Third Quarter GDP - 2% Annual Growth

It appears the economy is still growing, kinda. Here is a nice a review by one of my professors at Oregon. There is one glaring issue. The economy grew at a 2% rate, but that is mostly due to a change in business inventories. In the next few chapters we are going to spend a lot of time looking at the components of GDP. Business inventories are particular interesting, as they are also an indicator of future GDP. An increase in business inventories suggests businesses anticipated selling more today than they actually sold. Of course, the increase could be because firms are building inventories prior to the holidays. Nonetheless, when they accumulate inventories GDP increases and when they sell off their inventories GDP will decrease.

Other interesting things to note:
1) Personal consumption increased at a 2% rate.
2) Equipment and software grew at a 12% rate. Firms are making more investments, that's good.
3) Residential investment decreases at a 29% annual rate. This is a stark turn from the second quarter when residential investment increased at a 25% annual rate. Of course the first-time homebuyer credit expired in the middle of the second quarter.
4) Imports increased at a much faster pace than exports (17% to 5%)

A Primer on Monetary Policy and Quantative Easing

Here is a nice primer introducing monetary policy and quantitative easing. It is very readable.

The Problem with Politicians

The recent Nobel Prize winning economist Peter Diamond was appointed to the Federal Reserve Board of Governors by President Obama. Peter Diamond is more than qualified to serve on the Board. He is only an expert in public finance and structural unemployment.

Quantitative Easing

On Wednesday we will begin talking about monetary policy. To help a struggling economy the Federal Reserve will lower interest rates by increasing the amount of money available for banks (through an increase in reserves). Remember banks are able to lend out excess reserves. The interest rate influenced by the Federal Reserve is called the federal funds rate. The federal funds rate is a short-term interest rate that is determined in the federal funds market. The federal funds market is where banks borrow and lend to other banks. A bank that needs more reserves can borrow from other banks. It's not uncommon for a bank to make to many loans and have a shortage in their reserve account. When the Federal Reserve lowers the federal funds rate they will increase the amount of excess reserves in banks, with more reserves in the banking system, banks will lower interest rates to attract more lenders. During the recent recession, the Federal Reserve has increased bank reserves by nearly $800 billion, but banks have not increased loans meaning long-term interest rates have not come down and the money supply has remained relatively unchanged. More importantly, investment has remained low.

To help encourage more borrowing, the Federal Reserve has taken steps to reduce the long-term interest rate. This process is called quantitative easing. Normally a lower short-term interest rate will lower long-term interest rates. Long-term interest rates are an average of short-term rates. Despite having short-term interest rates near zero, long-term rates remained high. Long-term interest rates were high because banks were worried about future mortgage defaults and government deficits. The solution was for the Federal Reserve to directly buy long-term debt instruments. This would reduce yields on long-term debt, which will hopefully increase borrowing.

To date the Federal Reserve has purchased $1.4 trillion in long-term debt. You can see their balance sheet here (for those interested you would want to look at reserve bank credit). This is the size of the banks balance sheet, if you look back a few years you will notice a large increase.

More shocking is this report by Goldman Sachs that says the Federal Reserve will need to purchase an additional $4 trillion in long-term debt. This behavior will create inflationary concerns.

Negative Bond Yields

Investors are accepting negative returns on TIPS. Remember TIPS pay the bond holder a nominal return plus the inflation rate. If they are willing to accept a negative nominal return it must be they are expecting higher inflation.

Trade Fact of the Week

Given my talk on China I thought some of you may find this interesting.  Here's a longer article.

Here is Greg Mankiw on currency manipulation. 

Here is Paul Krugman on currency manipulation.

And let's add one more. 

So should the U.S. pressure China into letting the yuan appreciate?

Note:
Yes there is a lot of political pressure to protect American jobs. Most politicians understand there are benefits and costs when it comes to trade. Normally the benefits outweigh the costs (job losses). The job losses are concentrated in states that have historically relied on manufacturing. These states (i.e. the rustbelt) are also political swing states. Again this is the difference between economics and politics.

Remember a country's currency is priced relative to another country. The yuan is priced at 7, which means it takes 7 yuan to buy 1 dollar. If the yuan appreciates it will take fewer yuan to buy a dollar. It terms of trade, if the yuan is low (undervalued) then one dollar can purchase a lot of yuan (and subsequently a lot of goods). As the yuan appreciates the price of Chinese imports increases, and U.S. exports decreases.

Fortunately most countries price commodities in terms of dollars. A lower value of the dollar won't have a large impact on the price's because the commodities won't change.

The Dollar, Foreign Investment, and Government Deficits

Here is Martin Feldstein with his view on the role of the dollar in international markets.

Blog Participation

I have updated everyone's blog participation scores so I could provide relatively updated midterm grades. You can access the blog scores here.

If there is a mistake and you feel I missed one of your posts let me know. I do have a couple of user names that I am unclear on. If you have not been posting, I strongly recommend you start posting. I will be happy to give you half credit for missed posts.

I have submitted midterm grades. The grade submitted represents your blog participation (I will factor use attendance and classroom participation at the end of the course in determining your final grade), one quiz score (your lowest score is dropped), and 4 homework scores (your lowest score is also dropped). I elected to drop only one homework score when calculating your midterm grade, this way your grade is not biased upward.

If you feel I made a mistake, please contact me sooner rather than later.

I know a number of students have expressed frustration over not clearly articulating the role of the blog when evaluating class participation. I know I have mentioned the need to make 1-2 blog posts per week. We discussed the blog the first day of class and in the syllabus. Further I emailed the following to everyone a week before classes:
Fifteen percent (originally ten percent) of your grade is based on course participation. This is your participation in the course blog. I will post articles, write ups, and other interesting economic events on our blog. It is your responsibility to actively follow the blog and make comments. You do not need to comment on all the postings, but at least once a week you need to sit down and make an effort. The course blog is public domain, but the only access is through the URL. It will not show up through a search engine. This should keep your posts relatively private. You can create a user name, just make sure I know the real name behind it. You are not judged based on your views, you are judged on your ability to articulate and argue those views. I will generally update the blog 2-3 times per week.

I'm sorry if you feel that I was not clear in my expectations, but I don't know what else I can do without feeling like I am constantly nagging students to make posts. I am giving everyone a chance to make up missed posts for half credit. Please take advantage of this.

The Saving Paradox

As we talked about in class, saving today is good for future economic growth. But as we shift away from consumption the economy will worsen in the short-run. Clearly this has important policy implications. So what's the solution. Well apparently it's a little of both. We need to spend and save.

What policies can we implement. I still think the number one problem is household debt. Many households own more on their homes than what they are worth, throw in consumer debt (credit cards and car loans) and student loans it's easy to see why households are reluctant to spend. A well structured loan modification program will reduce household monthly debt payments. This needs to be followed up solidifying the Bush Tax cuts for at least the households earning less than $250,000, and with investment tax credits for businesses.

More on the low saving rate

Here's an opinion on our low saving rate.

Note: The current account deficit is the difference between saving and investment in a country.

The next asset price bubble?

Are commodities experiencing a bubble? As we move into monetary policy and the determinants of inflation this article is of particular interest. As the Federal Reserve injected trillions of dollars into the financial system (to keep interest rates low) a number of investors are betting inflation is just around the corner. As of today banks are flush with cash, but are not issuing loans. This behavior is likely keeping inflation low, but the concerns over high future inflation are increasing. There are two ways to hedge inflation risk, buy treasury protected securities or invest in commodities (gold).

We know bubbles are contagious, after one bubble ends another bubble forms. It's usually just a matter of time before another bubble is spurned.

Where are you likely to live after graduation?

You can find the answer here.

Why Economists Disagree

Here's a nice piece in the NY Times. The article does mention economists agree on many issues, but ultimately divergence arises under very subjective issues. The underlying issue is equality. What's fair? The article talks about taxes in particular. Is making someone pay $10,000 when they earn $100,000 equally as fair as taxing someone $4,000 that earns $20,000? Does it matter how they earn that income? Going beyond how they earn the money, but who's right is it to decide how much we pay in taxes?

We all have different opinions, even among economists. When issues become subjective in nature it is difficult to come to a reasonable solution. This is part of the story behind the current debates over extending the Bush tax cuts.

10 Trillion and Counting

Here is the video for today.

Quiz 2, Question 2 for 1:10 Section

When I graded question 2, I primarily looked for the following:

1) Did you calculate the inflation rate
2) Did you find the real interest rate
3) Did you use the real interest rate (instead of the nominal rate) to find your return.

There is a second approach to the problem. You could find the nominal return which is 1000*(1.08)^3 = 1259.71 or a 25.9% return.

The next step is to find the rate the price level increased. This is done by taking the price level multiplied by the inflation rate.

Year 1: 100*(1.06) = 106
Year 2: 106*(1.075) = 114
Year 3: 114*(1.035) = 118

This means that prices have increased from 100 to 118 or an 18% increase. Then you can calculate your return 25.9% - 18% = 7.9%.

If you did this please bring your quiz on Wednesday.

An Extension to the College Tax Credit

Obama wants to extend the American Opportunity Tax Credit. This credit allows households with income less than $80,000 a tax credit up to $2,500. The average tax credit is nearly $1,700.

In class we've talked about the need to shift taxes away from things that are productive into a consumption based tax. I like this extension. With the rising prices of college it is a huge break for middle income families. This also provides more fuel to my argument, why should anyone pay taxes on money that is being used to send their children to college. We have established 529 college saving plans which act as a tax shelter, but unfortunately most households are not taking advantage of these benefits. If they were then we wouldn't need these income tax credits. Further, the households that are using the 529 plans are generally higher income. So again the middle income families are facing larger tax burdens.

Instead of having to create these tax credits and the necessity for 529 saving plans a simple switch from an income tax to consumption based tax would solve a number of problems.

Economists' World Debt Clock

The Economist has a nice image of global debt levels. The debt recorded is public debt. For the United States this amount is about $8 trillion dollars. Our current national debt is about $13 trillion, this means $5 trillion is held about other government agencies. If you look at public debt as a percentage of GDP the United States is not nearly as bad as many other countries. This doesn't make it better, just not as bad.

Picture of the Week

The Nobel Prize in Economics

The Nobel Prize in Economics went to three economists for their work in labor market frictions. Sound familiar.

Quiz 2

Here is a brief answer key for the quiz.

1:10 Section
Question 1: You need to think about how income is earned. All income is tied into the production of something. At the end of the production process the final market value of an items is compensating workers and owners for their contribution to the production process. 
Question 2: Can be found in the practice questions for Inflation on Connect
Question 3: Changes in inflation are zero sum (people are neither richer or poorer), but inflation does have a cost. The main cost is a reduction in economic growth, but you should have also listed redistribution of income.
Question 4: Was completed in class when we discussed globalization and wage inequality. The demand for labor in the high skilled industry increases (wages increase) and the demand for labor in the low skill industry decreases (wages decrease). Supply does not change.
Question 5: Promote saving and investment, human capital, and a better legal system

2:10 Section
Question 1: GDP only accounts for production it ignores other factors that have improved our standard of living. These include health care, education, environment, and leisure time.
Question 2: Can be found in the practice questions for Inflation on Connect. The one catch is in 2009 the price of chickens increases to $6.00 and ham to $12.00. If people are indifferent between 2 chickens and 1 ham, given the new prices their bundle will not change (hams cost twice as much as chickens). There is no substitution bias.
Question 3: Can be found in the practice questions for Wages and Unemployment on Connect. If 65% of the working age population is in the labor force than 35% of the working age population is not in the labor force. In other works .35x = 52.5 or 150 million in the working age population. Which means the labor force has 150 - 52.5 or 97.5 people. If 5.5 % of the labor force is unemployed than the economy has 5.36 million workers unemployed and 92.14 million workers employed.
Question 4: Real wages have risen because of a shift in labor demand (technology making workers more productive). Over the last 25 years the growth in real wages has slowed because of an increase in labor supply (baby boomers and woman).
Question 5: The four poverty traps are landlocked, natural resources, bad governance, and civil war.

A new focus on community colleges!

Obama announced a massive push in promoting community colleges. This is huge! We've talked about the higher levels of unemployment for low skilled workers and this is one potential solution. The only people upset over the proposal for profit colleges! I wonder why? I'm not a huge fan of for profit higher education. Lately there have been many issues surrounding how for profit college (i.e. University of Phoenix and Kaplan) exploit the financial aid system. So when they come out swinging, it makes me think it's a good idea.

But not everyone is on board with the effort. Organizations like Kaplan, the University of Phoenix, and various for-profit colleges are lashing out at Obama's plan, charging that community colleges are being showered with too much presidential attention and federal aid at the expense of other institutions.

 In other words the federal aid will be going to lower income families that want to attend community colleges, which happen to be a fraction of the price of for profit colleges. Many for profit colleges cost nearly the same to attend as private schools.  For profit colleges exploit the financial aid system leaving the students in debt and often without any employment after graduation. Here's a nice video by Frontline on for profit colleges.

Bernanke Warns of Increased US Debt.

Over the next couple weeks we will beginning talking about the position of the US debt. Here's Bernanke's take.

America's declining wealth

The net wealth held by American households has decreased by $17 trillion dollars following the housing market meltdown. Here's a nice review. Households will continue to increase saving to help offset the losses in housing equity and retirement accounts. This will only prolong the current recession. Again we are seeing the major difference between short-run and long-run factors. Increased saving in the short run will worsen the current recession, but will put us a more sustainable path in the future. This is especially true with the large fiscal deficits.