January 2007 Archives

(FOMC press release)

The Federal Open Market Committee decided today to keep its target for the federal funds rate at 5-1/4 percent.

Recent indicators have suggested somewhat firmer economic growth, and some tentative signs of stabilization have appeared in the housing market. Overall, the economy seems likely to expand at a moderate pace over coming quarters.

Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time. However, the high level of resource utilization has the potential to sustain inflation pressures.

The Committee judges that some inflation risks remain. The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth, as implied by incoming information.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; Timothy F. Geithner, Vice Chairman; Susan S. Bies; Thomas M. Hoenig; Donald L. Kohn; Randall S. Kroszner; Cathy E. Minehan; Frederic S. Mishkin; Michael H. Moskow; William Poole; and Kevin M. Warsh.

Mark Thoma summarizes the differences word-for-word. There are a couple of significant changes in the language.

First, they state that "some tentative signs of stabilization have appeared in the housing market." I know some commentators would disagree with that, but by putting this into their statement it conveys that the FOMC is less concerned today about the possibility of housing dragging the economy down than they were six weeks ago. In the same paragraph, they removed the words "on balance" from the last sentence. I would interpret this as meaning that they are more confident that the economy is now, to use a colloquial phrase, "firing on all cylinders."

They are still "two-handed" on inflation, but the hands have switched places. Look closely and see what I mean. In December they said:

Readings on core inflation have been elevated, and the high level of resource utilization has the potential to sustain inflation pressures. However, inflation pressures seem likely to moderate over time, reflecting reduced impetus from energy prices, contained inflation expectations, and the cumulative effects of monetary policy actions and other factors restraining aggregate demand.

Translation: On one hand, inflation pressures still exist. On the other hand, lower energy prices, past rate hikes, etc. may cause inflation to moderate.

Today they said:

Readings on core inflation have improved modestly in recent months, and inflation pressures seem likely to moderate over time. However, the high level of resource utilization has the potential to sustain inflation pressures.

Translation: On one hand, inflation pressures have been moderating. On the other hand, high levels of resource utilization (i.e. strong growth) may lead to a renewal of inflation pressure.

Rhetorically, people (economists included) often use the construction of the "other hand" to indicate something that could happen but is less of a certainty. Read that way, this is encouraging news indeed.

In the next paragraph, they drop the word "nevertheless." Let's not over-analyze that.

It was unanimous, but that was anticipated given that the rotation of the voting members. Mr. Lacker is not voting this year. I do wonder if, given recent data, he would still want one more increase or if he has moderated his stance.

Based on this, and the solid (not stellar, but solid) GDP report today, I don't look for any change in rates for some time. New data could always change that, but right now it looks like it's "steady as she goes." A couple more data points in favor of a soft landing.

For more, read Reuters and the Wall St. Journal reports on GDP.

The fed funds probability charts at the Cleveland Fed now indicate that a rate hike is more likely than a rate cut in May. The market is still predicting that the Fed will keep the funds target rate at 5.25% with near certainty at the next two meetings. It is less certain about May, but if you predict movement either way, you're still facing pretty long odds.

It's a quantitatively small shift, but represents a growing sentiment out there that those rate cuts that a lot of folks were counting on in 2007 may not materialize. It's a turnaround from early December when speculation of a rate cut at its height. It was to the point that I couldn't ignore it but I was really torn. Here's what I said on December 7:

The part of me that wants to give a prediction that is right is turning to the view that there will be at least one rate cut in 2007.

The Cassandra in me is having a tough time with that.

Thank goodness for my inner Cassandra for keeping me from jumping all the way on that bandwagon.

So will we get a clue from the statement tomorrow as to which way things will break? Possibly. As Reuters reports:

Economists polled by Reuters forecast the economy grew at a 3 percent annual rate in the fourth quarter, rising from the 2 percent growth pace of the previous quarter.

Tomorrow we will know. And a statement from the Fed highlighting prospects for this pace of growth for 2007 will be interpreted as a sign of higher rates to come. But the price of oil remains a wild card. Low oil prices could keep the Fed content to remain where they are. The funds rate could stay at 5.25% all year as inflation pressure continues to abate and real GDP hits the sweet spot of 3% growth.

I believe that would be called a soft landing.

While it may be a bit premature to be calling a soft landing already, it's not too early to start establishing some criteria. What will you call it if real GDP growth is around 3% for the next two or three quarters while core PCE inflation drops below 2% and job growth averages between 125K and 150K per month? Are those appropriate criteria?

Let's see what tomorrow (Fed and GDP) and Friday (employment report) brings.

UPDATE: In related news, Bill Conerly looks at the data on housing vacancies and cannot dismiss that the possibility of recession still hangs over our heads. Calculated Risk worries about a nationwide fall in home prices this year, but gives Bernanke credit where credit is due.

John Tierney writes in the NY Times:

Five years ago, Dr. [Martin] Rees posted this prediction: “By 2020, bioterror or bioerror will lead to one million casualties in a single event.” He reasoned that “by 2020 there will be thousands — even millions — of people with the capability to cause a catastrophic biological disaster. My concern is not only organized terrorist groups, but individual weirdos with the mindset of the people who now design computer viruses.”

He didn’t get any takers on LongBets.org, which seems to me a missed opportunity. So I’ve posted an offer there to bet him $200 — not a huge sum, but enough to put both our reputations on the line. I realize that betting on disaster may sound ghoulish, but neither of us will personally profit (if I win, the money goes to the International Red Cross). And I think bets like this serve a purpose.

This jogged my memory. In August 2005, he proposed a bet with Matthew Simmons concerning the price of oil. Simmons predicts we will see $200 per barrel by 2010. Here's what I said:

I'm sure someone has already told them that they should get their bet on the record for all to see at longbets.org. If not, I just did.

I e-mailed Tierney as well. Whether it was me or someone else who got him to check out longbets.org, he appears to have latched on to the concept.

Oh, and I hope Tierney wins this one too.

Today is Milton Friedman Day. I urge everyone to watch the documentary The Power of Choice on PBS tonight (check your local listings). If you want to see the old Free to Choose series, go to IdeaChannel.tv.

Many economists credit Friedman in some way with inspiring them--either directly as his students (we should all have been so fortunate) or indirectly through reading his books and articles or watching Free to Choose. As a beginning student, I found Friedman's popular articles extremely compelling and fun to read. Capitalism and Freedom was an early favorite of mine. His essay arguing that the social responsibility was to increase profits also caught my attention as a college sophomore. At that time, most college macro texts had not fully embraced rational expectations. In the macro texts at the time, there was still a lot of discussion of Keynesianism vs. Monetarism. I found all that to be very interesting, and I sided with Friedman for a lot of it. But to try to be fair, I also read a lot of Keynes's work. This I did on my own on a number of evenings in the library--especially when working on my senior honors thesis. It was worth it.

While my graduate school years were filled with rational expectations and dynamic programming, I never forgot those early days of hanging out in the library clandestinely reading those Friedman articles that we were never assigned in class. I even managed to eke out some time for those readings in grad school. Some of them were even assigned readings.

On this day dedicated to remembering Milton Friedman, I would like to encourage today's students to take a little time to browse the library for the works of the masters--Friedman in particular. You don't have to become a scholar of the history of thought, but you should be familiar with some of the ideas that changed the discipline. You might even get hooked on some of those ideas. I firmly believe that students should find something in their discipline that inspires them, and many people would tell you that Milton Friedman's work is fertile ground for those ideas.

In the NY Times, Ben Stein ably defends capitalism but correctly recognizes the glue that holds the system together--trust.

When I see what the top dogs at all too many corporations are now doing to that trust, I feel queasy. Outrageous — yes, obscene — pay. Greedy backdating of stock options, which in my opinion is straight-up theft. Managers buying assets from their trustors, the stockholders, at pennies on the dollar, then forestalling competing bids with lockups and insane breakup fees.

These misdeeds and many, many more are hammer blows at the granite foundation of trust we built in the 1940s and ’50s. How long democratic capitalism can survive these blows before it gives in and gives birth to revolution or to an out-and-out aristocracy, I am not sure.

As I have repeatedly pointed out, capitalism is not a no-holds-barred "greed is good" system as it is often portrayed. The success of capitalism depends on the rule of law, enforcement of property rights, and, yes, trust.

As we approach Milton Friedman Day, it is fitting that we remember that when he said that the social responsibility of business was to increase profits, he added the qualifier,

...so long as it stays within the rules of the game, which is to say, engages in open and free competition without deception or fraud.

Things like this are good to hear. From the WIU Athletic Department:

Half of Western’s sport programs and 50 percent of the approximately 400 student-athletes earned grade point averages of at least 3.00 last semester. Thirty-one students recorded a perfect 4.00 GPA, leading to an overall student-athlete semester GPA of 2.83 - just below the overall University semester GPA of 2.87.

...

Western Illinois placed 58 student-athletes on the Fall 2006 Mid-Continent Academic All-Conference Team earlier this week, just one shy of Valparaiso which had a league-high 59 honorees. To be placed on the list, student-athletes must have a 3.00 or better GPA in the semester in which they compete. A total of 356 Mid-Con student-athletes from the sports of men’s and women’s cross country, men’s and women’s soccer and volleyball were honored.

...

Athletically, Western Illinois is following its most successful year as more teams earned Mid-Con titles in 2005-06 than any of the past 10 years and more teams advanced to NCAA postseason tournaments than any year in Western’s Division I history.

Already this year, men’s soccer won the Mid-Con title, volleyball finished as the runner-up, and women’s soccer advanced to the title game of the Mid-Con Tournament. Baseball, men’s tennis and softball were ranked either first or second in the 2006 Mid-Con preseason polls.

Not to mention that the men's golf team was named one of the top 10 stories of the 2005-2006 season by Golfweek.

I've had a number of student athletes in my classes, and have nothing but good things to say. The college athletics system is far from perfect, but there are thousands of students across the country who play sports that don't get a lot of attention. They play simply for the love of the game. You won't see them on ESPN on Saturday afternoon, but you wouldn't know it from the effort they put forth. They tend to put forth the same effort in the classroom as well. Way to go!

David Warsh places Richard Musgrave's work in the context of one of the more interesting discussions in economics. Economists are increasingly speaking of goods being either rival or nonrival rather than public or private. The distiction between rival and nonrival deals essentially with the question of whether the good can be enjoyed by more than one person at once. The pen in my pocket is rival. The movie I saw on the screen in the theater a couple weeks ago was nonrival. Musgrave originated the use of that terminology, but it took a while for it to enter general use.

Go read it at Warsh's site, Economic Principals. A Week, Long Ago, in Biarritz

Today, the Wall Street Journal publishes an interview of Milton Friedman conducted via e-mail last July.

China just wrapped up a major policy conference. We know a little about what was discussed. The rest, I presume, will be gradually revealed as piecemeal reforms such as we have seen for the last several years.

China Daily reports:

Among the key initiatives announced by Premier Wen Jiabao at the two-day National Financial Work Conference which is held every five years were:

The three policy banks, which are State-owned lenders that concentrate on meeting the country's economic goals instead of profitability, will be commercialized, starting with the China Development Bank. The other two are the China Export and Import Bank and the Agricultural Development Bank of China.

Agricultural Bank of China (ABC) will be restructured. ABC is the only one of the "Big-Four" State-owned banks not listed.

"ABC will strengthen its role as a financial service provider for farmers and county-level businesses," Wen said, adding that the restructure would be across the board and the bank's businesses would not be split.

The government will push for innovation in providing financial services for rural areas and build a multi-tier rural financial structure.

The bond market will receive special attention in the development of the capital market with an emphasis on corporate bonds.

From the U.S. point of view, it seems that they buried the lede.

Managers of the country's huge foreign exchange reserves are encouraged to "explore new means and extend channels" for the use of the money.

The Wall Street Journal didn't miss it:

Global financial markets are likely to zero in on what the weekend meeting means for China's dollar policy. Mr. Wen said nothing about selling dollars, but currency traders are hypersensitive to any signs Beijing is losing its appetite for the U.S. currency. Wang Qing, an analyst at Bank of America in Hong Kong, said the message of the conference is twofold: Beijing intends to encourage imports in a bid to erode its currency reserves, and it is planning to create an entity that will invest a portion of the reserves. For markets, "this might rekindle this talk of diversifying the reserves" away from dollar-denominated assets such as U.S. Treasurys, Mr. Wang said.

Indeed. But the Chinese clearly have their own reasons for doing something. In a related story at China Daily:

Excess liquidity has mainly been blamed for the country's runaway investment, and the central bank has raised commercial banks' reserve requirements four times and interest rates twice since April 2006.

Zhou Xiaochuan, governor of the central bank, said earlier this month that the PBOC does not rule out taking more measures to dampen liquidity.

The bank said yesterday that it would "continue to follow a prudent monetary policy and resort to multiple monetary policy tools" to achieve sound economic growth.

The central bank said the flexibility of the renminbi exchange rate regime has significantly improved since the path-breaking foreign exchange reform in July 2005.

"The role of the market will be further promoted in the setting of the renminbi exchange rate."

China Daily columnist You Nuo sees the result of modernization:

Not all the Financial Work Conference's policy proposals have yet been released to the public, as the nation's key financial institutions are still holding their own meetings to set their work agenda for the year that has just begun.

But whatever the specific policies, the stage is already set for China's domestic capital market to show unprecedented liquidity and become one of the world's main magnets for investor money.

Rumor abounds in Chinese-language financial newspapers about millions of US dollars pouring into the Chinese stock market, now partially open to overseas investors.

And yet...

Having said all this, it will be for the benefit of the entire world if the central government in Beijing can handle its "financial work" with new concepts and new skills. Despite the old name, Beijing's financial work is vastly different now from just two years ago, and increasingly changing. There will be a day, not far from now, when the renminbi is fully convertible and the A-share market completely open to international investors, including all the hot money that can easily throw a careless government into a helpless state.

Indeed.

Michael Mandel responds with a comment on his blog that reveals the point he really wants to make.

But I'm just wondering whether "constrained optimization" or scarcity is really the most useful or interesting angle to approach economics with. Right now I have access to far more information, at a zero marginal money price, than I can ever consume (trust me...we in the MSM are living with the flip side of this right now). I could in theory set this up as a constrained optimization problem--time spent online versus time spent working. But solving the constrained optimization problem never would have shown me that blogging, say, or wikipedia, would be useful ways of organizing the flood of information.

Now we're getting somewhere. The textbooks of economics have not caught up with this. He is talking about the economics of information. This is in part a story of increasing returns (along the lines of David Warsh's Knowledge and the Wealth of Nations). This is about division of labor being limited by the extent of the market. And the internet suddenly make the market bigger--hence, blogging and Wikipedia, and so forth. The result is an incredible expansion of information "goods" and a seemingly limitless supply of said information. Some of it worth paying for (in money and time), some of it not (and some of it worth paying for, but offered free of charge...only costing you the time it takes to read it). Hence the market for news/blog aggregators. Hence the value of having someone or something sift and organize the wealth of information. Scarcity is ultimately still there, but not in its 19th century diminishing returns industrial form.

That's the stuff. Let's shift the discussion in that direction. I need to be somewhere in 10 minutes. More later.

UPDATE: Ok. It was not obvious from Mandel's proposed definition that this was what he had in mind. But given his position in the MSM, I can see where he is coming from. However, while the cost of transmitting knowledge has decreased dramatically, this does not eliminate the problem of scarcity--even from markets where such knowledge is traded. The basic tools of economics do not need to be thrown out. Issues of market power become more important. Pricing decisions and intellectual property rights are pushed to the fore.

Here's an example. Suppose you run a web site with free and premium content. The decision about what to make free and what to put behind the subscription wall and what price to charge is one that requires solid economic logic. It's still a profit maximization problem--as surely as for a manufacturer of widgets. But the cost structure is different. Network effects must be addressed. The key determining factor in your decision is going to be what kind of value you provide for the customer. Through your pricing strategy, you try to capture some of that value. (Elasticity of demand matters!) The firm in the knowledge economy wants to know how to provide value, how much of its product to license publicly vs. keep proprietary, and how to effectively segment the market and practice price discrimination. New uses for old tools.

So we are talking about pricing decisions in the presence of very low marginal costs of production--not exactly an area which hinges explicitly on scarcity. However, scarcity is lurking not far away. Think about the way in which a content provider has to think about marketing itself. Mr. Mandel's time is scarce. An information producer has to figure out the best way to get itself in front of his eyeballs--otherwise it's a tree falling in the forest with no one around to hear it. Positioning itself on scarce advertising real estate, exploiting network economies ("such-and-such links to it on his blog..."), and setting its pricing strategy all come together to determine whether the venture is a success. Scarcity and choice are clearly part of what is going on.

But it's not the Malthusian, diminishing returns sort of scarcity that most people associate with the word (and with economics in general). So, in that sense, I understand why he would want to downplay it. Indeed, as I said in the previous post, I do not include the word "scarcity" in my one sentence definition even though I thoroughly address it in my classes.

And since the story can be told quite well by applying the old tools in new ways, I don't see any reason to radically change the definition of economics. However, I do hope that textbooks can catch up and tell the story of innovation and pricing with high fixed costs and low marginal costs. (There are some specialized texts that are starting to, but it hasn't filtered down all the way.) That would be an improvement.

Now there is an iPod index (Reuters). It is based on the same idea as The Economist's Big Mac Index.

One of Australia's biggest banks, the Commonwealth Bank, has used the latest version of Apple's music player -- the slimline Nano -- to compare global currencies and purchasing power in 26 countries.

Along the lines of the Big Mac index launched 20 years ago by The Economist magazine, the survey prices the 2GB Nano in U.S. dollars and found Brazilians pay the most for an iPod, shelling out $327.71, well above second-placed India at $222.27.

Canada was the cheapest place to buy a Nano at $144.20, while Australia ranked 19th at $172.36, cheaper than Germany ($192.46), France ($205.80), South Korea ($176.17) and China where the machine is manufactured. The U.S. was fourth cheapest at $149.

"Interestingly, especially with freight costs close to zero, China is middle ranked in terms of global prices at US$179.84," Craig James, the Chief Equities Economist at Commonwealth Bank, told Reuters.

You know what comes next, don't you?

James said the results suggested the U.S. currency had scope to rise against a range of major currencies except for the Hong Kong and Canadian dollars or the Japanese yen.

If this story was being read on SNL's Weekend Update, the "laughter" sign would be flashing about now.

However, the results could be influenced by different pricing policies that Apple might apply in different parts of the world, James said.

Ya think?

Ok. It's a clever idea and a good discussion starter, but not a serious test of purchasing power parity. In fact, it makes the Big Mac Index look methodologically sensible by comparison.

But if you tell people that you've got a test of purchasing power parity based on the iPod, people will stand up and take notice. It is clever, but don't take it too seriously.

To their credit though, it will be interesting to watch what happens to the index over time (more for what it will tell us about Apple and how they operate in each of these countries than for what it says about purchasing power parity, however).

UPDATE: Surfing around, I found this from three years ago. (Guardian Unlimited January 8, 2004)

Apple Computer is set to review the UK pricing of its iPod mini music player, launched on Tuesday, after complaints about a substantial mark-up for non-US buyers of the device.

The iPod mini will go on sale next month in the US for $249 - which would translate to a UK price of £162 including VAT if today's exchange rates were applied. Yet Apple's UK arm announced on Tuesday that it plans to sell the device for £38 more, at £199, immediately sparking an outcry from the company's European customers.

Now a senior Apple executive has said the company will review its pricing outside the US, and blamed the high pricing on the continuing weakness of the dollar against other currencies.

In an interview, Apple vice president Greg Joswiak told Online the price announcement was "subject to change" and that the company would settle on a UK price "closer to the availability date, simply because of the volatility of the currency exchange".

The exact pricing would depend on the strength of dollar relative to the pound, he said. "What we don't want to do is lock Europe into a price now, see the dollar continue to weaken, and have done all of ourselves a disservice by pricing too early," said Mr Joswiak.

Here is the $/pound exchange rate for the period between the time of this article and the present.

When predicting exchange rates, the most important thing is to be correct about whether the rate ends up above or below where the market (forward or futures) is predicting. Why? Because that determines whether you take a long or short position. In this pricing problem, the position you take is whether to price above or below what current market conditions imply (assuming that this price is sticky). Let's say they re-evaluated their position a year later. Did they get it right? Looking at exchange rates in 2005, you would say no. The iPod would appear to have been overpriced.

Indeed that was the case as we see in The Register in February 2005:

Tacitly acknowledging that the color iPod Photo was overpriced, Apple lopped $150 off the price of the high end 60GB model, which is now $449 (UK:£309), and replaced the $499 40GB iPod Photo with a 30GB version that's also $150 cheaper (UK:£249). The cheapest 4GB iPod Mini is now $199 (UK:£139), a price cut of $50. It's joined by a 6GB model at the old price of $249 (UK:£169). The UK prices quoted include VAT.

In fact, somewhere along the line it was cut from 199 pounds to 169 pounds (the U.S. price in early 2004) before dropping to 139 pounds.

Applying today's exchange rate to the Reuters story implies that the UK price is somewhere around 100 pounds. I saw a website advertising it for 128 pounds. Perhaps either the iPod index doesn't include the VAT (I would think that it would though) or it was based on exchange rates a few months ago when the dollar was a bit stronger than it is today (seems more likely).

Given that Apple has at least once in the last couple years been chasing changes in the exchange rate, it seems reasonable to suggest that the iPod index's indication of an undervalued dollar is more likely to be a sign that Apple will be adjusting its pricing policies than a sign that the dollar is likely to rise. I doubt that is what Commonwealth Bank had in mind when they constructed the index.

CLARIFICATION: The iPod Mini referenced in the older articles has been discontinued in favor of the newer iPod Nano. It is the closest comparison. Since the introduction of the Nano, similar stories of price cuts in the U.K. are readily found.

Given that this is the first week of a new semester here, I thought this would be appropriate. Michael Mandel doesn't like using the word scarcity in the definition of economics. He offers an alternative:

Proposed definition: Economics is the study of the functioning-–and malfunctioning--of the economy, with the aim of improving living standards

First of all, saying that economics is the study of the functioning of the economy is in the same vein as saying, as Jacob Viner famously quipped, "Economics is what economists do." True, but not terribly helpful. That economics has the aim of improving living standards is, for me at least, a bit problematic as a definition. It opens up a can or worms over what you mean by "living standards". Not that we shouldn't open that can of worms. In fact, I think it would be useful to have precisely that sort of discussion at the introductory level. But that is precisely the point. I'm not sure it works to have a phrase that is open to so much discussion and interpretation as a crucial part of a definition. To define economics that way would require a lot of context. So, to be fair, I will end my criticism here until I see that context.

Back to the original question, it is true that nearly every textbook definition of economics uses the word "scarcity". But it is not universal. For example, The Economic Way of Thinking by Heyne, Boettke, and Prychitko uses this definition:

Economics is a theory of choice and its unintended consequences. (page 11 of the 10th edition)

Prominent among the unintended consequences in their definition is the emergence of spontaneous order. (You learn this if you read the introductory chapter carefully--again, the context provides a clue.) It's not a bad definition.

In a slightly different vein is this little title hoisted from a syllabus from one of my grad school courses back in the day. From memory (I'll hunt around for the actual copy to make sure I got it right), it was something like this:

Macroeconomics: A study of allocative (in?)efficiency

I've always liked that one. Then there is the definition that I have used for quite a number of years in teaching macro and micro principles. To my knowledge it is not in use anywhere else in precisely these words. I first put it on paper as a grad student and have used it ever since, maybe changing a word or two over the years. I was inspired to write this while trying to put the familiar "circular flow" into words.

Economics is the study of choices made by individuals, how markets coordinate those choices, and how governments influence those choices.

See how it reflects the circular flow that is part of nearly every textbook description of economics? Like Heyne, Boettke, and Prychitko, I give individual choice top billing in my definition. I dislike definitions that put it in terms of how "society chooses". Society doesn't choose. People choose. How those decisions are aggregated matters immensely.

Sometimes individual decisions are aggregated in markets. That implies certain outcomes. Other times, individual decisions are aggregated through direct voting or a representative form of government. That often implies different outcomes. Decisions made by firms are really the result of an aggregation process within the firm itself. Institutions matter. The "rules of the game" matter. (Here again, my thinking has been influenced by Heyne, et al.) What some might call society's choice is a particular combination of individual choices coordinated by markets and influenced though the law by government as well as the weight given to market and to government in the process. How much is market and how much is government is determined by many factors. Most of them are outside the scope of your average economics course, but are still worth thinking about.

My definition has three parts. Individual choice is the heart of all economics--even parts of economics that don't fit neatly into areas related to markets or government (e.g. game theory and bargaining). One could, I suppose, put a full stop right here and call it a day. It is beneficial, however, to single out the role of markets and the role of government as two identifiable arenas in which those choices play out. They are not the only such arenas, but they are the ones about which the body of knowledge in economics has the most to say. When I deliver this lecture in class, this is the context that I try to give my definition.

Let those of us who teach economics never forget that individual choices are the building blocks and that the manner in which an economy aggregates those decisions matters.

UPDATE: See the comments for more. PGL comments and expands on it over at Angry Bear. Arnold Kling at EconLog says this in response:

I am two-handed on this issue. On the one hand, just because food, say, has become more abundant does not mean that we can ignore scarcity. At any moment in time, for a given state of know-how, the conventional definition of economics as dealing with the allocation of scarce resources among competing ends applies.

On the other hand, some of the most interesting economic observations concern relative abundance. Look at our standard of living compared to 100 years ago. Look at South Korea compared with North Korea. Robert Lucas famously said that "The consequences for human welfare involved in questions like these are simply staggering: Once one starts to think about them it is hard to think of anything else."

The Lucas quote has to be one of the most often quoted lines in all of economics. I quoted it in a different context in the comments to this very post.

However, I don't see "relative abundance" as being on a par with the fundamental problem of scarcity. I agree that the observations to which Kling refers are interesting (and I use those very examples every semester), but they are problems that can be addressed in the context of choices and institutions--which are the twin pillars of my definition above. Focusing on the relative abundance of South Korea and the implications of that abundance for the choices people make is an interesting side issue, but it misses the larger point. What is it about South Korea that is different from North Korea that can explain their relative abundance? In my preferred framework, the relative weight given to markets vs. government in aggregating individual choices is a good place to start.

Back to the original question. Scarcity implies choice. That's the bottom line. And it is my opinion that defining economics in terms of choice (rather than the word "scarcity") resonates more with students. It's not that I don't think scarcity matters, it's that I think there is a better way to word it to get the point across. Here's a slide from tomorrow's lecture to my principles class:

I've been using the same slide (updating the page number with new editions of the text) for I don't remember how long.

And the punch line several slides ahead (after talking about market vs. command economy and--time permitting in this lecture--a brief look at property rights and so forth):

This is a lecture/discussion that I really get into with my principles classes. Sometimes I think that it's the most important lecture of all. If you don't get hooked on economics by talking about these issues, I don't know what will get you. I guess it goes back to the Lucas quote again.

UPDATE 2: Link to EconLog corrected.

Ok, this is one of the best animated graphs I've seen in a while. Play with it. You can change the variables on the axes. It was created by the Gapminder Foundation. I will definitely use this in my classes when I need to illustrate economic growth.

Hat Tip: Division of Labour

I'm sitting here thinking about the first day of the semester tomorrow--trying to come up with some choice little bits to throw into the lecture. One of my classes is an advanced macro course for the MA program. I'm thinking of ending the intro to the lecture like this: "In Econ 502 we cover about 2 or 3 weeks worth of my intermediate macro course on the first day as a review... then things start to get interesting. Let's begin..."

UPDATE: I did say this, and the response was muted--a couple of smiles. They knew I was serious.

For those interested in what we cover, the first couple weeks are a review of static and dynamic optimization with macro applications, followed by growth (Solow, Ramsey, Romer, etc.) and concluding with real business cycles (overview of the literature along with critiques). I plan to sprinkle in a good dose of David Warsh's Knowledge and the Wealth of Nations to stimulate critical discussion. These students have (for the most part) already had exposure to IS-LM, an overview of New Keynesian macro, time consistency, and the permanent income hypothesis. This course is well suited to those looking to apply to a Ph.D. program after finishing their MA here.

Brad DeLong reprints the "Letter from the Birmingham Jail". This was required reading when I went to college. Is it still?

NY Times:

SHANGHAI, Jan. 5 — China’s central bank said late Friday that it had raised the reserve requirement ratio for banks, the fourth increase in six months, to further tighten the nation’s money supply.

The modest move, which takes effect this month, increases the reserve ratio by half a percentage point, to 9.5 percent. Analysts said it was the government’s latest warning that too much money in the financial system could ignite inflation and perhaps fuel a stock market bubble.

The reserve requirement is a blunt instrument of monetary policy. If open market operations are a scalpel, the reserve requirement is a chainsaw. That China is on such a trajectory with its reserve requirements says that they are clearly concerned about the inflation prospect. However, 9.5% is not extremely tight. In the U.S., the rate for most banks is 10% at the margin (see this table for details). That the Chinese economy has grown to an extent that higher reserve requirements are necessary is another encouraging sign that they are becoming a player in the international financial community. They are experiencing what the U.S. went through in the "roaring '20s." They are hoping to avoid their own 1929. Given the vigor with which money is flowing into China, I would not be surprised if they continue to tighten throughout the year ahead.

Hope everyone had a great New Year's holiday. I have been trying to catch up on things. Unfortunately blogging has suffered. Now I'm off to the ASSA meetings, so blogging will be light for a couple more days and then return to a more normal schedule.