September 2007 Archives

Andrew Samwick informs us of the Treasury Department's series of issue briefs on Social Security reform. The first one is already up on the Treasury website.

He is pleased to see that the Treasury issue brief points out that:

Delay reduces the options for distributing the financial burden of reform across generations because delay exempts additional generations from sharing in the financial consequences of reform.

Samwick said something similar in the early days of his blog (October 2004).

...each year that elapses without reform causes the burden of financing the unfunded obligations to be shifted away from one more birth cohort that crosses the threshold of being "at or near retirement." The more we wait, the larger the burden on future generations...

I couldn't agree more. My comment in Feburary 2005, when talk of reform hit its peak was similar.

The more gradual the transition, the more the transition cost can be spread out. The sooner we start, the more gradual we can afford to be.

Now to be sure, I'm not one of those who thinks the system is in imminent danger. However, the fact that the system is on solid ground for a number of years to come reinforces the idea that any reform can be gradual. If we start now with a cautious and reasoned plan, the result will be better than if we wait another ten years and need to consider something less gradual.

As I put it in my first post on the subject:

Could the right sort of adjustment/modification/reform of Social Security in the next few years make future retired persons better off? Almost without question, yes.

Is Social Security on the verge of becoming the nation's biggest fiscal problem if it's not fixed in this presidential term of office? Definitely no.

...

But I also concede that you can't just take any old privatization scheme off the shelf and say that it will be a Pareto improvement.

I think that still sums up my thoughts on the matter.

The Philly Fed is upbeat.

Activity in the region’s manufacturing sector picked up in September, according to firms polled for this month’s Business Outlook Survey. Indexes for general activity, new orders, and shipments increased, reflecting continued underlying growth. Firms continued to report a rise in prices for inputs, but price increases for finished manufactured goods were not widespread. On balance, the forecast for growth over the next six months has not diminished appreciably, even though, according to responses to special questions this month, over one-quarter of the firms said they are scaling back employment and capital spending plans because of the recent deterioration in the construction industry and uncertainty in financial markets.

...

Respondents continue to report higher prices for inputs this month. The prices paid index increased eight points, after edging lower in the previous three months. Thirty percent of the firms reported higher input prices; 7 percent reported lower input prices.

Less than 10% of firms surveyed expected a substantial decline in employment or capital spending as a result of recent developments.

I think I just heard a bond price drop. The 10 year yield stands at 4.63% and climbing.

Chairman Bernanke gave testimony to Congress on the subprime situation today. Read it on the Fed's newly redesigned website. The only mention of monetary policy is at the end, and it includes nothing new, only some quotes from the press release Tuesday.

In other related news, initial jobless claims were down, reaching their lowest level since July 28. This suggests that the employment report may have been a blip. Employment is somewhat of a lagging indicator, so don't get too worked up and thinking that the threat is over. More trouble could still be to come. Nevertheless, we'll take good news when we can get it. The Index of Leading Indicators, however, was down slightly.

Meanwhile, a certain former Fed chairman is enjoying his time in the spotlight. It is hard to get used to seeing Alan Greenspan all over the place talking to the media candidly, but get used to it we will. (Reuters)

Asked in an interview on Bloomberg television whether the Fed's half-percentage-point rate cut on Tuesday had lowered the chances of a recession, Greenspan said: "I think so, but remember that we still have a problem out there, which is a large overhang of unsold newly constructed homes."

...

Greenspan said the chances for a recession in the United States were still "somewhat more" than 1 out of 3, despite the cut in the Fed's overnight federal funds rate to 4.75 percent, but cautioned it was hard to be more precise.

"We are often wrong but never in doubt on too many issues," he said.

Indeed.

We're watching history unfold here, folks. The unwinding of the subprime mess is without precedent. But the monetary policy action has parallels in the past. Will this episode be more like 1998 (heading of systemic risk, short lived easing and a return to previous levels in a year) or like 2001 (the beginning of a series of cuts and the re-inflation of a bubble)?

To apply the wisdom of Greenspan, someone who doesn't have some doubt stands a good chance of being wrong.

John Palmer reads this article in The Economist on Chinese inflation and points out the four... count them, four... things they missed.

UPDATE: Thomas Palley also has a post on Chinese inflation that gets it right.

And so 50 basis points it shall be. Where do we go from here?

This was one of the most difficult Fed decisions to predict in recent memory. It was a bold move the Fed, and there are those who would disagree with it. A lot of us (Tim Duy and Barry Ritholtz, for example), myself included, were surprised. The market called it a toss-up. To my way of thinking, a 50 basis point move was a considerably less likely. I didn't put a probability on it, but I probably wouldn't have gone much over 20 or 30%. At least I was right that the move in the discount rate would match the cut in the funds rate and that they would not cut the discount any by an additional amount. But all that is ancient history now.

Perhaps a Q&A format would be a good way to organize my comments here. The questions are the things I've been hearing in the last day or so, and the answers are just my thoughts. You are free to agree or disagree (and comment).

Question 1: Did this move cost the Fed credibility?

Not as much as some think, but they did cash in some chips. The true cost to their credibility (or lack of cost) will not be known until we see the effect on inflation. The Fedspeak was not unambiguously pointing this way, but this wasn't totally out of the blue. Even those of us who were hoping for (and expecting) only 25 basis points were not shocked. We knew it was a possibility. Yet those of us who were hoping for 25 basis points were, I think, doing so on the basis that a larger rate cut isn't going to do as much good at preventing a spillover of the housing mess into the broader economy as it could do long term harm in the campaign against inflation. The Wall Street Journal is worried about their credibility too.

When I see a speech where a Fed official says this...

I believe disruptions in financial markets can be addressed using the tools available to the Federal Reserve without necessarily having to make a shift in the overall direction of monetary policy. A change in monetary policy would be required if the outlook for the economy changes in a way that is inconsistent with the Fed’s goals of price stability and maximum sustainable economic growth.

... it doesn't exactly scream out 50 basis points. So a 25 basis point cut certainly would have cost them less in the immediate run. Now, they are smart people, and they must have realized that. Yet they voted (unanimously, I might add) to do it anyway. That leads to the next question.

Question 2: Do they see something that we don't?

I anticipated this question back on the 10th. Clearly one of the risks to doing a 50 basis point cut is that people will think that it's worse out there than they thought (or worse than it is). But the answer to the question is, I believe, "no". To the extent that they see something we don't it could be that the inflation picture looks better than we thought. PPI and CPI data from the last couple days would support that claim. It's certainly too early to declare victory, but they may be hearing things from their contacts in the business community that allow them to take this position. But as for fighting a recession, if it has already begun, which it may well have, this isn't going to make much difference. So no, I don't think the see anything negative about growth that we don't already know.

Question 3: Is this "one-and-done"?

That is, did they figure that they could avoid the loss of credibility by making a larger cut now and then stop. Yeah, that's the question you want to have answered. Sorry to disappoint, but I can't say for sure. The fed funds futures market doesn't think so, however. They're looking for another 25, maybe 50 basis points, by the end of the year as December futures are implying a rate of 4.4%. If they want the market to believe that this is "one-and-done", they'll have to come out and say it because the message will not get through otherwise. If forced to make a guess right now, I would predict 25 basis points in October and December, but it's early and that's subject to change.

The problem I see is that in order for the Fed to hold steady, they are going to have to be able to state that the risk of a spillover from the housing market into the broader economy has materially diminished. I don't see how they'll be able to make that claim. A month from now the housing picture will not change much from what it is now.

Question 4: What are the downsides to this decision?

You saw the stock market reaction, right? You saw the double digit percentage gains among the homebuilders, right? You saw the price of gold, right? You saw this, right? Now, I don't always agree with Dean Baker, but in this post he is spot on 100%.

A bit of history would have been useful to include in this context. As some articles noted, this cut bears a resemblance to the Fed's 0.5 percentage point cut in January of 2001 at an unscheduled emergency meeting. That cut also led to a very enthusiastic response from Wall Street. The Dow rose 2.8 percent following that cut and the Nasdaq jumped by a record 14.2 percent. In reporting on the significance of the cut, the NYT quoted Bruce Steinberg, chief economist at Merrill Lynch: "there's a simple message, the Fed will do whatever it takes to keep the U.S. economy from going down the tubes.''

Mr. Steinberg may have been right about the Fed's intentions. It did continue to cut interest rates, lowering the federal funds rate by a total of 5.5 percentage points to 1.0 percent, the lowest rate since the mid-fifties. However, this rate cutting did not prevent the economy from falling into a recession. It began to lose jobs just a month after the January rate cut. In spite of the Fed's aggresive rate cutting,the economy remained so weak that it took four full years to once again reach the employment levels of February 2001.

The market may celebrate now, but this is fleeting. The punch bowl has been refilled, but you may have just made more work for the clean-up crew. Listen to Tim Duy, for example:

The Fed statement did claim that “some inflation risks remain,” but the concern rings hollow in the wake of a 50bp cut. Oil and gold gained on the news, while the Greenback sunk to a record low against the Euro before recovering. Were these, like the equity surge on Wall Street, just knee-jerk reactions? To some extent yes, but traders tend to get the direction right even if the magnitude is initially wrong.

He's not in the one-and-done camp either.

James Hamilton has this to say:

But the really interesting thing is what happened at the longer end of the yield curve. The ten-year nominal yield actually increased, which is in contrast to the usual historical pattern for long yields to move, albeit less dramatically, in tandem with the short. Taken together with today's fall in the 10-year inflation-adjusted Treasury yield, the bond market seems to view the Fed as having surrendered some on its long-run inflation goals.

Right. From the gallery in the CBOT, we watched it happen as the 10 year numbers went red and you just wanted to have a moment of silence for the passing of low inflation expectations. You teach this stuff for years, saying "this is what can happen..." and then it does.

I have to admit that the market reaction troubled me a bit. They didn't get the message. Or they got the wrong message. Or worse...they got it just right.

Question 5: Do I have anything good to say?

Yes. I am happy that the language of the statement does not appear to lock the Fed into any particular decision in October. True, I think they will continue to ease. However, I don't get that from the statement as much as I get it from the present circumstances. They will have a chance to move expectations, but the window will be open for only a short time. If they want to hold steady in October, they better get out there soon and communicate that, or it will be too late.

In fact, I think that the language of the statement was about as good as it gets for something like this. It was different, and fresh. We needed that.

The bottom line is that we'll have plenty to talk about for the next few weeks.

I intended to post last night, but lack of sleep got the better of me. Anyway, the reason that I was away from the computer yesterday is that two other economics faculty and I took a group of econ majors, graduate students, and other interested folks up to the Chicago Board of Trade yesterday to watch what happened on the floor when the Fed announcement came out. Astute readers will recall this post from a few weeks ago:

Note to self: WIU economics faculty and students usually make a trip up to Chicago to see the Board of Trade every year. I am one of the faculty who works on scheduling and arranging the trip. I must do what I can to see if we can get up there on an FOMC day this fall.

The blog is great for keeping some of those notes to self in writing so they can be remembered and acted upon.

Let me also say that I am very happy to be part of a department that places such value on these kinds of experiences for students.

Last spring we saw the Board of Trade on a day where there was considerable activity in the grain markets, but the financial markets were absolutely dead. There were just a few people milling around checking the computer screens, reading the newspaper, and so forth.

Contrast that with yesterday. In the gallery there was a map showing what instruments are traded in each pit. It appeared that the most activity was in the bond futures and options, particularly the 10 year, but a bit of activity in the 2 and 5 year as well. There were some people in what the map showed was the fed funds pit, but the activity was not frantic. My guess is that a lot of that activity is electronic. There was some activity in the Dow futures, more on that later.

We got up to the gallery shortly before 1:15 as traders were quietly waiting for the announcement. I was looking at the bond options area when I heard a noticeable rise in volume from the floor. That's when I turned to the big CNBC monitor in the corner and saw that the announcement had come out and that it was 50 basis points. Within seconds, the pace of activity had increased from relative calm to a rather brisk pace. Yet it was controlled rather than frantic. I would guess that every trader on that floor had a game plan for this possibility that they had thought out ahead of time. They were executing that game plan rather than simply reacting. Had the decision been for 25 basis points, the game plan would have been different, but it would have been similarly executed.

Casual observation: There was some media coverage on the floor. I could see the cameras but from my vantage point I could not see the reporters. It looked like CNBC cut to their camera on the floor a couple times while we were there, and when it did the volume level on the floor seemed to rise. (Playing to the camera?)

Prices of various instruments were posting up to the big digital boards on the wall. Green numbers under the 2 year note futures, red numbers for the 10 year futures reflecting the movements taking place on Wall Street as the short term prices rose (yields fell) and the news was mildly negative for the longer term bonds. As someone who takes an interest in this and teaches it, I have to say that it was quite a sight to see those the hand signals in the pit and look up and see the numbers on the board go red and green as the traders digested the information.

Another way that the trading in Chicago mirrored that on Wall Street was in the Dow futures. Again, we could see on the digital price board that the DJIA was heading upward while all of this was going on. It was up about 170 points at the point when I started to notice what was going on with the futures. Every few minutes there was a little outburst of activity in the futures. As the Dow climbed, the futures kept pace. The September contract expires on Friday, and of course other months prices rose in lock step (this is where you can illustrate the law of iterated expectations).

All told, it was a great day for the students to see economics and finance in action. Before the announcement, we even got to go down to the trading floor briefly as a guest of a trader who knew one of our students. Also that morning, before going to the CBOT, we visited a consulting firm. That gave our students a chance to see more about how economics is used in the "real world". Now I'm working on a handout and presentation as a "debriefing" for the students to reinforce what they learned. I think the title of the presentation will be "What happened while you were watching and why?".

We also got to meet up with a student of ours who just finished an internship in Chicago and leaves next week for a study abroad term at Oxford. Did I tell you that our students can compete with the best?

Later, some thoughts on the rate decision itself.

I've got to get some sleep. I'm going to be pretty busy tomorrow (today, actually). More about that later. For now, Mark Thoma has some posts that are worth looking at. First, he reminds us, via Greg Ip, that the discount rate could be cut (or not) tomorrow as well. We haven't given as much time to that. My own guess is that they will cut the discount rate by as much as the fed funds target. There's an outside chance of a 50 b.p. cut if the funds rate is only cut by 25 b.p., but I'd regard that as less likely. 25 b.p for both seems most likely.

Next, Mark offers an idea to increase transparency.

Here's an idea for additional transparency into Fed thinking. Suppose we require that each of the twelve members of the Federal Open Market Committee (the committee that sets the federal funds rate) post their stance on monetary policy once per day on a central web site.

On the Fed's main web site there would be a page listing each Committee member's answer to the question "If I had to set the federal funds rate today, I would set it at ____" and a table would list all twelve answers along with the last time the answer was updated, Committee members would be required to update their answer at least once per day, even if there is no change, and they could update it more often if desired, e.g. in response to news about the economy (the basic unit of time could be weekly as well). It would probably be best if the votes were anonymous, but that isn't essential.

I have my doubts. There's a nontrivial chance that such a plan would destabilize the market. I mean just imagine how much more volatile futures contracts would be if they were responding to actual forward looking statements about the vote from the members themselves. Then there's the matter of credibility. How would the market interpret frequent changes in sentiment? How would they interpret a sudden reversal, or double reversal? I, for one, am glad that the voting members weren't giving us a day-by-day update on their vote. I don't think it would be helpful to have that play out on a daily basis, especially during a time of crisis. If things get bad enough, have an intermeeting cut. If not, then send the signals through fedspeak and retain some flexibility.

If you want more transparency and accountability, go for an inflation target. Then you might get a little more stability to boot.

As for those futures contracts, Mark does the reporting on that as well. We seem to have settled on 50-50 between a 25 b.p. and 50 b.p. cut.

That's all for now. I'll post in the evening and tell you about what kept me busy.

The New York Times will stop charging for access to parts of its Web site, effective at midnight tonight.

More here, at the Times, of course.

I guess they realized that in today's internet media environment putting their best stuff behind the firewall wasn't the best way to get it out into the wider conversation.

Of course, this was predicted. Here's one link. It's not hard to find a few dozen. When they opened up to ".edu" addresses, you had to know that TimesSelect was in its death throes.

'Bout time.

Former Fed Chairman Alan Greenspan has left the obfuscations of Fedspeak behind him. Now he comes right out and tells it like it is. Mr. Bernanke can't be too happy about this one:

WASHINGTON (Reuters) - Former Federal Reserve Chairman Alan Greenspan said in an interview published on Monday the Fed would have to raise interest rates to double-digit levels in coming years to thwart inflation.

Yikes!

Well, anything is possible, but this one isn't too likely in my book in the near future. But then again, Greenspan is probably looking out future ahead than the next easing and tightening schedule--ahead to a time when China may be looking at runaway money growth and exporting inflation to the rest of the world. Impossible, you say? Well... (Wall St. Journal)

BEIJING -- China raised benchmark interest rates late Friday as it stepped up efforts to damp accelerating inflation, and analysts predicted the central bank's fifth rate increase this year won't be its last.

Fueling the need to raise rates is an economy that expanded 11.9% in the second quarter and shows no signs of slowing. Data released last week showed continued strong growth in money supply and investment spending.

How do you look at that situation and not get concerned? We talk about soft landings. They're riding a rocket. How do you pull off a soft landing that way?

Anyway, today is the calm before the storm. I'll be busy, so posting will be light unless something exciting happens today. Besides, if you've been reading the blog for a while you know what I'm thinking. It's not how I would have wanted to see things go, but I think a 25 b.p. cut is the most likely outcome. Ultimately, the inflation cost of one 25 b.p. cut is probably not that large right now. An honest case can be made that a cut will soften the blow should things turn downward this fall. However, 50 b.p. would be a mistake, IMHO. That does not mean that it can't happen.

I will not be posting until late on Tuesday, but I will have something whatever the result.

Allan Meltzer writes in the Wall St. Journal:

With annual inflation at 2% or more and unit labor costs rising at a 5% rate, loose fed policy risks reviving the latent fears that it is willing to permit higher inflation now to respond to a forecast that unemployment may rise. That returns to the policy that made the Great Inflation costly and durable.

The better policy is to wait until the very mixed data of the moment forms a pattern. High-frequency data is often revised. It often has transitory aberrations that do not persist. Unfortunately, after a major change in underlying conditions, we know even less than usual about the future.

86 hours to go.

Ta-da! We have our 1000th comment! And yes, that does include my comments. I try to have a conversation with people in the comments when feasible. It makes the experience more fun for everyone. By my count, I'm responsible for about 266 of those comments, leaving about 734 from my excellent readers who really help make this site what it is and give me a reason to keep doing it. Make that 737 from the readers as we are actually at 1003 as I write this.

So who was #1000? It was Spencer, who has been commenting on the blog since the early days (his first comment was in April 2005) and has contributed to the discussion 80 times, or roughly 8% of all the comments here. (PGL of Angry Bear narrowly beats him out with a total of 86 comments, including the 8th comment the blog ever received back in January 2005.) Thanks, guys, for keeping me honest.

In honor of the 1000th comment, I thought I'd dig through the archives and recall some of my favorite comments. In some cases I'll just post the first sentence to two (which is usually the best part). Go read the whole thing if you care to. We've had a lot of long passionate debates over the last couple years, but some of my favorites were from posts where I didn't expect much, or at least I didn't expect what I got.

So here they are, in reverse chronological order:

Well there's a difference between liquidity which is water and that which is sewage. Perhaps what we need is an effort to clean up this liquidity, rather than keeping it circulating. Dumping more water into the sewage isn't really helping much. --Donna on this post about the recent liquidity issues

Wow. There must be some sort of market-friendly radiation coming out of Minnesota U. --Gabriel upon hearing that ticket scalping is now legal in Minnesota

Polley

I'm the guy from the other blog who said he wouldn't read this if you paid me.

But you sounded like such a nice guy i felt a owed you a look. --Coberly on a post that turned into a discussion on the rewards to education

I knew who it was right away. Love the commercial, love his voice!!!! --Heather, who is apparently a George Clooney fan

Polley is making some very good points and I find myself attracted to his analysis.

On the other hand... --Spencer on this post about free markets

Welcome to the Helicopter Patrol. --Stephen Karlson welcoming me to the ranks of judges for the high school Fed Challenge

Someone once pointed out to me that the existence of boring numbers can be disproven by contradiction. If there were a set of boring numbers, that set would include a "least boring number", which would therefore have an interesting property and thus not belong in the set. --knzn waxing philosophical in response to this post about the number 23

After interviewing recruits at the ASSA meetings, I really have to ask "What IS macroeconomics these days?" --John Palmer (aka EclectEcon) responding to this post and expressing a thought that a number of people have communicated to me as well

Off-topic. What's with all the silence? It's December. Time for a new post! ;-) --Gabriel, annoyed that I took a few days off...funny because of this post of his

Paper cuts. Absolutely deadly.... --Ironman upon hearing that J.K. Rowling was stopped by airport security for carrying on her Harry Potter manuscript

Since it agrees with my analysis I have to say good analysis. --Spencer proves that we agree once in a while

Yep - I was a Happy Bear this morning. AB may have to pull the plug on my posting! --pgl, giddy with excitement over February 2006 job growth

Yes, but he no longer has a boss that does not want good answers. --Spencer on Ben Bernanke's move from the CEA to the Fed

BTW, the real expense of popcorn is probably cleaning up after it. --Lord on the reason popcorn is so expensive at the movies

I had noticed the same pattern on my blog, but wondered why. Your story makes sense. --The Unknown Professor on all of the hits we get from ".edu" addresses when term papers are due. (John Palmer noticed it too.)

Oh, goody. Screw up a universally understood and accepted human interface. Just jolly. --Donna, who was unimpressed with smart elevators

Brilliant! --Calculated Risk with this blog's only one word comment so far. Here's the post. You be the judge.

And hey! Who is that guy in the suit and tie? That is a long way from the photo at the "economic geyser" in Yellowstone! --Calculated Risk again, noticing from my picture on the Econoblog that I do clean up well (I may be in a jacket and tie, but it was just a head shot...I was wearing jeans.) The Yellowstone photo is here, if you haven't seen it.

the ten year is under inflation?! aye carumba! --c. I guess that sort of speaks for itself.

Ice Cream. Mmmmmmmm.... --pgl again. Read the post and the comment, and smile.

Krauthammer nailed it. Your sophistry doesn't change that. --Brian on this post from the early days...you are not compelled to agree with the host

Well, that's the highlight reel. I hope you've enjoyed some of these blasts from the past. I hope that they brought a smile to your face because I'm just sitting here grinning from ear to ear thinking about what a fun ride this has been so far.

My readers share in the success of the blog. Comments are always welcome. We've already started on the next thousand.

And soon we'll be coming up on 1000 posts. I'll have another highlight reel then as well. Have a good weekend.

Alan Greenspan is quoted in the NY Times

“While I was aware a lot of these practices were going on, I had no notion of how significant they had become until very late,” he said in an interview to be broadcast Sunday on CBS’ “60 Minutes.” ”I really didn’t get it until very late in 2005 and 2006.”

Set your DVRs. His book comes out on Monday.

UPDATE: The book was scheduled to be released on Monday. Apparently someone didn't get the memo. The Wall Street Journal went shopping...

The book is scheduled for public release Monday. The Wall Street Journal bought a copy at a bookstore in the New York area.

And thus, journalistically, it is fair game.

Many economists say the Fed, by cutting short-term interest rates to 1% in mid-2003 and keeping them there for a year, helped foster a housing bubble that is now bursting. In his book, which was largely written before much of the recent turmoil in credit markets, Mr. Greenspan defends the policy. "We wanted to shut down the possibility of corrosive deflation," he writes. "We were willing to chance that by cutting rates we might foster a bubble, an inflationary boom of some sort, which we would subsequently have to address....It was a decision done right."

So he admits to 60 Minutes that he "didn't get it" when it came to the subprime debacle, but he defends the the decision to keep rates low.

Can't wait to see the interview and read the book.

Best line from the article:

Mr. Greenspan recalls his amazement when an adviser to Russian President Vladimir Putin asks him to discuss Ayn Rand, the libertarian philosopher with whom Mr. Greenspan had been friends.

Wish I could have heard that conversation.

Mark Thoma and Felix Salmon have much more.

UCLA law professor Stephen Bainbridge (aka Professor Bainbridge) wanted to build an addition on his house. The zoning department told him that according to their records, his house doesn't exist. (Neither does his street!)

At this point I would start looking for Rod Serling to come out from behind a tree because it sounds like this zoning department is in the Twilight Zone.

Suffice to say he won't be getting his addition. Read his story.

The NY Times visits my old stompin' grounds (or close, anyway).

Nine-man football is the province of small towns in Minnesota, North Dakota and South Dakota. “It’s simple,” said Nic Thompson, the Storm’s defensive back coach. “Nine-man just doesn’t have tackles.”

In Minnesota, it began in the mid-1960s after teams evolved from six- and eight-man football. Now, with 81 teams, it represents the state’s largest class. To qualify, high schools need to have fewer than 165 students. Stephen/Argyle Central has 111, 68 of whom are boys.

The article discusses how life has changed on the prairie on and off the football field. My town was not that small, and our football team had tackles. Even so, parts of the article sounded familiar. Read the article and catch a glimpse of the small town experience.

Clip art by T.C. Design

In the newest Journal of Economic Perspectives (Summer 2007) is an article titled "Repugnance as a Constraint on Markets" by Alvin Roth. It's part of a symposium of three articles on organ transplants. I've skimmed it now and will read it more carefully later. Roth makes the claim that as economists we should continue to educate the public about efficiency and tradeoffs, but also be aware of the sources of repugnance that has led legislatures to outlaw drugs, prostitution, ticket scalping, and the sale of human organs, among other things.

It would be a great reading for an undergraduate seminar.

By now you have probably heard about the speech given by Charles Plosser. Read it. It is destined to be a classic as it is an extremely candid recounting of the events of the last few weeks from an "inside the Fed" perspective. The speech itself clearly shows that Plosser is reluctant to cut rates on the 18th. In an interview afterwards, he makes it crystal clear. (Bloomberg)

"We want to be careful not to overweight one piece of information,'' he said in an interview late yesterday after a speech in Waikoloa, Hawaii. "I've not made up my mind at all'' on whether a rate cut is needed, he said.

Tim Duy doubts that the expected cut on the 18th will be the only one. Unfortunately, they might be in a lose-lose situation. If they cut only 25b.p., people will expect more. If they cut 50b.p., people will infer that it's worse out there than they thought... and thus they will expect more. Knzn has more to say about why he wants 50b.p. I'm still expecting just 25b.p. and even that is causing me a lot of internal struggle. I'm basically in the camp with Plosser and Poole, and if you read the last line of Tim Duy's post, you'll know why.

I was listening to Bob Brinker's Money Talk on the radio this weekend. He says that the Fed is being dragged into this "kicking and screaming." Brinker says the Fed is behind the curve... a statement that neither Duy nor I would agree with. But he's right about the kicking and screaming part.

Finally, I found a brand new blog while ego-surfing this weekend. It will be entirely based on Fedspeak. It's by Marc Shivers and it's called "The Talking Fed." Check it out.

Happy Monday!

Tyler Cowen has been pushed too far. Why? Listening to people complain about Apple cutting the price of the iPhone.

One customer, Kevin Tofel, was quoted in the NY Times as saying:

“I just felt so used as a consumer,” he said. “They hyped up the iPhone for six months and built up our expectations, and then they grabbed our extra $200 and ran.”

This was too much for Tyler.

It is you people, you who resent Coase (1972), you people who induce wage and price stickiness and widen the Okun gap. You people, who don't know what it means to sit back and enjoy your consumer surplus. You beasts! (emphasis in original)

Ok, so who among us did not expect that this would happen? In fact, when the iPhone came out, one blogger wrote:

There is one certainty however. In a few months, there will be a better model that will be released at about the same price and this one will be sold at a discount. For tech products like this, there is most certainly a dynamic form of price discrimination partly due to the nature of quality improvement and innovation over time and partly due to calculated profit maximizing behavior. The effect is to segment the market into the patient and the impatient.

Man, that sounds familiar.

The only thing I didn't get right about it was how fast it would happen. Two months is sooner than I would have expected, but not terribly so.

So let this be a lesson to you. Big hype around a high tech innovation just cries out for this sort of dynamic price discrimination. The market will be segmented into the patient and the impatient. If you are impatient, you will pay more than those who are patient. There is a price for being the first on the block with a new toy. You gave away some of your consumer surplus, but you've probably got some left. So enjoy being first as long as it lasts. The patient masses will soon join you in enjoying what Tyler calls those "icons of modernity". Should I feel sorry for someone who buys a $2000 computer and complains that a few months later a better one sells for $1800?

"You people...who widen the Okun gap." That's just beautiful.

UPDATE: Wired has a story that should soothe Tyler

"If they told me at the outset the iPhone would be $200 cheaper the next day, I would have thought about it for a second - and still bought it," said Andrew Brin, a 47-year-old addiction therapist in Los Angeles. "It was $600 and that was the price I was willing to pay for it."

Not good. Nonfarm payrolls fell by 4000 workers--given that revisions can be substantially larger than this, we can just say that it is flat. And flat is not good at all.

Here's something out of the report that highlights the even softer underbelly of this already soft report:

The number of persons employed part time for economic reasons, at 4.5 million in August, was 359,000 higher than a year earlier. This category includes persons who indicated that they would like to work full time but were working part time because their hours had been cut back or because they were unable to find full-time jobs.

That's roughly an 8% jump in the number of people employed part time for economic reasons since last year. Hard to put a positive spin on that.

As usual, PGL at Angry Bear reports on the employment to population ratio and the labor force participation rate.

How does this affect the outlook for the FOMC meeting? Glad you asked. The CBOT binary options now put a 93% probability on at least a 25 basis point cut and now a 60% probability on at least a 50 basis point cut.

The market is now firmly, solidly, and perhaps irrevocably convinced.

And it is hard to argue with it. All along this path, I have argued that it would take genuine weakness in the economy to push the Fed off its trajectory. As we went through spring and summer many observers, myself included, became more convinced that the strong 2nd quarter GDP figures may be the last gasp before significantly slower growth in the 3rd and 4th quarter. Recession probabilities are higher. Given that the labor market is lags the overall economy slightly, it is possible that in hindsight we will look back and say that at this point a recession had already begun. While I still think it is premature to make that call, it would be wrong to ignore the possibility.

Just in case you don't have enough to worry about already, listen to what Michael Mandel has to say.

If you are worrying about the economy, don't start with the weak job report--start with yesterday's productivity report. Nonfarm productivity has only risen by 0.9% over the past year. The four-quarter average of nonfarm productivity has only risen by 0.5%, the smallest increase since 1995.

Productivity growth establishes the sustainable growth rate of the economy. The fact that productivity growth is so slow has two consequences. One, it means that the economy is much more vulnerable to shocks that can push it into recession. Second, it puts Bernanke into a bind...with productivity slow, he has to be much more worried about inflation.

It is the latter consequence, the inflation threat, which weighs over Chairman Bernanke's head as they go into the meeting. While it is unlikely that a single rate cut this month would significantly increase inflation, the Fed needs to be very careful about what they communicate about where they will go from here. In 1998, the Fed cut three times and didn't remove the accommodation for almost a year. Some say that contributed to the end game of the bubble and bust of the dot coms in 1999 and 2000. An analysis of that episode and its lessons for today could spawn many essays.

And so we go into this weekend under the expectation that a rate cut on the 18th is almost a foregone conclusion. And that means it's time to start thinking seriously about October, which is not a foregone conclusion yet. We'll see a lot of data between now and then. Lots of things to think about.

For the 18th, a 25 basis point cut with the risks weighted equally towards lower growth and higher inflation would acknowledge what is happening without locking them into anything for the next meeting. It is imperative that they not lock themselves into anything for October. I have less objection to a 25 basis point cut if it is understood that it is NOT the first in a sequence. If it is interpreted as the first in a sequence, that will only lead to problems later.

Of course, it's not just the speeches of Fed officials that are so interesting, but the Q&A afterwards can give real insights. Bloomberg has the summary from Thursday.

Sept. 6 (Bloomberg) -- Four regional Federal Reserve bank presidents declined to endorse a cut in the benchmark interest rate this month, as policy makers gauge the impact of the credit-market rout on the U.S. economy.

Did anyone expect them to?

Kansas City Fed President Thomas Hoenig and Dennis Lockhart of the Atlanta Fed said they hadn't seen sure signs of a housing spillover into the broader economy. St. Louis Fed President William Poole and the Dallas Fed's Richard Fisher said the effects of the turmoil so far are unclear.

The comments suggest some Fed officials may need more convincing before deciding to lower the main U.S. interest rate for the first time in four years when they meet Sept. 18. Most economists and investors expect the Fed to reduce the rate at least a quarter point from the current 5.25 percent to contain economic risks from housing and subprime-loan fallout.

Hoenig and Poole are voting members, for what it's worth. Further down the article...

Lockhart, 60, making his first speech on the economic outlook since succeeding Jack Guynn in March, said in Atlanta that "so far, I have not seen hard or soft data that provide conclusive signs that housing problems are spilling over into the broad economy.'' He cited "real-time information'' from regional business contacts.

Poole, speaking in London, said the Fed will not be "pushed into a decision.''

That's a bold statement. It looks to me like a number of committee members, including Chairman Bernanke, do not want to cut the fed funds rate eleven days from now. But what if they do vote to cut the funds rate? Am I to infer that something has changed from what I'm hearing in these speeches? Or am I to infer that they were pushed into it? This post on the Wall Street Journal's MarketBeat giving five reasons that the Fed will cut rates reminds me that we're not all on the same wavelength here.

The market is expecting it. Federal-funds futures contracts traded on CME Group are still pricing in a 100% guarantee that the Fed will cut rates on Sept. 18. While the Fed isn’t one to necessarily respond to bile-spewing yahoos on television demanding rate cuts, it isn’t in the habit of ignoring the market as a practice. According to Bianco Research, in 29 of the last 30 Fed meetings, by this time (10 trading days before the meeting), the futures contracts were accurately forecasting what the Fed planned on doing.

Yes, but 29 out of the last 30 meetings have been really easy calls. (I believe the meeting after Hurricane Katrina might be the odd one out, but I'm not positive.) This is, I think, the first time in several years that we're this close to a meeting and I don't have more than an 80 or 90 percent confidence in the way things are going to go. So with regards to Bianco Research, I'd say that past performance is no guarantee of future results. And while CME futures might be more certain, the CBOT binary options are still at "just" a 75% probability of a cut.

For his part, Barry Ritholtz says that this is irrelevant. And of course, if you've been following the general tone of my posts for the last few weeks, you know that on this point, I am predisposed to agree with Barry, and with Poole. They're not going to be pushed into this. And yet... I still acknowledge that a cut is possible if, say, their real-time contacts start to turn at the last minute or if we get a flare up of the problems experienced in August.

So how can I help but worry a little about how this decision (whichever way it goes) will affect the Fed's credibility and the market's perception of their communication strategy going forward? In a perfect world, the meeting would be a week or so later, so that they would have another week to get their communication strategy together and put some distance between the August meltdown and the meeting. Unfortunately, that is not an option.

Back to the Bloomberg article one more time...

Lockhart said the Fed's current challenge is to balance three concerns: responding to economic risks, preserving gains against inflation and keeping the financial system stable. His comments indicate he may not yet see a reason to lower interest rates, as most economists and investors anticipate the Fed will do this month. Lockhart starts voting on rates in 2009.

"Current readings of inflation represent progress, but not victory,'' Lockhart said, voicing concerns that Bernanke omitted from his last speech. "I would like to see inflation sustained at a somewhat lower rate -- with emphasis on 'sustained.' If inflation is allowed to accelerate, bringing it back down will be costly and painful.''

That's the same mantra you might have heard a year ago. And so it goes.

In other news, the ECB kept their rates constant yesterday. A few weeks ago, everyone was expecting an increase. Why do I bring this up? If the Fed does cut rates, it would preserve the spread between U.S. and European interest rates that would have been expected a few weeks ago. That's not a reason to cut, but it would suggest that the impact of a cut on the dollar would be muted somewhat. The implications of keeping rates steady given the ECB decision are left as an exercise to the reader.

Later this morning... the August employment report, and perhaps a baby step towards some resolution of uncertainty. Or not.

Brad DeLong is teaching American economic history. I'm scheduled to teach it next year, and I feel his pain when he says that his eyes are bigger than his stomach.

The canonical course on American economic history spends:

* one week on the Spanish conquest

* one week on Amerindians

* one week on colonial settlement

* one week on the American Revolution

* one week on Alexander Hamilton

* one week on agriculture in the Old Northwest

* one week on New England manufactures

* one week on slavery

* one week on the Civil War

* one week on the Gilded Age

* one week on Populism

* one week on Progressivism

* one week on immigration

* one week on the Roaring Twenties

* one week on the Great Crash and the Great Depression

* one week on the New Deal

And we have overshot the end of the semester by three weeks.

He goes on to say that he wants to make room for post WWII history by getting to 1865 by the fourth week. Wow. I think you could buy a little time by spending just one day rather than a full week on the pre-colonial period and on Hamilton. Due to my location, I would switch out agriculture in the Old Northwest for agriculture in the Midwest, put it later in the semester (together with the railroads). Make Populism and Progressivism a day each instead of a week each. Similarly for immigration and the 1920s--make them a day instead of a week.

But even at that, you've only crammed that syllabus into the proper length of the semester. You haven't made room for post WWII.

This is going to require some serious contemplation.

The latest Beige Book is out, and it will not add any fuel to the fires of those expecting a rate cut.

Here's how it begins...

Reports from the Federal Reserve Districts indicate that economic activity has continued to expand. St. Louis and Kansas City described the pace of activity as moderate; Cleveland, Chicago and Minneapolis said their economies were expanding at a modest rate; and Boston and Atlanta reported that activity was mixed. New York cited continued expansion. The economies in Philadelphia, Richmond, Dallas, and San Francisco continued to grow; however, the pace of activity has slowed.

Most Banks reported that the recent developments in financial markets had led to tighter lending standards for residential mortgages, which was having a noticeable effect on housing activity, and several noted that the reduction in credit availability added to uncertainty about when the housing market might turn around. While several Banks noted that commercial real estate markets had also experienced somewhat tighter credit conditions, a number commented that credit availability and credit quality remained good for most consumer and business borrowers. Outside of real estate, reports that the turmoil in financial markets had affected economic activity during the survey period were limited.

In calculus terms, we might say that the first derivative of GDP is still positive, but the second derivative is negative. It's at times like this when honest minds can disagree about whether a rate cut really is warranted. But overall, the Beige Book does not lend a tremendous amount of support to those wanting a rate cut. Nor will it change very many minds of those who want a rate cut. In that sense, it's not much that we didn't know. However, it is very important to consider how this will affect those who will actually be voting at the FOMC meeting in a couple weeks. Given that Chairman Bernanke recently stated that the Fed would be closely watching the incoming data, this would lead one to expect that the Chairman and those in his camp will see this as justification for holding the line for at least one more meeting.

That certainly seems like a reasonable interpretation, and if you read Reuters, you'd be led to the same conclusion.

NEW YORK (Reuters) - Stocks added to losses on Wednesday after the Federal Reserve's Beige Book summary of economic conditions suggested continued strength in the economy, reducing expectations for an interest rate cut.

Yet, the traders at the Chicago Board of Trade aren't buying it. 30 day fed funds and the binary options haven't budged.

There should be some interesting Fedspeak in the next few days. Maybe that will give us more clues.

The Wall Street Journal Real Time Economics Blog has more quotes from the Beige Book

Edward "Ned" Gramlich, who warned of the consequences of lax standards in the banking sector while a governor at the Federal Reserve, has passed away at the age of 68.

From a Bloomberg article on Gramlich today:

"Sometimes one's advice must be weighted toward economic practicality, sometimes toward humanity,'' Gramlich told the Senate Banking Committee. "A good economist should know how to balance both objectives.''

By that measure, Ned Gramlich was a "good economist".

Here are some of the links to articles reporting on Gramlich's passing.

Wall Street Journal

Months ago Mr. Gramlich agreed to give a luncheon address at the Federal Reserve Bank of Kansas City's annual symposium in Jackson Hole, Wyo. Since he was too sick to attend, his prepared remarks were delivered Friday by David Wilcox, deputy director of research at the Fed. Mr. Wilcox, before delivering the remarks, said he and the rest of the staff felt a special bond to Mr. Gramlich because he had been a staff economist there in the 1960s. Mr. Gramlich found "it perfectly natural to treat us all truly as colleagues when he returned as a governor."

Reuters
Forbes
Washington Post
Statement from Federal Reserve Chairman Ben Bernanke
Urban Institute Press Release

Bryan Caplan had some fun at lunch recently...

At a recent GMU lunch, two economists sparred over the optimal quantity of cash to keep in one's wallet. Economist A holds very little cash, on the grounds that you can pay for virtually everything with credit cards. Economist B holds lots of cash, on the grounds that the foregone interest is virtually nothing, and his time is very valuable.

Whose side do you take, and why? Value of time and foregone interest calculations are welcome.

P.S. Please don't repeat the textbook model of money demand. I'm asking for a concrete solution, not a general framework. :-)

Greg Mankiw defends the textbook model:

For example, suppose that the GMU economist spends $10 per day in cash, takes 10 minutes to go get cash out of his ATM, has a value of time equal to $60 an hour, and earns 5 percent annual interest on balances held at his bank. From this information, the Baumol-Tobin model yields a very specific prediction: The prof should take out $1200 from his bank three times a year and hold an average of $600 in his wallet....

Most people hold much less money on average and go to the ATM much more often than the model predicts for their parameter values. This is a puzzle. It is also a great example to work through in an intermediate macro class. You can generate a good classroom discussion about why the model fails to match behavior.

He then gives two examples (neither of which he finds compelling). My answer to Caplan is that personally, I'm with "Economist A". I don't carry a lot of cash, but that's mainly because I use very little of the stuff and have extremely convenient access to an ATM on campus (which charges no fees as I am a customer of the bank that owns the ATM).

Mankiw's puzzle, however, is not really a puzzle to me. The problem for the model is that the value of time tends to be overestimated in examples like this. Perhaps I can bill my time at $60/hour, but that does not mean that I will at all times and in all places behave as if my time is literally worth $1/minute.

Consider the example that circulated a while back about how Bill Gates wouldn't even bother to pick up a $100 bill off the ground because he makes more money in the time that it would take him to bend over and pick it up. (A clever rendition of that story, complete with a chart, can be found here.) But there's something about the example that doesn't wash. Does Bill Gates literally get paid by the second? No. As clever as this example is, it is not literally true that Bill Gates would forgo the fraction of his income that could be attributed to 4 seconds out of his day when he bends over to pick up a $100 bill. The amount he would forgo might even be more, and is probably often less. Using the value of time as an explanation only makes sense if there is truly something given up. Think about it this way, would Bill Gates be more likely to stop and pick up a $100 bill on his way into an office building for a meeting or on his way out? On his way in, his mind is focused and he doesn't want anything interfering with getting to the meeting. On his way out, he may have a bit of "slack time" (unless he's late for the next meeting). The point is that the true opportunity cost of Bill Gates' time is not uniform throughout the day.

Or how about this one... A lot of people don't bother to pick up pennies. Is it because the value of their time is more than the value of the money that is picked up? Perhaps it is sometimes. But it seems more likely (and more in tune with my own experience) that you just don't want to carry a penny around, or maybe because you suffer disutility from bending over. The value of time matters, but it doesn't have to do all the heavy lifting in this example.

The fact of the matter is that most of us have a bit of "slack time" built into our day by accident or design. Suppose that it takes me 50 minutes to eat lunch and that I like to get to class 5 minutes early. If I'm passing by the ATM on my way to get lunch and it's 60 minutes until my class starts, the time that it takes me to get cash comes out of the 5 minute buffer that I have in my schedule. That's time that I would spend checking my e-mail, looking at my notes, or enjoying the view out my window while I get my thoughts in order. It's a low opportunity cost window of time--small enough to just be counted as the time equivalent of loose change. Those fleeting moments don't aggregate very well into billable $60/hour blocks.

Viewed that way, the puzzle disappears. Personally, ideas tend to come to me in low opportunity cost moments of time, so paradoxically, I value those moments highly. Discuss.