Monday, February 28, 2011

The Federal Reserve, Monetary Policy, and Oil

Over the next few weeks we will begin discussing the role of the financial system and in particular the role of the Federal Reserve. In short, the Federal Reserve lowers interest rates when the economy is slow and raises interest rates when the economy is fast. Today they have set interest rates very low and would like to keep rates low until the economy fully recovers. Unfortunately there is a large constraint on their ability to keep interest rates low, inflation. When the Fed lowers interest rates, it gives us more money for loans, which results in more inflation. So lower interest rates lead to higher inflation, and when inflation starts to increase they raise interest rates.

Right now is an unique period. Interest rates are low, and have been for three years, but inflation is also very low (around 1%). Unfortunately oil could ultimately force the Fed's hand. The results could potential start a second recession. Low interest rates makes it cheap to borrow money (we like cheap money), if the Fed is forced to raise interest rates investment will slow down and it will get much more costly to borrow money. Here's a good article explaining everything.

Friday, February 25, 2011

More Pessimism

It looks like we are headed for a slowdown, our economy will be growing but not at the rate needed to sustain job growth. The effects of oil are going to weigh down the economy, but also people don't realize that cutting government spending will also play a large role in the slowdown. To ignore what is happening in UK following their budget cuts is foolish.  This is primarily why, in class, I focused on cutting long term spending (e.g. cuts in defense, medicare, and social security). Cutting spending during a recovery will hamper and delay the recovery. If the cuts are large enough it could result in a second recession. What this will likely mean, higher unemployment, lower income, lower tax revenue, and smaller deficit reduction than expected. Democrats over used their power the first two years since Obama took office and it appears Republicans are on the same path of irresponsibility. Yes we need to reduce our deficit, but not by cutting spending today. Don't we all just love government.

Thursday, February 24, 2011

Sound familiar.

Here's a timely article.

Here we go again!

Gas prices are surging and it's not good (here's the Economists take). The one thing that can derail our recovery would be a spike in gas prices and it looks like that is about to happen. The question now is there anything we can do? In the short run the answer is no. Unless we want to end up like the early 80's (double digit inflation and unemployment) our hands are tied. Households will feel the pinch, spending will drop, and the economy could easily enter into another recession.

In the long run (which means this policies should have been implemented 10 years ago) we need to push for higher fuel standards and encourage households to buy more fuel efficient vehicles. How could this have been achieved? You guessed it, a gradual increase in gas prices. Ten years ago the economy was robust and growing (one minor recession), if gas priced increased by 0.10/gallon households would have slowly shifted their purchases into more fuel efficient cars. We would be further along in the development of alternative energies, and most importantly we would have reduced the dependency on oil.

Today the average American drives a car that gets 22 mpg (not much higher than 10 years ago) and drives 15,000 miles per year which results in consuming 681 gallons of gasoline per driver. This means the average driver would pay $68 more per gasoline if we raise the price by 0.10. Since we also know the US consumes 72,000 million gallons of gasoline per year (this is 72 billion gallons of gasoline). Dividing the 72 billion gallons of gas by the 681 gallons consumed per person gives us about 105 million drivers (which sounds about right). Now what if the 105 million drivers drove cars that average 30 mpg (this is not an unrealistic assumption given the average new car purchased gets 28mpg). We would then consume 500 gallons of gas per person and a total of 52 billion gallons of gasoline. There are approximately 44 gallons of gasoline in a barrel of oil. By saving 20 billion gallons of gasoline (that's a lot of gasoline) we would reduce our oil consumption by 450 million barrels of oil.

(Two effects I'm not accounting for (1) some people may drive more with more fuel efficient cars (2) some people may drive less because of more expensive gasoline. Let's assume these effects cancel each other out, but I would actually think (2) would outweigh (1) especially with promoting mass transportation and alternative energies)

Is 450 million barrels of oil a lot? We consume an average of 9-10 million barrels per day. So 450 million barrels amount to 45 days worth of oil which means we would reduce our oil consumption by 12% (I think this is a very conservative number, I think we would actually be consuming less than 52 billion barrels of gasoline prices increased).

How much do we save? If a barrel of oil costs $100 and we would save 450 million barrels of oil that results in a savings of $45 billion per year. Now that's a lot of money. Now what about that tax? On average Americans would have paid $68 per year for a total of $700 million (105 million drivers each pay $68).

So what I'm saying is pretty simple, we could have raised gasoline by 0.10 per gallon per year which would have encouraged the American household to buy more fuel efficient vehicles. Car manufactures would have emphasized higher fuel standards and developed alternative energies. It's not unrealistic to assume an average fuel standard of 30 mpg which results in a savings of $45 billion at a small price of $700 million. Now yes, the benefit would not be as large during the first few years, but after a few years the benefits will significantly outweigh the costs. Only if we had thought about this 10 years ago. Oh wait economists did, but no one listened.

Saturday, February 19, 2011

Why Does College Cost So Much?

This is only tangential to class, we will begin looking at the key factors of growth and one is education. More than anything I thought this article was very interesting.
Everyone has three objectives for higher education: lower tuition, higher quality, and less government spending on subsidies. The unfortunate truth is that we can have any two of these, but we can’t have all three. If we mandate low tuition, we have to give on one of the other two. Either the government has to increase spending on subsidies, or the quality of the education schools will be able to provide will suffer. There are no easy choices.

Wednesday, February 16, 2011

Rising Income Inequality

This report by the CBO turns out to be very timely given our lectures this week.

Changes in the Distribution of Workers’ Hourly Wages Between 1979 and 2009: Wages1
Wages2 Here's a summary of the CBO report:
Changes in the Distribution of Workers’ Hourly Wages Between 1979 and 2009, CBO Director's Blog: Wages are a key component of the overall economic well-being of individuals and families. Hourly wages and hours worked determine an individual’s earnings, and for most nonelderly adults, earnings constitute the bulk of their family’s income. A CBO study released today, prepared at the request of the chairman and former ranking member of the Senate Finance Committee, documents changes in the amount and distribution of hourly wages received by workers in the United States between 1979 and 2009. It also reviews the leading explanations for changes in the supply of, and demand for, workers with different sets of skills, as well as how labor market institutions affect wages.
The wage rate (the wage per hour of work) received by workers in the middle of the wage distribution (the 50th percentile) increased by about 20 percent over the 1979–2009 period after adjusting for inflation, reaching about $17 per hour in 2009. The dispersion of wages—the gap between wages at the top and bottom of the distribution—also increased over that period, but the pattern of changes at the top and bottom differed. For men and women alike, the gap between the wage rates received by high-wage (90th percentile) and middle-wage workers expanded throughout the 30-year period; the wage rates of high-wage women grew especially rapidly. In contrast, the gap between the wage rates received by low-wage (10th percentile) and middle-wage workers widened for both men and women early in the 1980s but has remained stable for the past 20 years.
Wages are affected by market forces (the level and distribution of skills supplied by workers and employers’ demand for those skills) and institutional factors (such as minimum-wage laws and changes in the share of the workforce represented by unions). Given the complex pattern of changes in the wage distribution between 1979 and 2009, it is not surprising that no single explanation can account for the entire pattern.
In the category of market forces, the growing demand for skilled labor, particularly for highly educated workers, accounts for most of the widening gap during the past 30 years between the wages of college graduates and high school graduates. Although the post–World War II period saw steady growth in demand for college graduates that put upward pressure on their wages, growth in the share of workers with college degrees offset some of that pressure during the early part of that period. Beginning in the early 1980s, however, people entering the workforce did not have significantly more education than those retiring and leaving the workforce. That slowdown in the improvement in educational attainment combined with growing demand for more-educated workers drove the wage premium for college graduates higher—a key reason for the increasing wage dispersion in the top half of the wage distribution
Shifts in international trade might also have contributed to increasing demand for skilled labor, relative to that for less skilled labor, as imports from low-wage countries substituted for some domestic production and employment; however, research on the significance of that effect is inconclusive. In addition, a rising number of foreign-born people in the workforce affected the supply of workers with different amounts of education, but that shift appears to have had only a modest effect on the distribution of wages.
Turning to institutional factors, the federal minimum wage did not keep pace with inflation during the 1980s, and the decreasing real (inflation-adjusted) value of the minimum wage probably increased wage dispersion in the bottom half of the wage distribution during that period. Moreover, a decline in the share of workers who belonged to unions contributed to increasing dispersion in the upper half of the wage distribution for men over that same decade. Neither of those factors is a plausible explanation for the changes in the wage distribution in the 1990s and 2000s, however.
Although this study focuses on hourly wages, changes in the amount and distribution of hourly compensation, which includes both wages and fringe benefits, are also important. Unfortunately, data on hourly compensation are more limited than data on hourly wages. The available data indicate that the dispersion in hourly compensation in the upper half of the distribution was similar to the dispersion of wages, on average, between 1987 and 2007. In the lower half of the distribution, the dispersion of hourly compensation was somewhat greater than that for wages, on average, during the same period. Nevertheless, for both the upper and the lower halves of the distribution of compensation, the changes in dispersion over those two decades were similar to the changes in the dispersion of wages.

Monday, February 14, 2011

Picture of the Week

Not only are we lagging behind a number of countries in math and science but it appears we are also falling short here.

Notice the countries that have higher consumption levels. How could one use this map when discussing living standards, happiness, and GDP.

Unemployment The New Normal

There has been a lot of debate over the new normal. Traditionally we viewed the economy to be operating at potential when the unemployment rate was 5%. Following the recession there has been a lot of talk over the new normal. Will see unemployment at 5%. Here is an article at CNN (reviewing a more technical article at the Federal Reserve Bank of San Francisco).

We talked about this a lot last semester. I made a few comments that I think are still true today (here and here).

Tomorrow we will start our discussion of the labor market. Many of these terms are new, but hopefully after tomorrow you'll know a bit more.

Sunday, February 13, 2011

Winning the Future

Here is an excellent post by Greg Mankiw. The point is simple, it's not us against them. It's us with them to ensure everyone is better off.

Emerging Markets as Partners, Not Rivals

By N. Gregory Mankiw

Published: February 12, 2011

IN his State of the Union address last month, President Obama set the stage for a coming policy debate and his re-election bid with a catch phrase. Six times, he called on Americans to “win the future.” And he used the variant “winning the future” three other times. But is this really a good way to frame the economic challenges we face?

No doubt, the phrase appealed to White House political advisers and speechwriters. It is always better for presidents to focus on our future potential than the immutable past. And who doesn’t want to win? Americans love rooting for their favorite teams, and no contest seems more vital than that for international economic dominance.

Yet this catch phrase is also problematic. For one thing, “Winning the Future” was the title of a 2005 book by Newt Gingrich. It is almost as if Mr. Gingrich were to run for president in 2012 under the banner “Audacious Hope.” And then there is that pesky abbreviated form of the phrase — WTF — that does not exactly inspire confidence.

More troublesome to me as an economist, though, is that calling on Americans to “win the future” misleads us about the nature of the policy choices ahead. Achieving economic prosperity is not like winning a game, and guiding an economy is not like managing a sports team.

To see why, let’s start with a basic economic transaction. You have a driveway covered in snow and would be willing to pay $40 to have it shoveled. The boy next door can do it in two hours, or he can spend that time playing on his Xbox, an activity he values at $20. The solution is obvious: You offer him $30 to shovel your drive, and he happily agrees.

The key here is that everyone gains from trade. By buying something for $30 that you value at $40, you get $10 of what economists call “consumer surplus.” Similarly, your young neighbor gets $10 of “producer surplus,” because he earns $30 of income by incurring only $20 of cost. Unlike a sports contest, which by necessity has a winner and a loser, a voluntary economic transaction between consenting consumers and producers typically benefits both parties.

This example is not as special as it might seem. The gains from trade would be much the same if your neighbor were manufacturing a good — knitting you a scarf, for example — rather than performing a service. And it would be much the same if, instead of living next door, he was several thousand miles away, say, in Shanghai.

Listening to the president, you might think that competition from China and other rapidly growing nations was one of the larger threats facing the United States. But the essence of economic exchange belies that description. Other nations are best viewed not as our competitors but as our trading partners. Partners are to be welcomed, not feared. As a general matter, their prosperity does not come at our expense.

To be sure, there are exceptions to this rule. When China uses our intellectual property such as software without paying for it, we should view that as a form of theft. And when other nations’ economic growth has side effects on the global environment, as it does when they emit the greenhouse gases that contribute to climate change, the United States has good reason for concern. But these limited exceptions should not blind us into taking a more generally adversarial approach to international economic relations.

During the address, Mr. Obama lamented the fact that many foreign students attended colleges and universities in the United States and then returned to their countries of origin. “As soon as they obtain advanced degrees, we send them back home to compete against us,” he said. “It makes no sense.”

The president is right that we should encourage a greater number of highly educated foreigners to migrate here. Because skilled workers pay more in taxes than they receive in government benefits, increasing their supply would reduce the fiscal burden on the rest of us. But if these foreign students decide to return home, as many do, we shouldn’t worry that they are competing against us.

Instead, we should view higher education in the United States as one of our most successful export industries. The United States has 5 percent of the world’s population but most of the best universities. Is it any wonder that students from many nations flock here to learn? And as they do so, they create opportunities for Americans — from the professors who teach the classes to the grounds crews who maintain the campuses.

When the foreign students head home, they take the human capital acquired here to become productive members of their own communities. They spread up-to-date knowledge, so it can foster prosperity everywhere. Some of this knowledge is technological. Some of it concerns business, legal and medical practices. And some is even more fundamental, such as the values of democracy and individual liberty. Nothing could be better for the United States than these thousands of American-trained ambassadors who have seen at first hand the benefits of a free and open society.

As we confront the many hard policy choices ahead, let’s prepare for the future. Let’s invest for the future. Let’s be willing to make hard sacrifices for a more prosperous future. But let’s not presume that the future is a game requiring winners and losers.

N. Gregory Mankiw is a professor of economics at Harvard. He was an adviser to President George W. Bush.

Friday, February 11, 2011

For those interested in gold

We don't spend a lot of time talking about individual assets but over the last few years (and over the next few) the topic of gold will continue to be a hot issue (especially if Ron Paul runs for president). Gold is an asset (like stocks and bonds) and prior to 1973 the US dollar was backed by gold (we'll talk more about this in a few chapters). Today investors tend to buy gold when they expect higher inflation in the United States and sell gold if inflation is low. All of you have probably seen the infomercials talking about gold being at an all time high. Gold prices spiked following the Great Recession in 2007 and now a debate has started about the value of an ounce of gold. Is gold overpriced? There is no definitive answer. Stocks and housing tend to have a fundamental value, the stock price should reflect future profitability, a home price should reflect the cost of renting. Gold does not have a fundamental value, what should an ounce of gold be? Lately the demand of gold has been increasing drastically while supply has remained nearly unchanged (there are a few gold mines in Africa and Australia).

Anyway here is an interesting article on gold (I'm sure there will be more to come).  For those curious $1 invested in gold ten years ago would now be worth $5. Which sounds pretty good, but for comparison $1 invested in Apple would be worth $48 today (an increase of 3600%).

Inflation and Relative Price Levels

Inflation today remains fairly low (around 1%), but many people are confused because they are seeing reports of rising prices (food and commodities). How is that inflation is low, while prices are rising? Comes down the confusion of inflation with relative prices. Here's a good post (a bit more technical).

Thursday, February 10, 2011

China and the U.S.

China's $2 trillion dollar problem. 

Everyone knows China has been funding U.S. deficits. We buy a lot of stuff from China in doing so China lends us a lot of money. They currently hold $2 trillion in U.S. government bonds. Why this matters? Well, its a lot and they need the dollar and the U.S. economy to stay strong. If the dollar decreases in value (say 20%) the value of those bonds will decline by 20% (that's a big loss). China needs the U.S. economy to stabilize and for American's to keep purchasing Chinese goods and services.

Inflation and the Public View

Here is a post by the Federal Reserve Bank of Atlanta about how inflation is perceived in the public's eye.

UPDATE: Alright so I took the quiz and scored 12/12 (but had to quasi guess on the PM of Great Britain, I totally blanked on his name). But more importantly I was able to check the 18-29 age group. Unfortunately, I'll be old in a few months. 

Tuesday, February 8, 2011

The Miracle Cure

By now you should know I am a totally crazy left wing environmental nut. No not really, but I love the idea of a carbon tax. I know there are people opposed to a gradual (not sudden) increase in oil prices, but the majority of economists, left and right, support the idea of a carbon tax.  My concern is is not so much environmental, but on minimizing the impacts of oil shocks on the economy. Here's an article by Alan Blinder (complete opposite in his political views compared to Greg Mankiw) about carbon taxes but both are two highly respected economists. And yes I do think it could be a miracle cure.
The Carbon Tax Miracle Cure, by Alan Blinder, Commentary, WSJ: In his State of the Union address..., President Obama called for a major technological push for cleaner energy: "the Apollo projects of our time." But when the details emerge, it is predictable that his political foes will object to the new government spending and decry the "heavy hand" of government in telling business what to do. Fortunately, there is a marvelous way to square the circle.
Under this policy approach, decision-making is left in private hands and the jobs created will be in the private sector. Furthermore, the policy would ... eventually reduce the federal budget deficit significantly. Plus, there are a few nice side effects, like reducing our trade deficit, making our economy more efficient, ameliorating global warming, and showing the world that American capitalism has not lost its edge.
What is this miraculous policy? It's called a carbon tax—really, a carbon dioxide tax—but one that starts at zero and ramps up gradually over time.
The timing is critical. With the recovery just starting—we hope—to gather steam, this is a terrible time to hit it with some big new tax. Hence, while the CO2 tax should be enacted now, it should be set at zero for 2011 and 2012. After that, it would ramp up gradually. ...
Think about what would happen. Once America's entrepreneurs and corporate executives see lucrative opportunities from carbon-saving devices and technologies, they will start investing right away—and in ways that make the most economic sense. ... Jobs follow investment, and ... many of the new jobs will be good jobs with good wages, just what America needs right now. ...
Up to now, our country has done approximately nothing to curb CO2 emissions. A stiff tax would make a world of difference. ...
I know this sounds like a pipe dream now. America has elected a Republican House of Representatives... These folks are not about to vote for a CO2 tax, even one starting at zero. ... But eventually we'll succumb to the inexorable logic of a phased-in CO2 tax. Just watch—if you're young enough to live that long.

Sunday, February 6, 2011

Where'd All the Manufacturing Go?

I think this article is a must read for anyone concerned about the future of American manufacturing. So where'd the jobs go? Who's to blame? China? Technology?

Friday, February 4, 2011

Gonzaga's Macroeconomics Blog: Unattended Consequences

I'm reposting this from last semester:

This article reminds me of one of my favorite questions. Here's the question:

Suppose that, in an attempt to induce citizens to conserve energy, the government enacted regulations requiring that all air conditioners be more efficient in their use of electricity. After this regulation was implemented, government officials were then surprised to discover that people used even more electricity than before.

The Jobs Report

Thursday, February 3, 2011

Trade with China

There is a lot of talk over the impact trade with China has had on the United States and global economies. Hu Jintao in his meet with President Obama claimed China's exports to the United States (so stuff we bought from China) saved American's more than $600 billion dollars from 2000 through 2010. In addition the exports additionally created 14 million jobs. We need someone to unload the ships and remember China is a very large country for selling domestic goods. If you're curious the United States lost 3 million jobs in manufacturing industry that are in competition with China while gaining 19 million jobs in other industries during the same time period.

We it turns out he may have underestimated the impact, and China's exports have actually saved U.S. households even more and created more jobs.


I am by no means an expert on the political uprising in Egypt, but I think it is important to spend a minute trying to understand what is happening in Egypt and the impact on the rest of the world. Here are a couple posts by Barkeley Rosser (a very good and knowledgeable economist at James Madison University). If anyone else has any good links summarizing the events in Egypt please pass them along.

The Political Economic Basis Of The Egyptian Uprising

Yesterday, Juan Cole posted on "Class Conflict in Egypt," As usual, very insightful on the poltical economic foundations of this uprising. He argues that the original base of support for the Nasserist regime that took over in a coup in 1952 was rural land reform, with the rural middle class that got land still the base of the regime. However, over time with urbanization and slow growth and the rise of corruption since Mubarak took over, that base has eroded. Nasser also gained credibility for throwing out the British and standing up to other outsiders (with the US and Soviets ironically siding with him in the 1956 Suez Crisis against the UK, France, and Israel).

Real wages doubled between 1960 and 1970, when Nasser died, but stagnated after that until 2000, with nearly zero real per capita income growth and a worsening income distribution. Neo-liberal policies, including relaxation of food price controls in the 1990s, did not produce much, although growth did increase after 2000, running at a 5-6% rate. But it has not been enough to provide jobs for the many urban youth, particularly the better educated ones.

Also, since 1980 the regime has been seen as supported by outsiders, particularly the US, Israel, Britain, and France, in contrast to the Nasser period. As economic problems surged with the food price spikes in 2008 and the subsequent Great Recession in the world economy, this made for a weak foundation of support for the regime. We should expect any successor to take a more independent line, especially the moderate El-Baradei who was so badly treated by the US previously.

I must note, however, that while inequality has increased, it is not all that bad compared to many other countries, with Egypt's current Gini coefficient of 34.0 putting it in 90th place in terms of inequality in the world.

Finally, I note that the chances for Mohamed El-Baradei succeeding Mubarak (eventually anyway) have increased with him receiving the support of the Ikhwan, the Muslim Brotherhood. However, there are other more radical Islamist groups in Egypt calling for an Islamist state with Shari'a imposed as law, although they appear to be a minority on that side, even though they are more moderate than the expelled Egyptian Islamic Jihad, whose leaders include the #2 and #3 figures in al-Qaeda.

Whither Egypt?
I was last in Egypt more than a quarter of a century ago, in the early days of the Mubarak regime, before the US had seriously paid down the bill for the martyred Sadat's Camp David signing, which Mubarak upheld. That payment, probably the most serious thing that billions of US aid over three decades did for actual Egyptian citizens, was replacing the sewer system of Cairo, whose exploding flooding had triggered massive "sewage riots," although not as large as the food price riots of 1977 when Sadat attempted to remove subsidies and price controls on food under pressure from the IMF, by far the largest riots until those now occurring there.

This has been a long time coming and how it will end is very far from clear. Roughly there seem to be generally three possible outcomes: 1) Mubarak maintains control following the Iranian success in suppressing street uprisings, an outcome that reportedly the Israelis are predicting and most certainly hope will come true; 2) Mubarak falls to be replaced by Mohamed El-Baradei, former director of the IAEA, whose accurate reporting of the state of nuclear weapons in Iraq led G.W. Bush to try to remove him from his position and who has returned to be surrounded in a mosque with supporters by security forces giving him Islamic cred, even though he is the main hope of the social democratic secularists; 3) Mubarak falls to be replaced by the main opposition in the parliament, who are front parties for the Ikhwan, aka "Muslim Brotherhood," with this possibly leading to more radical factions of that group coming to power, ending in a Sunni-Egyptian version of Iran. As of now, there is no way to know which of these will triumph, and there are other more complicated possible outcomes.

Regarding the economics of this, Egypt is a peculiar combination of decaying state socialism and horrendously corrupt emerging capitalism. Egypt is an ancient country that is very cynical. They have seen it all, but they have been under an increasingly repressive rule with increasing inequality and growth unable to provide jobs for a rising and technicially sophisticated generation, this despite such ameliorative policies as the longstanding price controls on food.

The situation in Egypt parallels in many ways that in such countries as Tunisia, Algeria, Yemen, Jordan, and Lebanon, all of which have been experiencing uprisings led by young Sunni Arabs, although the details vary from country to country, along with the seriousness of the uprisings. It is in Tunisia and Egypt where these uprisings seem the most serious, with real possibilities of some kind of secular social democratic outcome quite possible, which would be a dramatic breakthrough of enormous significance. Unfortunately, the US has been very slow and far behing getting aboard these movements and supporting their more progressive elements. But in the end, the outcomes in all of these countries will have little to do with the US and everything to do with the people in those countries.

I note that Juan Cole at as usual provides very useful reporting, commentary, and links on what is going on there.