Monday, December 29, 2008
Friday, December 19, 2008
Bailouts and Moral Hazard
For an economist, bailouts raise a lot of red flags regarding incentives. Wikipedia defines moral hazard as:
Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.
The problem with bailouts: If the expectation is created that the government will bail out firms experiencing economic hardship, they will pursue riskier opportunities than they would otherwise. Of course there is no free lunch, taxpayers end up bearing the cost burden of the now risk enhanced behavior.
Moral hazard is the prospect that a party insulated from risk may behave differently from the way it would behave if it were fully exposed to the risk. Moral hazard arises because an individual or institution does not bear the full consequences of its actions, and therefore has a tendency to act less carefully than it otherwise would, leaving another party to bear some responsibility for the consequences of those actions.
The problem with bailouts: If the expectation is created that the government will bail out firms experiencing economic hardship, they will pursue riskier opportunities than they would otherwise. Of course there is no free lunch, taxpayers end up bearing the cost burden of the now risk enhanced behavior.
Thursday, December 18, 2008
Friday, December 5, 2008
Extreme Losses
As part of the personal finance portion of my contemporary economics course, student spend $10,000 on a portfolio of the stocks of four companies and sell thirteen weeks later. Thus students hold the stocks for one quarter. Students bought their stocks on September 11, 2008 and sold on December 1, 2008. The S&P 500 over that time period lost 41%. Needless to say, students lost a bundle. The consolation is that the money was not real, so the losses are not real either.
Recession: Deep and Wide
The recession looks like it may be a scary one. Click here to read today's unemployment report which shows job losses of 533,000 and an unemployment rate of 6.7%. Get Greg Mankiw's opinion by watching this clip from CNBC.
Thursday, December 4, 2008
Pigou Club, Hibbing Chapter
Professor Greg Mankiw of Harvard invites prominent economists and lawmakers who believe that the tax on gasoline should be increased to join the Pigou Club. I invite students to read Mankiw's Pigou Club Manifesto and make a comment below.
Do you support the idea of raising the gasoline tax by $1 over ten years?
What should the tax revenues be used for?
Should the tax be revenue neutral? (This means the new revenue would offset the revenue government receives from other taxes, resulting in no net tax increase on the American people)
Is this a good time to raise the gas tax? The chart below shows average U.S. gas prices over the previous twelve months. Notice the price of gas in Canada. The gap between the two lines represent the difference in the gas tax.
Defend your decision to support or oppose an increase in the gas tax using economic reasoning.
Update: China has bravely announced an increase in its gas tax. Read the full story here. It may interest you to see that it is being offset by reductions of fees and taxes elsewhere and being imposed during a slowing economy. Of course, the Chinese political system makes a tax increase an easier task.
Do you support the idea of raising the gasoline tax by $1 over ten years?
What should the tax revenues be used for?
Should the tax be revenue neutral? (This means the new revenue would offset the revenue government receives from other taxes, resulting in no net tax increase on the American people)
Is this a good time to raise the gas tax? The chart below shows average U.S. gas prices over the previous twelve months. Notice the price of gas in Canada. The gap between the two lines represent the difference in the gas tax.
Defend your decision to support or oppose an increase in the gas tax using economic reasoning.
Update: China has bravely announced an increase in its gas tax. Read the full story here. It may interest you to see that it is being offset by reductions of fees and taxes elsewhere and being imposed during a slowing economy. Of course, the Chinese political system makes a tax increase an easier task.
Wednesday, December 3, 2008
The Paradox of Thrift
There is much talk of the paradox of thrift these days. Wikipedia defines it this way:
The paradox of thrift (or Paradox of Saving) is a paradox of economics propounded by John Maynard Keynes. The paradox states that if everyone saves more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population. One can argue that if everyone saves, then there is a decrease in consumption which leads to a fall in aggregate demand and thus leads to a fall in economic growth.
Game theory reasoning can also be applied where saving is the dominant strategy.
The paradox of thrift (or Paradox of Saving) is a paradox of economics propounded by John Maynard Keynes. The paradox states that if everyone saves more money during times of recession, then aggregate demand will fall and will in turn lower total savings in the population. One can argue that if everyone saves, then there is a decrease in consumption which leads to a fall in aggregate demand and thus leads to a fall in economic growth.
Game theory reasoning can also be applied where saving is the dominant strategy.
Monday, December 1, 2008
It's Official: Recession
The NBER has made the call, we are in recession and looks like the pain will last for a while. The full story is here.
The NBER — a private, nonprofit research organization — said its group of academic economists who determine business cycles met and decided that the U.S. recession began last December... Many economists believe the current downturn will last until the middle of 2009, and will be the most severe slump since the 1981-82 recession.
The NBER — a private, nonprofit research organization — said its group of academic economists who determine business cycles met and decided that the U.S. recession began last December... Many economists believe the current downturn will last until the middle of 2009, and will be the most severe slump since the 1981-82 recession.
I.O.U.S.A.
Watch for a new film I.O.U.S.A. that attempts to do for fiscal responsibility what Al Gore's "An Inconvenient Truth" did for environmentalism.
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