy. (83%)
12. A minimum wage increases unemployment among young and unskilled workers. (79%)
13. The government should restructure the welfare system along the lines of a “negative income tax.” (79%)
14. Effluent taxes and marketable pollution permits represent a better approach to pollution control than imposition of pollution ceilings. (78%)

Unfortunately economists have varied success in convincing the public and politicians of what the research and consensus of economists say. In his book "Hard Heads, Soft Hearts" Alan Blinder, an economics prof at Princeton, writes of Murphy's law of economic policy:

"Economists have the least influence on policy where they know the most and are most agreed; they have the most influence on policy where they know the least and disagree most vehemently."

Sticky Wages

Becker and Murphy on Stimulus

Nobel Laureate Gary Becker and University of Chicago professor Kevin Murphy weigh in on the stimulus package:

Our own view is that the short-term stimulus from the legislation before Congress will be smaller per dollar spent than is expected by many others because the package tries to combine short-term stimulus with long-term benefits to the economy. Unfortunately, short-term and long-term gains are in considerable conflict with each other. Moreover, it is very hard to spend wisely large sums in short periods of time. Nor can one ever forget that spending is not free, and ultimately it has to be financed by higher taxes.

The whole article is worth a read.

Obama, Summers and the "Third Rail"

In a recent article, Time magazine describes the abilities and experience of Obama economic advisor Larry Summers. Summers is brilliant and tends to be a relatively mainstream economist who favors intervention where there is merit, but prefers to let markets forces work their "invisible hand" magic. The article also mentioned that the Obama administration is planning to take on Social Security and Medicare reform.

And then, perhaps as early as March, they'll launch their biggest lift with the beginnings of a plan to reform Social Security and Medicare, the two entitlement programs that, even before the economy collapsed, were threatening the Treasury with bankruptcy. By any standard, it is a massive three-month agenda fraught with political risk. The key to getting it all done, Summers says, is entering into a "compact" with the country "that this isn't just government as usual throwing money at things." When Obama unveils his annual budget in late February or March, Summers promises that the President "is going to describe the kinds of approaches he wants to take to the entitlement problems that have been ignored for a long time." Some options might include delaying retirement, stretching benefits and lifting the cap on taxable earnings. Could one of these prevail? "Remains to be seen," Summers says.

Congress Wants a Trade War

The stimulus bill has everyone talking about the size, the mix of spending and tax cuts, and how soon the spending will actually enter the real economy. Economists debate the issues, but there is a growing concern about the protectionist policies in the bill. Burton Malkiel makes an effective argument for free trade.

Suppose that we did not allow free trade between the 50 American states. Citizens like me in New Jersey would be far worse off if we could not buy pineapples from Hawaii, wine and vegetables from California, wheat from Kansas, and oil from Texas and Louisiana while we sell pharmaceuticals to the rest of the country. The specialization that trade makes possible allows all of us to live better.

The situation is the same with respect to world trade. Both we and the Chinese are better off if we can import inexpensive clothing from China and sell them large-scale computers and data storage equipment.

Then he warns of fallout:

Hostility has been no less evident in Europe and China. The European Union has said that it will not stand by idly if the U.S. violates its trade agreements and its obligations to the World Trade Organization. The risks of retaliation and a trade war are very real.

Since the U.S. is the biggest exporter in the world, retaliation could cost America more jobs than the provision would create. It could also destabilize the global capital flows on which the U.S. depends to fund its deficits. Moreover, the provision could delay some shovel-ready infrastructure projects, since sufficient American-made materials may not be immediately available. The U.S. does not manufacture enough steel to meet domestic demand.

In 1930, just as the world economy was sinking as it is today, the U.S. Congress passed the Smoot-Hawley Tariff Act, which essentially shut off imports into the U.S. Our trading partners retaliated, and world trade plummeted. Most economic historians now conclude that the tariff contributed importantly to the severity of the world-wide Great Depression.

Dissent

President Obama and Vice-President Biden have implied that the economics profession is unanimous in its support of a massive fiscal spending package. This is not the case. Click here to find a message to President Obama signed by prominent economists from some of the nation's finest universities across the nation. The list includes James Butkiewicz and Ellie Craig, two of my favorite professors at my Alma Mater, the University of Delaware.

Here is their statement:
Notwithstanding reports that all economists are now Keynesians and that we all support a big increase in the burden of government, we do not believe that more government spending is a way to improve economic performance. More government spending by Hoover and Roosevelt did not pull the United States economy out of the Great Depression in the 1930s. More government spending did not solve Japan's "lost decade" in the 1990s. As such, it is a triumph of hope over experience to believe that more government spending will help the U.S. today. To improve the economy, policy makers should focus on reforms that remove impediments to work, saving, investment and production. Lower tax rates and a reduction in the burden of government are the best ways of using fiscal policy to boost growth.

Opposition to the Stimulus Package

The economic news is grim:

The economy shrank at a 3.8 percent pace at the end of 2008, the worst showing in a quarter-century, as the deepening recession forced consumers and businesses to throttle back spending.

Although the initial result was better than economists expected, the figure is likely to be revised even lower in the months ahead and some believe the economy is contracting in the current quarter at an even faster pace.

Meanwhile, criticism of the Fiscal Stimulus package is growing even as it appears it may pass both house and Senate easily. Here's what NY Times columnist David Brooks has to say about the package:

But they’ve created a sprawling, undisciplined smorgasbord, which has spun off a series of unintended consequences. First, by trying to do everything all it once, the bill does nothing well. The money spent on long-term domestic programs means there may not be enough to jolt the economy now (about $290 billion in spending is pushed off into 2011 and later). The money spent on stimulus, meanwhile, means there’s not enough to truly reform domestic programs like health technology, schools and infrastructure. The measure mostly pumps more money into old arrangements.

The Stimulus Package and Protectionism

The Stimulus Package includes some protectionist measures. Economists have speculated that this might happen. The pitch makes for good political sound bytes.

Here's what ND Senator Byron Dorgan says:

"The 'Buy American' provision will help stimulate our own economy," Sen. Byron Dorgan, D-N.D., who wrote the provision, told CNNMoney. "When taxpayer dollars are used, we should urge that money to support the things produced here at home."

So why are Economists concerned? The infamous Smoot-Hawley bill passed in 1930 to protect American producers during the Great Depression serves as a classic reminder of what protectionism can do to an already struggling economy. Most economists believe the legislation only added to the depth and length of the depression. Here's what Wikipedia has to say:

The Smoot-Hawley Tariff Act (sometimes known as the Hawley-Smoot Tariff Act) was an act signed into law on June 17, 1930, that raised U.S. tariffs on over 20,000 imported goods to record levels. In the United States 1,028 economists signed a petition against this legislation, and after it was passed, many countries retaliated with their own increased tariffs on U.S. goods, and American exports and imports plunged by more than half. In the opinion of some economists, the Smoot-Hawley Act was a catalyst for the severe reduction in U.S.-European trade from its high in 1929 to its depressed levels of 1932 that accompanied the start of the Great Depression.

Notice the proud moment in history when 1,028 economists stood together against the bill. Unfortunately they were ignored.

The Economy and the Powell Doctrine

$825 Billion? Why is the fiscal stimulus package so big? The economic view: consumers must be convinced that the package is big enough to end the recession in order for consumer confidence to return. If consumers are confident recovery is in the works, they will feel more free to spend. As for as the size, think in terms of the Powell Doctrine:

The "Powell Doctrine" is a journalist-created term, named after General Colin Powell in the run-up to the 1990-1991 Gulf War. ..asserting that when a nation is engaging in war, every resource and tool should be used to achieve decisive force against the enemy, minimizing US casualties and ending the conflict quickly by forcing the weaker force to capitulate.

So, $825 billion is like economic "shock and awe". Thanks to Wikipedia for the definition.

Fiscal Stimulus

Mankiw on Fiscal Stimulus

Harvard Economist N. Gregory Mankiw was on CNBC again this morning discussing the stimulus package. The bill that is being hashed out in Congress is a combination of tax cuts and government spending, seemingly textbook treatment of expansionary fiscal policy. The textbooks say that spending has a more direct stimulative effect and a larger multiplier because the money is actually spent. Tax cuts are often saved. Mankiw, and several others, are beginning to argue that recent research shows that tax cuts have a higher multiplier, in spite of what the textbooks say (including his own). Also, one of the big concerns with government spending is the lag time involved. How long will it take before the government spending projects actually translate into income for consumers? Also, skeptics of the package accuse Democrats of using the current situation to load up the bill with all the unfulfilled Democrat "to-do-lists" that haven't gotten done in the past fifteen years. Let's hope the wisdom of crowds prevails and the bill that results is truly the best effort of our representatives in Congress.

Inauguration Day 2009

Economist John M. Keynes wrote about the effect of "animal spirits" in respect to the economy. The Economist magazine defines animal spirits this way:

The colorful name that Keynes gave to one of the essential ingredients of economic prosperity: confidence. According to Keynes, animal spirits are a particular sort of confidence, "naive optimism".

One of the best gifts President Obama can give the economy is a confidence boost - an attempt to lift our animal spirits. Will the new President use his gift of rhetoric to inspire hope and confidence?

Wheelan for Congress

It is typical when discussing wise public policy from the economic perspective, and the reasons that they do not often translate into legislation, to have a student ask why there are not more economists in Congress. I usually respond that a platform full of economic platitudes is not often a politically popular platform. For instance, it is often easier to earn votes by pressing for protection of American industry with trade barriers than to explain the benefits of free trade. It is often easier to earn votes by fighting for the common man by increasing in the minimum wage than to explain how the policy ends up hurting low skilled workers.

Well, one of our own is running for Congress. Charles Wheelan, formally of the Economist magazine and the author of Naked Economics (scary title, good book) is running for the Illinois seat vacated by Rahm Emanuel.

Here is his platform:

At a time of unique challenges to the global financial system, it is imperative to have members of Congress with a sophisticated understanding of economics.

Economic stimulus that includes government spending should be carefully designed to ensure that only projects that have social value are funded. Infrastructure projects, identified by an objective panel, that likely would have been pursued without special funds are good candidates. If there are insufficient projects meeting a high cost-benefit threshold, additional stimulus should come in the form of tax cuts.

Any mitigation of greenhouse gas emissions in the United States should be pursued through market mechanisms that raise revenue, which can be used to reduce the personal, corporate and/or payroll tax.

The U.S. should make long-term investments in human capital, particularly in early childhood education for low-income and disadvantaged children.

Congress should promote free trade and work to reduce trade barriers around the globe. The best way to deal with the political costs of trade and the economic dislocation caused by international competition is to create a meaningful safety net for displaced workers.

Tax reform is necessary to improve the equity, efficiency and simplicity of the tax code. A priority of tax reform should be a reduction in the number of special incentives that narrow the tax base, induce tax avoidance and increase compliance costs.

The U.S. must deal with the looming fiscal obligations created by our entitlement programs: Medicare, Medicaid, and Social Security. Our current economic situation justifies increased deficits now, but today's policy must be attentive to the need for fiscal balance over the next several decades.


Check out Wheelan's website, The Naked Economist. Also check out the website Economists for Wheelan. Thanks to the Mankiw site for the link.