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In their work, economists are typically are not nationalistic. National boundaries mean little to them, other than that much data happen to be collected on a national basis. Whether a fellow American gains from a trade or someone in Shanghai does not make any difference to most economists, nor does it matter to them where the losers from global competition live, in America or elsewhere.

I say most economists, because here and there one can find some who do seem to worry about how fellow Americans fare in the matter of free trade.

In a widely noted column in The Washington Post, "Free Trade's Great, but Offshoring Rattles Me," for example, my Princeton colleague Alan Blinder wrote:

I'm a free trader down to my toes. Always have been. Yet lately, I'm being treated as a heretic by many of my fellow economists. Why? Because I have stuck my neck out and predicted that the offshoring of service jobs from rich countries such as the United States to poor countries such as India may pose major problems for tens of millions of American workers over the coming decades. In fact, I think offshoring may be the biggest political issue in economics for a generation. When I say this, many of my fellow free traders react with a mixture of disbelief, pity and hostility. Blinder, have you lost your mind?

Professor Blinder has estimated that 30 million to 40 million jobs in the United States are potentially offshorable -- including those of scientists, mathematicians, radiologists and editors on the high end of the market, and those of telephone operators, clerks and typists on the low end. He says he is rattled by the question of how our country will cope with this phenomenon, especially in view of our tattered social safety net.

"That is why I am going public with my concerns now," he concludes. "If we economists stubbornly insist on chanting 'free trade is good for you' to people who know that it is not, we will quickly become irrelevant to the public debate. Compared with that, a little apostasy should be welcome."

What do you think?

This led Mark Thoma to wisely say:

Saying that everyone could be made better off with increased international trade is not the same as people actually being made better off. There are winners and losers from increased international trade, and while I agree that the gains exceed the losses in almost all cases, the gains haven't been distributed in a way that leaves everyone, or even most everyone, better off (see, e.g., widening inequality and where the costs of these kinds of adjustments fall). When some people are made better off and others made worse off at the same time, economists cannot say it is unambiguously better or worse. If we are going to make the argument that trade is good because everyone could potentially be made better off, we should do much more than we have to ensure that this potential is realized, i.e. that the gains from trade are distributed widely across the population rather than concentrated among a smaller set of winners.

Which in turn led Tim Worstall to reply:

But this argument then generally morphs into an insistence that we should not have free trade until that compensatory mechanism is put in place, so that, say, I, who will be gaining from that free trade will be compensating those who will lose from that free trade.

Hmm. But do you see what is implicit in that argument?

That there are gains that I am not getting, gains that are going to some other, as a result of our not currently having free trade.

This is obvious: if free trade benefits me and disbenefits you, then not free trade must disbenefit me and benefit you.

Which leads to the question: are you compensating me for those benefits you are getting and the disbenefits I am getting from the absence of free trade?

Where, in short, is my check from those benefitting from protectionism?

I'd like to see Worstall defend that one in front of a class of principles of econ students who have seen jobs in their towns go overseas or south of the border.

Seeing as how for the last 16 years I've been defending free trade to classes of principles students who have seen jobs in their hometowns disappear because of free trade, I feel like I can take a crack at this.

Blinder gets it absolutely spot-on.  Print this one and post it on your wall.

If we economists stubbornly insist on chanting 'free trade is good for you' to people who know that it is not, we will quickly become irrelevant to the public debate.

That is exactly what 16 years of defending free trade to Midwestern college students has taught me.  And since I have no desire to become irrelevant to my students, I have found it useful to focus their attention on what I was taught about free trade.

You see, it is the potential for a Pareto improvement that makes free trade desirable. There are winners and losers.  But the winners gain more than the losers lose.  So effect a transfer from the winners to the losers that still allows the winners to gain but compensates the losers for what they lost.  Only then can you really say that free trade (with the compensating side payment) benefits everyone.  If the compensation is not there, then I cannot unconditionally advocate free trade.  I must call attention to the fact that some will lose.  Call it professional ethics.

I have shared this approach to teaching trade with liberal and conservative economists alike.  Economists, even many liberal ones, like Pareto improvements a lot better than redistribution--if a Pareto improvement is possible.  I've never really thought of this as controversial.  The devil is in the details, of course, since the transfer payment can be very hard to estimate and implement.  Economists are usually content to point out to their students that in the abstract it seems reasonable to try to compensate those who lose from free trade because the losers are usually few in number and identifiable (e.g. workers whose factory moves to Mexico) while the winners are numerous so a small tax on the many can compensate the few who lose their jobs.  We then leave it to the wonks to write legislation like the Trade Adjustment Assistance Act.

Worstall's logic seems appealing though.  If I gain and you lose from free trade, then the status quo harms me to enrich you.  That hardly seems fair.  So if you're not compensating me now, why should I compensate you under free trade?

There's a hint of utilitarianism in Worstall's logic as well.  If there is some inherent unfairness in either state of nature, then which one is preferred?  It must be the one that has the highest total utility.  If you're going to punt on the issue of distributional equity, then overall efficiency must be the primary, indeed maybe the only, criterion.

That's fine in a representative agent model, of course, because in such a model distributional equity means nothing.  The representative agent contains in his person both the winner and the loser, so there's no need to worry about compensation.  The representative agent model does allow us to gloss over some of the distributional questions to highlight the aggregate gains, but no responsible economist would stop there.

But ultimately what is wrong with Worstall's logic?  For me, it boils down to the notion of a social contract.  People make decisions, many of which are irrevocable or nearly so, on the basis of the best information and their expectations of the future.  Sometimes the biggest influences on our expectations are the existing law and the political environment.  If I then make a decision in good faith based on existing law, only to have the law change to my disadvantage, I will feel wronged.  That I benefited from the way the law was should not be held against me when arguing to change the law.

This is a big reason for the political process moving as slowly as it does sometimes.  There is rightly a reluctance to change if a change will harm people who made good faith decisions based on what they expected to prevail.

Take the mortgage interest deduction, for example.  Everyone who has a mortgage enjoys higher property values because the mortgage interest deduction is built into the capital value of the house.  I paid extra for my house to get it.  When I sell, I'll get it back.  If the present discounted value of the benefit equals the additional amount I paid for the house, then I'm not getting a free lunch.  I weigh the costs and benefits and made my decision--so did those who chose not to buy a house.  We all knew the rules.  The mortgage interest deduction is a thumb on the scale, but we all know that the thumb is there--and we all expect it to stay there and set our prices accordingly.

Take the thumb off the scale and it's no longer in balance.  Take away the mortgage interest deduction and my property value goes down in a way that I probably could not insure against, and certainly wasn't expecting.  I would feel wronged.  Since taking away the mortgage interest deduction would harm so many people, politicians will think twice about doing it.  People make decisions in good faith based on existing law.  We tend not to change the law arbitrarily and capriciously on them.

And that's why Worstall's logic fails the test of reality.  People make life decisions based on protectionism.  No, not directly just like that.  But trade protection has kept the factory in their hometown going.  They graduate from high school and apply for a job.  Maybe it was the only job in their hometown.  Sure, they could have gone to the big city to wait on tables or drive a cab but that would take them away from home and family.  The made the decision that was best for them based on what they knew and could in good faith expect.

And some people would say to heck with them.  What are we coming to?

When you break a contract in law, you must compensate the other party.  Sometimes it is in the best interest of both parties to allow that.  The social contract is no different.  We can, and indeed we should, at times rewrite the social contract, but when we do, the winners must compensate those who made good faith decisions based on the old contract.  If we do not, then the law is worth no more than the paper it is printed on, and that will lead to less economic activity for fear that it can always be taken away with the stroke of a pen.

It's April 15. Have you filed your taxes yet?

When I was in college, the local Dairy Queen ice cream stand would give away free chocolate sundaes from 10pm to midnight on April 15. You see, it was just a couple blocks from the post office (and the college). But the event became a college tradition (even though none of us actually waited until the 15th to file our taxes).

The line was longer at the Dairy Queen than at the post office. Much longer. And much happier!

I hope they still do it. If you're in Moorhead, Minnesota tonight, have a sundae for me.

To begin with, gross domestic product excludes a great deal of production that has economic value. Neither volunteer work nor unpaid domestic services (housework, child rearing, do-it-yourself home improvement) make it into the accounts, and our standard of living, our general level of economic well-being, benefits mightily from both. Nor does it include the huge economic benefit that we get directly, outside of any market, from nature. A mundane example: If you let the sun dry your clothes, the service is free and doesn't show up in our domestic product; if you throw your laundry in the dryer, you burn fossil fuel, increase your carbon footprint, make the economy more unsustainable -- and give G.D.P. a bit of a bump.

...

This points to the larger, deeper flaw in using a measurement of national income as an indicator of economic well-being. In summing all economic activity in the economy, gross domestic product makes no distinction between items that are costs and items that are benefits. If you get into a fender-bender and have your car fixed, G.D.P. goes up.

A similarly counterintuitive result comes from other kinds of defensive and remedial spending, like health care, pollution abatement, flood control and costs associated with population growth and increasing urbanization -- including crime prevention, highway construction, water treatment and school expansion. Expenditures on all of these increase gross domestic product, although mostly what we aim to buy isn't an improved standard of living but the restoration or protection of the quality of life we already had.

Common sense tells us that if we want an accurate accounting of change in our level of economic well-being we need to subtract costs from benefits and count all costs, including those of ecosystem services when they are lost to development. These include storm and flood protection, water purification and delivery, maintenance of soil fertility, pollination of plants and regulation of our climate on a global and local scale. (One recent estimate puts the minimum market value of all such natural-capital services at $33 trillion per year.)

Nature has aesthetic and moral value as well; some of us experience awe, wonder and humility in our encounters with it. But we don't have to go so far as to include such subjective intangibles in order to fix the national income accounts. As stressed ecosystems worldwide disappear, it will get easier and easier to assign a nonsubjective valuation to them; and value them we must if we are to keep them at all. No civilization can survive their loss.

Given the fundamental problems with G.D.P. as a leading economic indicator, and our habit of taking it as a measurement of economic welfare, we should drop it altogether. We could keep the actual number, but rename it to make clearer what it represents; let's call it gross domestic transactions. Few people would mistake a measurement of gross transactions for a measurement of general welfare. And the renaming would create room for acceptance of a new measurement, one that more accurately signals changes in the level of economic well-being we enjoy.

Our use of total productivity as our main economic indicator isn't mandated by law, which is why it would be fairly easy for President Obama to convene a panel of economists and other experts to join the Bureau of Economic Analysis in creating a new, more accurate measure. Call it net economic welfare. On the benefit side would go such nonmarket goods as unpaid domestic work and ecosystem services; on the debit side would go defensive and remedial expenditures that don't improve our standard of living, along with the loss of ecosystem services, and the money we spend to try to replace them.

The YouTube model is totally free--free to watch, free to upload your own video, free of interruptions. But it doesn't make money. Hulu is only free to watch, and you have to pay the good old-fashioned way, by watching ads you may or may not care about. Yet it generates healthy revenue. These two video outlets illustrate the tension between different variations on the free business model. Although consumers may prefer 100 percent free, a little artificial scarcity is the best way to make money.

Sound schizophrenic? That's the nature of the hybrid world we're entering, where scarcity and abundance exist side by side. We're good at scarcity thinking -- it's the 20th-century organizational model. Now we have to get good at abundance thinking, too.

PZ Myers rightly commends these words of Richard Feynman. There's a message in them too for people wanting to understand economics.

Feynman says:

People say to me: "Are you looking for the ultimate laws of physics?" No, I'm not. I'm just looking to find out more about the world, and if it turns out that there is a simple ultimate law that explains everything, so be it. That would be very nice to discover. If it turns out that it's like an onion with millions of layers and we just get tired of looking at the layers, that's the way it is.

If this is true for physics, it must be even more true for economics. In economics, the search for simple ultimate laws is impeded by the fact that people's behaviour is often* context-dependent; sometimes we're rational, sometimes not; often we're selfish, occasionally not; and so on.

For this reason, calls for a "new economics" based upon simple principles, such as this bilge, get things arse about face.

*not always - we can't generalize so glibly

I know that economists have tried to overcome the constraints these assumptions impose in higher level work. But that really does not matter. It is the basics that are taught in year one that people remember of their economics, and that is that life is all about profit and that unlimited growth is good.

Christian Zimmerman has set up a new blog aggregator for academic economics, called Econ Academics. Looks very good.

That reminds me I need to update my blogroll. Just need to get all my changes together and do it all at once.

Via Tim Schilling, we find this excellent piece from Rick Mattoon of the Chicago Fed.

He starts with the basics...

From a conceptual viewpoint of our economy, natural disasters impact our economic well-being in two basic ways. First, they destroy what we have produced in the past—our “capital stock”—including lives, homes, commercial buildings, public infrastructure and property. Second, they often interrupt normal commercial activity and production. Transportation and deliveries do not take place, people cannot get to work and work places become dysfunctional until normalcy is restored.

...

... Following the 1993 floods, estimates for the third quarter reduced personal income by $9 billion and forecasted uninsured losses to be $2 billion. Losses to proprietors’ incomes were estimated at another $1 billion.

Remarkably, such initial losses soon appear to translate into economic gains as business and households rebuild. The rise in construction activity and the resumption of business activity often boost gross domestic product (GDP) estimates for future quarters, as households and businesses attempt to rebuild their physical capital and, in the case of businesses, to fill order backlogs. For example, following Hurricane Andrew, annualized GDP growth hit 5.7% in the fourth quarter of 1992, spurred by rebuilding activities.

But take heed, gentle reader...

However, such rebuilding does not reflect an actual economic gain in the broad long-term perspective. In most cases the rebuilding merely replaces lost capital stock—meaning that, in the long term, the nation’s product will not exceed what would have been produced without the disaster. While the immediate burst of economic activity is quite evident, the losses from the foregone output of interrupted and diminished business activity may go largely undetected because the diminished growth takes place in small amounts spread over many years.

The last sentence is so true, yet so often forgotten.

Most of the rest of the article goes on to estimate the actual losses. Mattoon finds that the aggregate losses will likely be smaller this year than in 1993, in part because the geographical footprint of the flooded area is smaller.

He finishes with another comparison--one of which I know something from my western Minnesota roots--the Red River flood of 1997 which devastated Grand Forks, ND.

For business, the greatest disruption was for restaurants, bars, hotels and any business where discretionary spending is important. Many of these businesses had to lay off workers. Other businesses such as banks, health care and manufacturing suffered lost sales but did not suffer drastic employment declines. In fact given the gains in construction jobs, employment in Grand Forks rebounded to its pre-flood level in five months. To some observers, the newly rebuilt Grand Forks with its improved infrastructure and new capital stock is better positioned for growth than before the flood, but this is only true because of significant government subsidies and 10 years of hard work. And of course, it is not true for every household and business impacted by the flood, as many chose to leave Grand Forks.

Well said.

I'd sum it up this way. Natural disasters are not a net benefit for the economy. They result in arbitrary transfers of wealth and temporary changes (both positive and negative) in spending and income. The resulting equilibrium (new capital stock and all) is not a Pareto improvement.

Let me state it even more plainly. Anything a natural disaster can do could also be done by a government through the use of forced relocation, bulldozers, and other people's tax dollars.

With no major meltdowns in the financial markets in the last couple weeks, I have been trying to catch up on other things. Trying.

But here are a couple of things that caught my attention lately.

Tim Schilling writes a nice essay on the economic way of thinking about Romeo and Juliet. This post is just about Act I. Looking forward to the rest.

Professors who teach principles of micro... bookmark these articles for the next time you do supply and demand. Both the NY Times and WSJ describe how farmers will be planting less corn and more soybeans this year. Cost increases and relative price changes are the reasons given. The exam questions practically write themselves.

Sticking with the agricultural theme, this article on the lack of convergence in futures and spot prices is beyond the principles level. Give it to your grad students.

Give this one to your students who are going on the market soon. The FDIC is hiring. No need to guess why.

David Tufte links to this interview with Ed Begley Jr. At about the same time that this came out, Begley visited WIU and gave the same message.

It's a busy week ahead. The final push to the end of the semester is about to begin.

Lawrence White explains why the gold standard may not be such a bad idea. It's a Cato podcast... with a briefing paper to go along with it.

Tim Duy gets frustrated with people comparing our current problems with Japan in the 1990s. Me too. He also gives his take on Plosser's speech and more.

Jeff Frankel is blogging. Go. Read. Now.

Andrew Samwick is disappointed with congress over the stimulus package.

Every so often, you see a paper that just reaches out and grabs your attention by its sheer size and comprehensiveness. This is one of those papers.

"A Quantitative Theory of Unsecured Consumer Credit with Risk of Default" by Satyajit Chatterjee, Dean Corbae, Makoto Nakajima, and Jose-Victor Rios-Rull (Econometrica vol. 75 no. 6, Nov. 2007 pages 1525-1589.)

Non-gated version here. Homework assignment (!) based on the paper here.

I was Dean's TA for the graduate macro class at Iowa back in the day. I think he was already working on the seeds of this paper at that time (a dozen years ago or so). According to the note at the end of the paper, almost 5 years elapsed during the review process. This paper has a theoretical model with all of the requisite proofs befitting a lead article in Econometrica as well as a computer simulation of the calibrated model. They conduct a policy experiment similar to the recent change in bankruptcy laws. Their model predicts a significant increase in average consumption.

At first glance, the welfare gains they find are surprisingly large. I wonder how sensitive the welfare effects are to the parameters. This is a difficult question in any model with a complicated simulation (this I know from experience in my own papers), and their paper is already 65 pages long. So that question will probably need to be explored further in another paper. This paper will be of most interest to specialists who deal with quantitative macro models of heterogeneous agents. It's probably not destined for first year reading lists. But if you do any kind of work with these models or have an interest in the frontier of macro research on bankruptcy issues, then you should look at this impressive paper.

This interview was conducted in October 2005 but not released until now. Hat tip to Greg Mankiw.

Edward Nelson and Anna Schwartz of the St. Louis Fed and NBER respectively have published a working paper which responds to Paul Krugman's essay in the New York Review of Books, "Who Was Milton Friedman?"

The paper is titled: The Impact of Milton Friedman on Modern Monetary Economics: Setting the Record Straight on Paul Krugman’s “Who Was Milton Friedman?”

The abstract:

Paul Krugman’s essay “Who Was Milton Friedman?” seriously mischaracterizes Friedman’s economics and his legacy. In this paper we provide a rejoinder to Krugman on these issues. In the course of setting the record straight, we provide a self-contained guide to Milton Friedman’s impact on modern monetary economics and on today’s central banks. We also refute the conclusions that Krugman draws about monetary policy from the experiences of the United States in the 1930s and of Japan in the 1990s.

Hat tip: RGE Monitor

Now we tax based on intent. A scary thought for your Halloween. You can't make this stuff up. The Tax Foundation quotes from the Iowa Department of Revenue. Yes, my beloved Iowa has taken it upon itself to engage in this kind of silliness.

The Department recently refined its position on whether pumpkins are subject to Iowa sales tax to more closely match what we believe to be their predominant use.

In the past, pumpkins were exempt from sales tax as a food (edible squash), even if they were to be later made into jack-o'-lanterns or used as decorations.

Our position now is that pumpkins are taxable if:

1. They are advertised to be used as jack-o'-lanterns/decorations, or

2. It is understood that they will be used as jack-o'-lanterns/decorations

Pumpkins are exempt in the following circumstances:

* The buyer completes a sales tax exemption certificate stating they will be used as food, or

* The pumpkins are a specific variety used to make pumpkin pies and are advertised in that way, or

* They are purchased with Food Stamps.

Retailers who sell pumpkins should keep these guidelines in mind and make any necessary changes to their tax treatment of pumpkin sales.

I predict a surge in sales of pumpkins for pie making.

Hat tip to King at SCSU Scholars

My economist readers probably are familiar with RePEc. Christian Zimmerman has added a blog to the impressive list of resources over there. Here's what he says under the heading "about this blog".

We, the RePEc team, discuss here the workings of RePEc and seek input from the community on how we can improve. We also want to give more volunteers opportunity to be part of this project and provide valuable services to the profession. Finally, we also discuss issues about the dissemination of research on Economics.

Here's what he means by addressing the dissemination of research. On the topic of peer review...

We can think completely differently. Think of this blog. I rant on a topic, and then others can comment on it and openly declare whether this rant was valuable or not. Why not do this with academic work? An early attempt was done with WoPEc. This was the first RePEc service, similar to IDEAS and EconPapers today, which offered for some time on each paper’s abstract page a discussion section. Participation was minimal and there was very little value added (see an example, I could not find one that actually had comments). This aspect of WoPEc was finally abandoned. A second attempt was organized by SOLE (Society of Labor Economists), that would post every two weeks a new paper to discuss. Again, participation was small, and the project was finally abandoned.

The latest attempt is the Economics E-Journal, which allows registered users to rate and comment on discussion papers. Once the editors find that a paper has generated sufficient interest, it is promoted to the journal, where it can still be discussed. This initiative started this year, so the jury is still out whether it will be successful in the end. So far, it looks very promising.

From time to time, members of the RePEc team are approached and asked whether a discussion section could be added to our services. Given the past experience with WoPEc and the large monitoring costs involved, we are not enthusiastic. Of course if other volunteers are interested in working on this, we may think about it. But first we need to understand whether there is really a demand for this. Maybe RePEc is now too large for this and such initiative should be left to field specific initiatives (SOLE again?).

RePEc is a quality operation. Zimmerman has been one of the driving forces for the site in recent years. Though there is a long history going back to the now-defunct WoPEc as he mentions. (The site still exists but is no longer updated.) One could also trace its lineage back to the working paper site (EconWPA) at Wash U started by Bob Parks. Bill Goffe's Resources for Economics also came out of those early years. Zimmerman also had a quantitative macro and RBC site that is now part of RePEc that goes back to 1995 according to the copyright. (It's a trip down memory lane thinking about all those early sites.) That sounds about right. That was about the time that I was starting grad school and was pretty early in "Internet Time." The RePEc blog might be a good way to get more people involved, and that would be positive for the site and the profession.

Hat tip to Greg Mankiw.

A footnote: The Wash U connection to all those early internet archives is everywhere. As a minor in computer science in college, I remember well the freeware archive at Wash U. It was probably the first internet address that I memorized... wuarchive.wustl.edu. If you were a CS student in the early to mid '90s, you used it. Sadly, this too is defunct. Does anyone else remember wuarchive?

King Banaian gets it. Responding to Rodrik's discussion starter, he writes,

Because I read more now, I think research is improved too.

I'll second that. And...

I worry about the lemons problem only insofar as one thinks econoblogging is about spreading the word of what's on the cutting edge of economics research or the policy debates. I have never concerned myself with the former, and as to the latter, I'm not terribly convinced that the best policy analysis comes from the economists with the longest c.v.'s. Again, that might be about where I'm from and what I do, a personal bias.

Since I, like Banaian, am on the faculty of a "Non-Flagship State U" we share a similar perspective. I agree that excellent policy analysis can come from economists without a long c.v. So if you can't judge a blog's quality relative to the market solely on the basis of the academic prestige of the author or his/her institution, does that lead to a breakdown of the market? No. Links are the currency of the realm here, and they are the way that information gets passed along. Suppose a brand new blog reader drops in on the economic corner of the blogosphere tonight. After how many minutes of clicking around will he or she figure out who the heavy hitters are? It probably wouldn't take long to get the lay of the land. A lot of those readers will never pick up a copy of the American Economic Review, much less Econometrica. And yet, they will figure out whose blogs are worth reading (and probably figure out who's got the best academic pedigrees as well). Whether their list of favorites would put their c.v.'s in rank order or not, well... de gustibus non est disputandum.

The blogosphere, even just the economics corner, is a big place with room for many styles and approaches. Rodrik seems to have come around on the question that kicked off this whole discussion as well. We'll gladly give him a mulligan on this one. In the world of blogging, that happens, and that's one of the things that makes all this interesting...and valuable.

Wow. Check these out. Here are some of the names: Arrow, Fischer, Krugman, Sen, Chari, Schelling, Samuelson, Fudenberg. If it's more than you'll have time for this weekend, download them now and savor them one at a time.

Dani Rodrik notes Greg Mankiw's recent post announcing the end of comments on his blog and wonders, "Is the econ-blogosphere sustainable?"

At this rate, in any case?

Two things happened in the last twenty-four hours which made me wonder if some of the best economics blogs may be on their way out. First, an economist with a very high-quality blog told me that he was not sure if he had made the right decision by starting it. He said he worried about coming up with new content on a daily basis, and that he may run out of energy at some point. Then, Greg Mankiw declares that he is too busy to be reading and filtering all the comments he gets on his site and turns off the comments section. In a long post, he says the whole blog thing is taking too much of his time, and intimates that he may not be doing this for ever.

So if economists with high opportunity costs of time start to get out, shall we have a lemons problem on our hands? Will eventually the only prolific bloggers remain the ones that are not worth reading?

It is ironic that this post comes in a rather slow period in my own blogging. My excuse? Working on getting a conference paper out. Not to mention the fact that conferences aside, as late October rolls around a lot of us in the academic community find ourselves in a pretty busy time. It's what I call the rhythm of the semester. In my case, a lot more is hitting right now than would be usual even for late October. Opportunity cost, baby!

But to call this a "lemons" problem is to imply that there is some information asymmetry in the market. In other words, when there are a lot of blogs out there, it is harder for people to tell which ones are the "good" ones and which ones are the lemons. Unable to command a price to cover their opportunity cost, the "good" bloggers exit and you're left with lemons.

Nah.

Finding a good blog is a lot easier than finding a good used car, and the commitment factor is a lot less of an issue. If you buy a lemon used car you're stuck. If you find you're reading a sub-par blog, you can move on. Information is passed in the form of links that tie us all together. Yes, there can be a bit of an echo chamber in some corners, but particularly in the economics wing of the blogosphere there is also a lot of cross-traffic between writers of different ideological persuasions. I mean, I comment at Angry Bear once in a while. They haven't kicked me out yet. My comments and their responses there and here build a stock of information about our blogs that makes it way around the network of readers. That helps people make decisions about who to read. So while I wouldn't say that the econ-blogosphere is a picture of a perfect market of ideas, it's got a lot of things going for it. I don't think the lemons issue is much of a problem.

I have a feeling that the stable long run equilibrium will have some of the better blogs that feature mostly economics and less of the daily political bloodsport will post better items less frequently. Also, blogs by academics will be subject to bursts of activity and periods of relative quiet. Readers who become familiar with that rhythm will accept it the same way that TV viewers are accustomed to sweeps week and summer reruns.

In other words, the death of the econ-blogosphere has been greatly exaggerated. It seems much more likely to me that the medium is simply entering another stage in its development.

Here is the press release from the Nobel Foundation:

Adam Smith's classical metaphor of the invisible hand refers to how the market, under ideal conditions, ensures an efficient allocation of scarce resources. But in practice conditions are usually not ideal; for example, competition is not completely free, consumers are not perfectly informed and privately desirable production and consumption may generate social costs and benefits. Furthermore, many transactions do not take place in open markets but within firms, in bargaining between individuals or interest groups and under a host of other institutional arrangements. How well do different such institutions, or allocation mechanisms, perform? What is the optimal mechanism to reach a certain goal, such as social welfare or private profit? Is government regulation called for, and if so, how is it best designed?

These questions are difficult, particularly since information about individual preferences and available production technologies is usually dispersed among many actors who may use their private information to further their own interests. Mechanism design theory, initiated by Leonid Hurwicz and further developed by Eric Maskin and Roger Myerson, has greatly enhanced our understanding of the properties of optimal allocation mechanisms in such situations, accounting for individuals' incentives and private information. The theory allows us to distinguish situations in which markets work well from those in which they do not. It has helped economists identify efficient trading mechanisms, regulation schemes and voting procedures. Today, mechanism design theory plays a central role in many areas of economics and parts of political science.

Here is the scientific background paper. Arnold Kling calls it a "Nobel Prize in abstraction". Marginal Revolution provides a translation as well as links about Leonid Hurwicz, Roger Myerson, and Eric Maskin. Mark Thoma lists some other media links as well.

In this post, Tyler Cowen muses about the practicality of their research, asking "Did these guys get at the real reasons why we don't organize the entire economy as a second-price auction?" That's a fair question. But the seminal contributions of these three to the theory of mechanism design are already central to the study of auctions, regulation, and social choice. Those are precisely the sort of things that the Nobel Committee likes to reward. For laying the foundations of this work, Hurwicz was a great choice. Maskin and Myerson are a little on the young side for an economics Nobel, but very appropriate choices to complement Hurwicz.

After hearing about this, I was having flashbacks to my Ph.D. micro courses all morning. Despite what you might think, that's not entirely a bad thing. I remember well the days and nights I spent poring over the work of these three prize winners. I learned a lot from their papers, and I'm happy to see them get the prize.

The previous post reminds us that The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel will be announced on Monday. Any picks? For years, I've been thinking that Jagdish Bhagwati would be a very good choice. Oliver Hart, Bengt Holmstrom, and Oliver Williamson would make a good trio of winners in the area of the theory of the firm. At the moment, Gene Grossman and Elhanan Helpman are the front-runners on the Thomson Scientific poll. Eugene Fama is also a possibility.

But never underestimate the committee's ability to surprise us. Edmund Phelps was not on a lot of short lists last year. Perhaps this year's will also be unexpected. Nonetheless, all of those mentioned above are deserving and will probably have their day eventually.

Comments are welcome.

www.friedmanlegacy.org

Baseball, Free Markets, and Milton Friedman (Mackinac Center for Public Policy)

Wall Street Journal Op-ed by Thomas F. Siems

PGL at Angry Bear points us to this TPMCafe piece by Jared Bernstein. They both reference the Barry Schwartz piece I discussed here in my last post.

Bernstein uses the Schwartz article as a springboard for detailing the shortcomings of the economics profession, including forecasting (thus the title of this post). Two of his critiques stand out:

2. Economists are reductionists.... the world doesn’t work like the textbooks say it should.

...

3. And one reason for that is, as the NYT oped argues, we misunderstand incentives. To be specific, we exaggerate them.

I have frequently argued (e.g. in this recent post about Iranian gasoline) that the textbook model is not perfect but still useful. In my discussion of the Schwartz op-ed, I conclude that monetary incentives can have nonstandard effects in certain circumstances. We don't completely understand those circumstances and therefore more work is needed. I'm not ashamed to admit that perhaps a little more humility is also needed when considering the possibility of these non-standard effects. But it still remains that the incentive story that drives most economic models is mostly right. The question of whether we exaggerate the magnitude of these effects in our rhetoric (even when we are correct about their existence) is another matter, and I'd be more comfortable if Bernstein didn't lump them together.

I should note also that I have responded to PGL's post in the comments over there. This whole issue of responding to incentives and the usefulness of textbook economics is a worthwhile topic and generates some of the more interesting conversations on the blog. I hope to flesh out some more ideas on this over time.

Bruce Bartlett on why blogging is like a seminar...only better.

Yep, in the grand accounting scheme of the intellectual debate, I'd say that blogging is on the plus side of the ledger.

Via Mark Thoma.

Roll the tape.... from Tuesday:

...I would be wary of a government managed plan for universal broadband access. My fear would be that they would adopt a 20th century solution to a 21st century problem.

Broadband technology (particularly the new wireless broadband) is still evolving. Once you make it a government program, you introduce a lot of rigidity. Better to keep some flexibility until we see which technology is superior. We can, I believe, afford to do that in this case because wireless is a low fixed cost operation compared to high fixed cost utilities such as the electrical grid, the copper wire laid down by Ma Bell, and even cable TV. There will be competition just as there is for wireless phone service--speaking of an industry that went from high class luxury to practically universal access in about a decade.

Friday's Wall Street Journal editorial has this to say:

Much of this [telecommunications sector] growth has been fueled by increased broadband deployment, which makes high-speed Internet services possible. The latest government data show that broadband connections increased by 26% in the first six months of 2006 and by 52% for the full year ending in June 2006.

Also noteworthy, notes telecom analyst Scott Cleland of the Precursor Group, is that of the 11 million broadband additions in the first half of last year, 15% were cable modems, 23% were digital-subscriber lines (DSL) and 58% were of the wireless variety. Between June 2005 and June 2006, wireless broadband subscriptions grew to 11 million from 380,000.

This gives the lie to claims that some sort of cable/DSL duopoly has hampered competition among broadband providers and limited consumer options. That's the charge of those who want "network neutrality" rules that would allow the government to dictate what companies like Verizon and AT&T can charge users of their networks. But the reality is that the telecom industry has taken advantage of this deregulatory environment to provide consumers with more choices at lower prices. Verizon's capital investments since 2000 exceed $100 billion, and such competitors as Cingular, T-Mobile and Sprint are following suit. So are the cable companies.

Memo to Congress: Don't mess this up.

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.

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.

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.

In Economic Principals, Warsh reviews Duncan Foley's new book, Adam's Fallacy: A Guide to Economic Theology. (hat tip to Mark Thoma):

Foley dwells entirely on what economists have managed to make so far of The Wealth of Nations, and gives short shrift to Smith's other book, The Theory of Moral Sentiments, and to the relationship of the one to the other.

He wouldn't be the first. Nor, I fear, the last.

As they say, read the whole thing. Also, Mark Thoma links to these Brad DeLong posts which include a rejoinder from Foley.

That is to say, it's easy over very short time horizons and almost impossible over longer horizons. In Monday's Wall Street Journal, E.S. Browning continues the chronicle of the widening disconnect between the Fed and the market.

The Fed is expected to leave target interest rates unchanged, fueling hopes that it will start cutting rates some time next year, which would be good news for stocks and bonds.

But worries are spreading that, longer-term, investor hopes for interest rates may have gotten a little out of hand. If so, stocks and bonds both could be in for some rough waters in the coming months.

Later in the article, his interview subject expresses thoughts that should be familiar to any reader of this blog.

"Inflation is the key here," says Ethan Harris, chief U.S. economist at Lehman Brothers. "Inflation is the enemy of all markets. If you get serious inflation, if the Fed's fears materialize, then you will have the Fed hiking instead of cutting, pushing growth weaker. That is a lousy environment for both" the stock and bond markets.

Mr. Harris isn't forecasting a resurgence in inflation. He thinks it could remain more or less steady.

But, like the Fed, he doesn't think that is a sure thing, and he thinks investors could be making a mistake to assume that inflation is dying....

Sorry. No "one armed economists" here. On the one hand inflation could be under control. On the other hand the battle may not yet be over.

Some people find a certain irony in all this.

Now, Mr. [Jim] Bianco [of Bianco Research in Chicago] notes, "the guy that is holding the Fed back from easing is Helicopter Ben. We got him all wrong, at least for his first 10 months" in office.

It is really hard not to say, "I told you so."

Anyway, while we sit here and think about the implications of what the Fed may or may not do, Ed Prescott reminds us in a Wall Street Journal op-ed today that it may not matter all that much. The op-ed is titled "Five Macroeconomic Myths" and is sure to provoke a response from people who, for example, think that the national debt is too large (it's #4 on his list). Read the whole thing. Here's part of myth #1 that monetary policy causes booms and busts.

Between 1975 and 1980, the inflation-corrected federal funds rate was low; at the same time, output trended upward until late 1978. So far, things look somewhat promising for the mythmakers. But looking closer at the data we see that output began its downward trend in late 1979 while monetary policy was still easy through most of 1980. Also, output continued its decline through 1982, when it began to climb at a time when monetary policy remained tight.

These facts do not square with conventional wisdom. Our obsession with monetary policy in the conduct of the real economy is misplaced.

Where monetary policy's effect on output is concerned, expectations matter. That is a fact which is not lost on Mr. Bernanke, especially these days.

The mint is taking another run at making a dollar coin people will use. In reality, it sounds like a dollar coin that people will want to collect. (NY Times)

The United States Mint is unveiling four designs for one-dollar coins today, featuring likenesses of the first four presidents. They begin a series that is to last a decade and portray every deceased president.

The United States Mint is planning a series of one-dollar coins to feature every deceased president, with the date stamped into the edge.

The first coin, displaying George Washington on one side and the Statue of Liberty on the other, will go into circulation in mid-February, in time for Presidents’ Day. After that, coins with John Adams, Thomas Jefferson and James Madison will be issued at three-month intervals.

...

The size, color and metal content of the $1 coins will be identical to those of the current Sacagawea dollars, but their luster should last longer because of a new anti-tarnishing compound that will be applied to blank coins between the time they are annealed, or softened by heating, and struck with the design.

The date and some inscriptions will be stamped into the edge, airing out the designs.

The director of the Mint, Edmund C. Moy, said the number of each presidential dollar coin issued would depend on circulation demands forecast by the Federal Reserve, regardless of how well known a president was. “This could be a renaissance for some of our lesser-known presidents,” Mr. Moy said in an interview.

...

Hopes are that the new dollars will be as popular as the state quarters, many of which have been taken out of circulation by collectors. The government has earned $4 billion to $5 billion on the state-quarter series since 1999.

I like dollar coins. We really should emulate Canada with both $1 and $2 coins. Count me in as collecting this series. I also love the quote from the director of the Mint. The number issued will be determined by circulation demand, not the popularity of the president. Be prepared to observe Gresham's Law in action. Andrew Johnson coins might circulate at face value while collectors hoard all the Jeffersons.

Here's the announcement from the U.S. Mint. Note that Grover Cleveland gets two coins for his non-consecutive terms.

Paul at Truck and Barter has done heroic work in putting so many links together.

OpinionJournal has a sampling of Friedman's many pieces written for the Wall Street Journal. Thomas Sowell has a tribute piece as well.

Lawrence Summers shows his class in his NY Times op-ed.

UPDATE: Robert Frank suggests a way to expand the earned income tax credit to be more like what Friedman envisioned while also getting the incentives right. Not an easy assignment, but worth discussing.

Relatively few of us live to age 94. Fewer are still professionally active at that age. Even among academics, who are noted for their ability to continue the intellectual enterprise under the title "emeritus", 94 years is an extraordinary age for a public intellectual.

Milton Friedman certainly was extraordinary in more than just this respect.

His scholarly accomplishments are being lauded widely today, and there is a lot to praise. But it was more than just the papers that he authored that made him so influential. It was that his ideas were infused into the very heart of the discipline. Ideas that he, his students, and his followers advanced have become the standard currency of the realm. Pick up a journal containing macroeconomic research today. You will be looking at his legacy. And what a legacy it is.

I never met the man, but I'm sure many of you would agree that after watching so many hours of his television interviews and specials over the years it was hard not to feel like you knew him. I so enjoyed and admired the way that he conducted himself in the public eye. In those interviews he had a twinkle in his eye that only comes from true passion for the ideas he advanced. He made no apologies for his position. He was staunch and steadfast but at the same time a consummate gentleman.

Whether you agreed with him or not, he forced you to think. As Bill Conerly wrote on his blog (Businomics) today, he did not tolerate sloppy economics. He didn't tolerate sloppy arguments of any kind. He made short work of many a question by an interviewer, sometimes in a way that made you feel for the person who just got put in their place. But there was no malice. He wanted to win people over not by browbeating them, but by convincing them with the strength of his argument. However his quickness could catch even a great interviewer off guard. He came up with the perfect answer right away whereas us ordinary folks would have taken some time to ponder the theory or plumb our memory for an example. It was as if he was one step ahead all the time.

But then he was extraordinary.

What gives me the greatest sorrow today is that there will never be another of those interviews for us to enjoy. No longer will we be able to hear his insight on the momentous economic events of our time. Even at age 94, he had so much more to give, as this op-ed in the Wall Street Journal (dated Friday) illustrates. He was as sharp as ever, right up to the end.

Over the upcoming Thanksgiving break, I plan to re-read parts of Two Lucky People and Capitalism and Freedom. The latter was an inspiration for me as I began my study of economics (by no means was my experience unique). Though I do not fully endorse every single idea in the book, I find it to be so engaging and thought provoking that it inspires new ideas in me no matter how many times I read it. Reading the words of Friedman, like reading the other true giants of the discipline regardless of their position on the political spectrum, sharpens your mind and refines your arguments.

His and Rose's memoir, Two Lucky People is special to me because it came out in paperback right about the time that I proposed to the woman who would become my wife. I told her about Milton and Rose, what a beautiful marriage they had, and what an inspiration he was to me professionally. The more I read about Milton and Rose, the more they became an inspiration to me personally. My future wife agreed and gave me the book as a gift. We celebrate our sixth anniversary on Saturday. That's not even one-tenth as long as Milton and Rose spent together. My wife and I hope and pray that we can enjoy that kind of longevity as a couple. The word "extraordinary" falls short of fully describing it.

In the coming days and weeks, I will offer some additional thoughts on Friedman's contributions and what we can still learn from his ideas, even those that have met with less success than others. Tonight, however, my thoughts tonight are for his family.

NY Times Obituary
WSJ Obituary

UPDATE: Paul at Truck and Barter has an extensive listing of links, including a link to David Friedman's blog.

This month's fedgazette from the Minneapolis Fed features poverty as its theme. There are a number of interesting articles that are worth your attention. In this post, I call your attention to one in particular on income mobility--the ability of individuals and households to move through the income distribution over time.

Income mobility is one of those things that we like to talk about and make claims about. We like to hear stories of "rags to riches", but how often does it really happen? It turns out that we understand relatively little about mobility from a statistical standpoint. Ronald Wirtz writes in the fedgazette article,

Bhashkar Mazumder, an economist at the Federal Reserve Bank of Chicago, has authored several mobility studies in recent years. He said, also via e-mail, that prevailing mobility research throws water on the common notion that U.S. income is highly mobile and more mobile than other countries. More recent studies, like his own, have used much richer longitudinal data that track income over longer periods of time, giving a more accurate reading of lifetime incomes in the United States. Research over the past decade and a half shows that “mobility is relatively low in the U.S. and lower than we thought,” said Mazumder.

...

Nathan Grawe has also done research on income mobility as an economics professor at Carleton College in Minnesota. In his estimation, the four best studies done to date on intergenerational mobility have both positive and negative findings, and most results were not statistically significant; in other words, the findings aren't particularly trustworthy. “All told,” Grawe said via e-mail, “I'd say we have no evidence of change.”

Part of the problem is that studies done before about 1990—which generally concluded that the United States had high mobility—are widely discredited today as faulty, mostly because they relied on very small windows of income data, often just a few years or less. In 1992, Solon published one of the first papers suggesting that U.S. mobility was not as high as everyone thought.

Mazumder's research comes to the same conclusion. But his most recent effort with Daniel Aaronson (also of the Chicago Fed) might have something of a silver lining. They found that current mobility might simply be returning to its historical trend line after experiencing an uptick in the 1970s. In other words, mobility might be worse compared to the 1970s, but it might well be in line with the country's historical average.

Obviously, a lack of longitudinal data going way back will remain a problem. Maybe in fifty years we'll be able to put the current period in historical perspective. Too long for some. You know what Keynes said about the long run. While the evidence here is conflicting and the conclusions not quite conclusive, the situation is better than that concerning the question of how much mobility is optimal.

The notion of perfect mobility—an equal chance for any outcome, regardless of where you start—has a hint of social and economic chaos, by virtue of the fact that it implies a lack of predictability in outcomes regardless of the very things that families and societies tend to value: effort, ability, education and other human capital investment, and parenting.

Economists believe incentives motivate behavior. Grawe, from Carleton College, noted that mobility research was often written “in ways which suggest more mobility is better.” But a society with no obvious determinants for income “would clearly have all sorts of incentive problems.”

For example, parents' attempts to offer certain advantages to their kids—reading to them, sending them to better schools, saving for college, transmitting certain values—might be for naught in a world where these things have no lasting economic effect. In a 2002 working paper on the notion of perfect mobility, sociologist Adam Swift of the University of Oxford wrote, “Even those that regard current mobility patterns as evidence of morally unacceptable unfairness should acknowledge that some mechanisms by which parents transmit advantage—or disadvantage—to their children are unobjectionable and would exist even in an altogether just society.”

In other words, there is no clear guidance at all on how much mobility is optimal or even what we mean by optimal mobility. One cannot escape the fact that mobility requires an appeal to long run incentives, but people do not always behave in accordance with those long run incentives. Hence, a divergence between opportunity and outcomes is assured. This is the world in which we live. And this is why the solution to the problem of income inequality is more difficult than many people realize.

As the last couple of paychecks of the year approach, many people get a temporary pay raise, as Ron Lieber of the Wall Street Journal explains:

By now, many of the 8.9 million Americans who earn more than $100,000 annually have already hit six figures; scores more will do so in the next few weeks. Here's what they may miss if they don't watch their paycheck carefully: A nice-sized raise that appears without warning, then vanishes just as quietly on Jan. 1.

Sound odd? It's a function of tax rules. Most workers have their paychecks docked 6.2% to fund Social Security. But they stop paying that tax on income above a certain level each year. This year, the threshold is $94,200. Next year, it is $97,500.

...

There's no excuse for frittering the funds away. Be deliberate, and start with the obvious checklist: If you haven't maxed out your 401(k), especially the portion that your employer matches, increase your withholding. (Then consider just leaving it there come January to see if you miss the money.) Pay off your credit-card debt, and if you can't get rid of all of it, at least pay down the higher-interest cards. Fund a Roth IRA if you're eligible, and take advantage of the tax-free earnings you'll be able to withdraw once you're older.

Sounds like an application of the permanent income hypothesis. However, since this comes at the end of the year, a lot of people probably do use it to cover their holiday bills. December always throws off my consumption smoothing plans a bit.

Robert Frank considers the relation between economic growth and happiness in today's NY Times

Does money buy happiness? The rapidly expanding literature on what determines “subjective well-being” appears to suggest a negative answer to this timeless question. Studies consistently find, for example, that when the incomes of everyone in a community grow over time, conventional measures of well-being show little change.

Many critics of economic growth interpret this finding to imply that continued economic growth should no longer be a policy goal in developed countries. They argue that if money buys happiness, it is relative, not absolute, income that matters. As incomes grow, people quickly adapt to their new circumstances, showing no enduring gains in measured happiness. Growth makes the poor happier in low-income countries, critics concede, but not in developed countries, where those at the bottom continue to experience relative deprivation.

All true. But these statements do not imply that economic growth no longer matters in wealthy countries. The reason, in a nutshell, is that happiness and welfare, though related, are very different things. Growth enables us to expand medical research and other activities that clearly enhance human welfare but have little effect on measured happiness levels.

Interpersonal utility comparisons are tricky, to say the least. Later in the article...

Since life is a continuing competitive struggle, this is as it should be. Accident victims who can recover their psychological footing quickly will function more effectively in their new circumstances than those who dwell unhappily on their misfortune. Windfall recipients who quickly recover their hunger for more will compete more effectively than those who linger in complacent euphoria.

...

These observations highlight the weakness of subjective well-being as a metric of welfare. The fact that people adapt quickly to new circumstances, good or bad, is just a design feature of the brain’s motivational system. The fact that a paraplegic may continue to be happy does not imply that his condition has not reduced his welfare. Indeed, many well-adjusted paraplegics report that they would undergo surgery entailing substantial risk of death if doing so promised to restore their mobility. Similarly, the fact that people may adapt quickly to higher incomes says nothing about whether economic growth makes them better off.

Critics of economic growth cite its threat to the planet’s survival. Yet it is not growth per se that threatens, but rather certain kinds of growth. Driving more S.U.V.’s causes harm, but taking more piano lessons does not. Any country with a government not beholden to corporate interests could easily curb environmentally harmful activities through taxation and regulation, redirecting spending toward things that really matter. Across developed countries, higher growth rates are actually associated with cleaner environments, not dirtier ones. The United States is the world’s largest emitter of greenhouse gases not because of its wealth but in spite of it.

Frank is angling for membership in Greg Mankiw's Pigou Club.

But growth’s most compelling promise is continuing progress against premature death, perhaps the most devastating of life’s tragedies. American families with five children in 1800 often saw two or three of them die before the age of 10. That this no longer happens has been a landmark achievement.

Intelligently managed growth will hasten our quest to defeat diseases that continue to strike people down in the prime of life. The mere fact that rising incomes do not bolster self-assessed happiness levels is no reason to abandon this quest.

It certainly is true that progress against premature death is one of the most important results of modern economic growth. But I have to ask if that was a result of intelligently managed growth or just plain growth. Intelligently managed growth sounds a bit too much like social engineering for my tastes. Of course there are limits to what an author can do in one short op-ed column. However, I wish Frank was a little more forthcoming about what he means by "intelligently managed." I wouldn't exactly say that the present growth picture qualifies as intelligently managed. What is the scope of the policies that would make our future growth intelligently managed.

I enjoy Frank's writing, and I certainly am in his camp in praising modern economic growth for what it has done for human welfare even if it doesn't show up in happiness studies. But the end of this column is a little hard for me to swallow. Who will manage the growth? What social welfare function will they maximize? Pigouvian taxes to correct well-defined, measurable externalities are one thing. Intelligently managed growth that taxes some activities and subsidizes others without reference to a specific market failure is quite another.

We'll come back to the price gouging discussion another time. But that episode does remind me that there are so many interesting questions involving basic economics that can generate a lot of interesting discussion.

One difficulty in writing for a general audience (including blogging) is that basic economic ideas tend to oversimplify reality. It's unavoidable really. But we should always remember that the basic textbook theories are useful as a starting point--a model, and not a literal description of reality. For example, a significantly higher minimum wage is sure to reduce employment in a ceteris paribus world. However, it will be nearly impossible to identify the winners and losers from a very small change in the minimum wage so it may not be worth getting too worked up about in a world where ceteris is not paribus. (Russ Nelson, however, would not be moved by this argument. On principle, I agree. But from a pragmatic policy perspective...)

Actually, any discussion in which we talk about "the wage" or "the labor market" is already oversimplified. But we do this anyway. The reason we do is that it can be difficult to go into the details in the length of an op-ed or blog post. We simply cannot possibly discuss a multitude of elasticities and other details. We use economic shorthand. The reader fills in the gaps, sometimes by making assumptions that were not intended. In blogging, at least the comments provide for discussion. Remember, just because the writer didn't say it doesn't mean it can't happen or that the writer didn't think about it or is dismissive of it. It just means that the writer wanted to emphasize something else. Occasionally it matters, but a lot of times it doesn't. Some of the best comment threads are where a commenter and I have agreed about most everything but disagreed about some finer point. Perhaps this post will generate some discussion about the assumptions we make, good or bad.

In the Financial Times, Tim Harford answers his "Dear Economist" mail.

How would an economist respond to the phrase “money is the root of all evil”?

Harford answers,

Economists always seem to talk in dollars and cents, yet few economic models contain any reference to the stuff.

The reason why economists will use strange phrases such as “the value of a kiss is $49” is not that they think money is particularly important, but simply that it is a convenient way to measure things. If a toffee apple is worth $7 then a kiss is as good as seven toffee apples; however if the toffee apples cost $6 and the kiss costs $50 then the toffee apples are a better buy.

I am, of course, reminded of this post from last year. In that post, I quote this article by Robert Frank, who poses a question:

"You won a free ticket to see an Eric Clapton concert (which has no resale value). Bob Dylan is performing on the same night and is your next-best alternative activity. Tickets to see Dylan cost $40. On any given day, you would be willing to pay up to $50 to see Dylan. Assume there are no other costs of seeing either performer. Based on this information, what is the opportunity cost of seeing Eric Clapton? (a) $0, (b) $10, (c) $40, or (d) $50."

I still get a bunch of hits from search terms "clapton dylan opportunity cost frank" and variations on that theme.

Harford is doing what Frank did in quantifying the concept of utility in terms of dollars so that comparisons can be made. Economists think like this all the time. Non-economists, not so much. The idea in both is "willingness to pay," which is one of the basic building blocks of economic thinking. It is not surprising to see the idea surface in Harford's column. It will undoubtedly come up again.

What do you think about this? Is this a simple abstract idea that has little application? How does reality complicate the story?

What about the concept of opportunity cost itself? How would you improve our textbook presentation of the idea?

UPDATE: No takers yet? Restating the question: Should opportunity cost be thought cost net of benefits or only what is literally given up with no regard to benefits? Does it matter?

Yes, I know that the original Dylan/Clapton question has been criticized for being poorly worded. Largely that is because it does not explicitly clue in the reader that it is asking for the net cost. One possible reason for confusion is that the textbook definition of opportunity cost is too trivial. Most textbook problems on opportuntity cost don't require any complex thought concerning net cost (e.g. the opportunity cost of 1 apple is 2 oranges or the opportunity cost of sleeping in is going to class). Even the old stand-by example that the opportunity cost of going to college is tuition paid plus foregone wages is stripped of all kinds of interesting details (like the life-changing benefits of socialization in a college atmosphere, etc.) because they are hard to quantify. But when opportunity cost is lurking (unstated) in the background of more complicated quantitative problems it helps to have thought about Harford's example or the Dylan/Clapton question. It is in bridging that gap that most principles texts are lacking.

Thoughts?

UPDATE 2: Gavin Kennedy reminds me that Harford's "Dear Economist" letter misquoted I Timothy 6:10 "The love of money is the root of all evil." I apologize for missing that. As such, Harford gives a terrible theological answer. I did not mean to suggest that his answer was appropriate to the question. I merely wanted to work his answer into this other discussion.

Comments are open to both aspects of the post. If there is sufficient interest, I'll split them off to a separate post.

In response to my last post, Spencer comments:

After disasters major corporations like Wal Mart, Home Depot, etc.., usually do a very good job of resuppling the damaged area with the suplies they need without a significant increase in prices.

Do you have any evidence that a bunch of "price gougers" in pick-up trucks would ever generate a significant increase in the supply of basics like gasoline, electricity, food, medicine and water. Or, is this just another example of assuming a can-opener.

The question got me thinking about those "price gougers in pick-up trucks". Because that is often how they are portrayed in the media. They swoop in with a load of water or chainsaws, charge a bundle, and they're gone. They tend to be from out of town, and the local politicians see it as their duty to keep such opportunists out.

Of course the very reason that price gougers often fit this profile is the fact that the state has made the act illegal. There is a risk to doing what they are doing. That alone contributes to the higher prices that they charge. It also means that it may attract people who are have less to lose, people who are willing to take a risk. The risk is not that the entrepreneurial venture might fail, but that the law might come after them. Established, reputable firms do not want to run afoul of the attorney general, and so you don't see them doing the price gouging. Reputable firms use the opportunity to create goodwill.

Case in point: Culligan donated five semi-truck loads of bottled water after Hurricane Katrina (see the list for a number of other corporate donations). Nice sentiment, and I'm sure the people who received it were grateful. But we wouldn't be having this conversation if a donation of five semi-truck loads was enough to satisfy the demand for water after the hurricane. I did not hear stories of Culligan increasing their sales of water in the area. A brief Google search doesn't turn up much either. But I do find multiple sites mentioning the five donated truckloads.

Consider Spencer's mention of Wal-Mart and Home Depot. Again, a lot of what they provide was donated. And while that is a wonderful thing, there is something a bit odd about the overall picture. What the large companies do in providing donations is good, but falls short of meeting the total demand for these items. Again, the fact that we are having this conversation suggests that in a perfect world these companies would do even more. Are they instead doing just enough to generate some goodwill, some TV ad copy, and a feeling among the residents that they care more than the price gougers in pick-up trucks?

It is also important to note the relevant time frame. The typical pattern as I have observed it reported in the media is that the price gouging tends to be worst in the immediate aftermath. As basic utilities are restored and transportation becomes easier, then the regular retail function of Wal-Mart, Home Depot, et al. can resume. And then price gouging (be it by big boxes or guys in trucks) becomes less of an issue.

Another possibility to consider is that the national chain stores could take a loss on bottled water for a short time in a localized area in the interest of goodwill with the community. That adds an insurance dimension to the problem. Remember that the increase in price after the disaster is associated with the cost of arbitrage across locations. That cost is likely to be smaller for a retailer with a national distribution network, and they might just eat all or part of that cost.

But as long as these disasters continue to lead prosecutors to start a "witch hunt" for anything even resembling a profit motive, reputable companies will not do enough to satisfy the demand. Sure, the token five truckloads of water will come, but that is, pardon the pun, a drop in the bucket. All you will see are guys in pick-ups, who make good targets for politicians wanting to score points with the voters.

There is that which is seen, and that which is unseen. What is unseen here is that Wal-Mart, et al. could possibly satisfy more of the excess demand if they weren't afraid of being punished for trying.

The fact that we treat bottled water in a disaster area in a manner that encourages reputable, national firms to make token donations rather than engage in the unseemly profiteering that might actually help more people should give us pause. The fact that this attitude in government also makes the actions of the less scrupulous profiteers more harmful by forcing them to take additional risks and fly under the radar should also give us pause.

So no, I don't have evidence that guys in pick-up trucks would do a better job. That's the wrong question. I do have a very strong reason to believe that large companies could do a much better job if they knew they wouldn't be excoriated by politicians and the media for making a modest amount of money from it. While I praise them for their generosity, I think you'd get more than five truckloads from Culligan if they could charge a modest amount for their trouble. The fact that there are still guys in pick-up trucks means the established, reputable companies are not doing enough.

The guys in pick-up trucks are a second-best solution to the problem. The first-best solution is for established, reputable firms to enter those areas and drive the high cost risk takers out of business. But that will only happen if the government eases ceases vilifying the notion of profit, even a modest amount, in these situations.

I do have evidence that the government does an absolutely lousy job of providing these goods and services. I don't think that the private sector would do this.

Remember when you were a kid and you couldn't wait to see the odometer in the family car turn over to some multiple of 10,000. Of course in today's cars the odometers are digital, so it's about as exciting as seeing your digital watch tick past midnight. Those old odometers looked like they really had to work to turn that last digit.

And so it is with the U.S. population clock which, as I write this, stands at 299,998,288. You can check the current number for yourself by going to the Census Bureau web site. In the morning, the big three-oh-oh (million) will have been reached. The Census Bureau's clock, like my odometer, is digital. The addition, be it by birth or by immigration, will arrive seemingly effortlessly. I think that is a good analogy. We're not running out of room in this country by any stretch of the imagination. Our society and economy will absorb the 300,000,000th person as readily as the 299,999,999th. And by 2050, we'll be adding number 400,000,000--a fact which causes Joel Kotkin to opine in the Wall Street Journal:

Unless there is some sort of cultural revolution, most people, particularly families, are likely to continue migrating to places where they can acquire a spot of land and a little privacy. And despite the much ballyhooed "return to the city" by aging boomers, most experts suggest that most are either staying in the suburbs or moving to towns farther out in the hinterland. At least 30% of Americans, according to surveys by the National Association of Realtors and the Fannie Mae Foundation, express the desire to move to the country or a small environment, far more than live there now. The scale of this dispersion depends largely on urban governance. If cities cannot, due to economic or regulatory constraints, provide sufficient job opportunities, people and businesses naturally will flee elsewhere. Other factors, such as preserving family-friendly neighborhoods and stamping out a nascent resurgence in crime, will also be critical.

Yes, we will find room for number 400,000,000 too. There is room for a few of you out here. Sorry, no "for sale" signs on my block. The few that were available this summer have long since been sold. Unlike some places, the real estate market here seems to be approximately in equilibrium. Growth is proceeding sensibly. I still have to get used to the sight of a new apartment complex a mile or two south of us. More room for the next hundred million Americans.

So rejoice at this milestone. Malthus was wrong. We're not doomed by population growth. While a growing country has always presented certain challenges, it has been our innovative responses to those challenges that have made this country what it is. And it's a reason that people keep coming.

To the 300,000,000th American: Welcome! We're glad you're here.

Kash Mansori has a new blog... The Street Light.

I've added it to my feed reader already.

BlogNetBiz is an interesting addition to the blogosphere. In addition to the usual aggregator function, the site keeps track of the most active blogs and most active comments sections. Sort of a real time ranking system. Check it out.

Hat tip: EclectEcon

Edmund Phelps has an op-ed in today's Wall Street Journal in which he defends a dynamic form of capitalism. He contrasts this dynamic form of capitalism found in America with the Continental European system.

There are two economic systems in the West. Several nations -- including the U.S., Canada and the U.K. -- have a private-ownership system marked by great openness to the implementation of new commercial ideas coming from entrepreneurs, and by a pluralism of views among the financiers who select the ideas to nurture by providing the capital and incentives necessary for their development. Although much innovation comes from established companies, as in pharmaceuticals, much comes from start-ups, particularly the most novel innovations. This is free enterprise, a k a capitalism.

The other system -- in Western Continental Europe -- though also based on private ownership, has been modified by the introduction of institutions aimed at protecting the interests of "stakeholders" and "social partners." The system's institutions include big employer confederations, big unions and monopolistic banks. Since World War II, a great deal of liberalization has taken place. But new corporatist institutions have sprung up: Co-determination (cogestion, or Mitbestimmung) has brought "worker councils" (Betriebsrat); and in Germany, a union representative sits on the investment committee of corporations. The system operates to discourage changes such as relocations and the entry of new firms, and its performance depends on established companies in cooperation with local and national banks. What it lacks in flexibility it tries to compensate for with technological sophistication. So different is this system that it has its own name: the "social market economy" in Germany, "social democracy" in France and "concertazione" in Italy.

One minor quibble that I would have is that the three economies he holds up as representative of the dynamic form of capitalism are quite different even among themselves in terms of how dynamic (i.e. conducive to entrepreneurial activity) they are. Indeed, states and provinces themselves differ. But I digress. The real issue is still to come...

Dynamism does have its downside. The same capitalist dynamism that adds to the desirability of jobs also adds to their precariousness. The strong possibility of a general slump can cause anxiety. But we need some perspective. Even a market socialist economy might be unpredictable: In truth, the Continental economies are also susceptible to wide swings. In fact, it is the corporatist economies that have suffered the widest swings in recent decades. In the U.S. and the U.K., unemployment rates have been remarkably steady for 20 years. It may be that when the Continental economies are down, the paucity of their dynamism makes it harder for them to find something new on which to base a comeback.

...

Why, then, if the "downside" is so exaggerated, is capitalism so reviled in Western Continental Europe? It may be that elements of capitalism are seen by some in Europe as morally wrong in the same way that birth control or nuclear power or sweatshops are seen by some as simply wrong in spite of the consequences of barring them. And it appears that the recent street protesters associate business with established wealth; in their minds, giving greater latitude to businesses would increase the privileges of old wealth. By an "entrepreneur" they appear to mean a rich owner of a bank or factory, while for Schumpeter and Knight it meant a newcomer, a parvenu who is an outsider. A tremendous confusion is created by associating "capitalism" with entrenched wealth and power. The textbook capitalism of Schumpeter and Hayek means opening up the economy to new industries, opening industries to start-up companies, and opening existing companies to new owners and new managers. It is inseparable from an adequate degree of competition. Monopolies like Microsoft are a deviation from the model.

I think a lot of us have given a lecture in class something along those lines, haven't we? And we might even use it as a springboard to talk about social/economic justice. Phelps writes,

... Are those whose dream is to find personal development through a career as an entrepreneur not to be permitted to pursue their dream? To respond, we have to go outside Rawls's classical model, in which work is all about money. In an economy in which entrepreneurs are forbidden to pursue their self-realization, they have the bottom scores in self-realization -- no matter if they take paying jobs instead -- and that counts whether or not they were born the "least advantaged." So even if their activities did come at the expense of the lowest-paid workers, Rawlsian justice in this extended sense requires that entrepreneurs be accorded enough opportunity to raise their self-realization score up to the level of the lowest-paid workers -- and higher, of course, if workers are not damaged by support for entrepreneurship. In this case, too, then, the introduction of entrepreneurial dynamism serves to raise Rawls's bottom scores.

Though this defense of capitalism probably will not satisfy the most adamant free-marketers (he takes a little jab at Hayek and Ayn Rand) it is a reasoned defense. It is a plea for justice for the entrepreneur. And yet, it is difficult within our political system to craft policies that encourage the entrepreneur without also aiding established wealth. "Corporatism" as a mutation of capitalism carries with it an ability to seek (and often obtain) rents from government (regardless of who is in power). To that extent, the street protesters have a point. Corporatism is not the dynamic capitalism that Phelps wants.

But we must rememeber that, as Phelps says in his concluding paragraph, that "Capitalism in its innovations plants the seeds of its own encrustation with entrenched power." Perhaps that means that while we must allow business to grow, we also need to prune it back once in a while for its own health. One of the most important policy debates will be how we can increase the dynamism of the U.S. economy without allowing corporatism to stifle it. This is both a macro and a micro question. On the macro side, how do we formulate tax policy that encourages small businesses when large corporations and their lobbies use the process to further their own objectives (which may run counter to broader social objectives)? On the micro side, how do you regulate intellectual property--the new wealth driver? How do we prevent firms from exercising their market power to pre-empt entrepreneurial entry into their markets? These are the big questions. These are the tough questions. Our record in dealing with them has been mixed. The consequences of failing to deal with them are dire. Economists are more likely than politicians or the mainstream media to bring up these questions. Perhaps it is where we are most useful. The lens of economics can bring these issues into sharp focus. Debate and disagreement is inevitable, but the alternative--ignorance of the economic consequences--is much worse.

UPDATE: Felix Salmon has a harder time overlooking the problems with the first couple paragraphs that I allude to above.

He starts off with a strong and almost certainly wrong assertion ("There are two economic systems in the West") – meaning the US, Canada, and the UK on the one hand, and continental Europe on the other. He never tries to show that his assertion is true, but he loves to ride it into weird wonderlands:

Yeah. The writing is not as sharp as what we have come to expect from Milton Friedman. But there is something worth taking away from it nonetheless.

UPDATE 2: The free link to the article is now provided, with a tip of the hat to Greg Mankiw.

A superb choice. Here is the official Nobel page for Edmund Phelps. Here is some information on his work that led to the prize. Here is a classic Wall Street Journal op-ed from 1996.

Tyler Cowen has the best blog entry that I read today.

Like Cowen, I find it hard to classify Phelps into a single category. Unlike fellow Laureates Friedman and Lucas, Phelps did not become the leader of a particular school of thought. Yet his ideas were picked up by a wide swath of the profession. In fact, New Keynesians and Neoclassicals alike can trace their lineage through Phelps' papers. Reading the titles of some of his papers from the '60s and '70s remind a person of just how far ahead of the curve he was.

Concerning the overall meaning of this prize, Cowen says it well.

Relevance and breadth triumph over narrow technical skill.

Gabriel Mihalache has a blog called Economic Investigations that you might want to check out. He is a self-confessed "neoclassical cowboy" who spent the summer reading David Romer's Advanced Macroeconomics and everything he could find by Robert Lucas. I think students might particularly like his blog because he comes at it from the point of view of someone who, well..., spent the summer reading Romer and Lucas. In other words, he's brimming with enthusiasm and ideas. Some of his posts would be good fodder for grad student discussions. Take a look!

This is nice to see. Norman Borlaug has received some press lately. In the Opinion Journal...

Who? Norman Borlaug, 92, is the father of the "Green Revolution," the dramatic improvement in agricultural productivity that swept the globe in the 1960s. He is now the subject of an admiring biography by Leon Hesser, a former State Department official who first met Mr. Borlaug 40 years ago in Pakistan, where they worked together to boost that country's grain production. "The Man Who Fed the World" describes, in a workmanlike way, how a poor Iowa farm boy trained in forestry and plant pathology came to be one of humanity's greatest benefactors.

...

Whether bread induces peace is a question for another day. It certainly kills hunger and saves lives. Contrary to Mr. Ehrlich's bold pronouncement, hundreds of millions of people did not die for lack of food. Far from it. Despite occasional local famines caused by armed conflicts or political mischief, food is more abundant and cheaper today than ever before in history. It is an absurd travesty that Mr. Ehrlich is still much better known than Mr. Borlaug, but perhaps Mr. Hesser's biography can begin to right the balance.

Mr. Borlaug is still tirelessly working to keep hunger at bay. He remains a consultant to the International Maize and Wheat Improvement Center in Mexico and president of a private Japanese foundation working to spread the Green Revolution to sub-Saharan Africa. He believes that biotechnology will be crucial to boosting world food supplies in the coming decades and decries the underfunding of the world's network of nonprofit agricultural research centers.

He also laments the unnecessary suspicion with which biotech is treated these days. "Activists have resisted research," he notes, "and governments have overregulated it." They both miss the point. "Responsible biotechnology is not the enemy: starvation is."

And in The Economist...

NORMAN BORLAUG, who won the Nobel peace prize in 1970 for his role in the green revolution, remains as sturdy and “high-yielding” as the varieties of wheat he helped to invent. Last week, at the age of 92, he gave a stirring lecture in Washington, DC, calling for a renewed effort to bring his revolution to Africa, the one continent it bypassed first time around.

The Economist does not mention Hesser's new biography.

The Canadian Broadcasting Corporation posted this on their blog. (I didn't know the CBC had a blog. I may have to check that out more often.)

Joining forces with the Rockefeller Foundation, the Gates foundation will immediately pump $150 million into seed research. Already the Rockefeller scientists say they have a developed a new strain of rice that could increase yields in West Africa five times.

...

Noting Borlaug's work took 20 years before it met with ultimate success, Bill and Melinda Gates promised their foundation will stay the course in the fight against African poverty.

It's clear the world's richest countries have not dented African hunger and poverty.

Private sources and philanthropy will finance Borlaug's ideas that worked so well years ago.

Give them better seed and resources. Help them grow more food.

Finally, for those who desire even more, the presentation links are here (transcript, video, and slides).

The Virtue of Capitalism (Townhall.com)

h/t Marginal Revolution

The NY Times has this to say:

Dr. McClellan wins praise from some Democrats and leaders of advocacy groups for focusing on important policy issues and responding to valid complaints. Some critics disparage him for toeing the administration line too uncritically. But even they think they will be lucky to get anyone so accomplished as his successor.

Mark McClellan was on the faculty of the economics department at Stanford before heading the Food and Drug Administration. He is one of a rare breed of Ph.D. economists and M.D. physicians. Grad school in economics AND medical school! Here is his bio from the HHS website. See it now, since it will probably disappear when he leaves.

[This started out being a single topic post, but it presented an opportunity to weave together a number of things that have come up in the news lately and have been on my mind. There is a common theme.]

Joel Kotkin looks toward my old stompin' grounds and likes what he sees. (Wall St. Journal)

Fargo-Moorhead, the pair of cities straddling the Red River (the boundary between North Dakota and Minnesota), is a thriving metropolis of slightly less than 200,000 that grew by over 20% between 1990 and 2000 and has added an additional 4,300 people over the past five years. One in five newcomers was an immigrant. Bismarck has seen a similar surge in population, growing by 3% over the past five years.

...

...According to the National Science Foundation, North Dakota ranks No. 2 in academic R&D dollars per $1,000 of gross state product, right behind Maryland and right ahead of Massachusetts. It ranks fourth in technology companies as a percentage of all business startups.

...

If the energy and technology booms bring more high-end workers to Bismarck, the broader labor shortages are driving up salaries, on average some 15% across the board between 2002 and 2005. This movement is even helping those workers who have historically had the lowest salaries. Bismark's McDonald's restaurants now start pay at upwards of $8 an hour, with some stores offering "signing bonuses" of between $100 and $150 to work under yellow arches.

Yes, opportunities abound, and the quality of life is good too. According to Bizjournals.com, the west and midwestern plains states are pretty good places to live and do business. In a survey of 577 "micropolitan" areas, the west and midwest were well represented. Bozeman, MT came in first. Minnesota has 7 in the top 50. Phil Miller will be pleased to know that Mankato came in 16th. David Tufte's home of Cedar City, UT was 48th. Here in Macomb, IL we made the top hundred (94th) which puts us in roughly the top 16%. Macomb narrowly misses the top 10 (11th) in percentage of residents with graduate degrees. Make no mistake--big university in a small town rockets a place to the top of a list like this. There is a lot to be said for living in a small town with a big (or medium sized) university. We have access to performing arts... a jazz festival that rivals those in much larger cities is coming up in a couple weeks. In October, the touring production of RENT comes to town. We have libraries, broadband access, and Division I athletics to entertain us. Not bad for a city of 20,000. By the way, micropolitan areas are defined as follows:

Micropolitan areas are smaller than metropolitan areas. Each micropolitan area consists of a county or cluster of counties that are economically dependent on a central city, town or village with 10,000 to 50,000 residents. The U.S. Office of Management and Budget has classified 577 micropolitan areas across America. Statistics in this study cover all portions of micropolitan areas, not just their central communities.

With such a good quality of life in places like Fargo, Iowa City, and Macomb a person can follow his or her vocatio and be very happy, very unlike the "Great Gatsby." As it happens, Robert Frank discusses happiness in today's NY Times,

Gatsby’s unhappiness may also be explained in part by the finding that those who focus most consciously and intensely on material success also tend to experience low levels of measured happiness. This is a singularly important finding for the many incoming freshmen whose only apparent goal is to become fabulously wealthy by age 25.

A far more promising strategy, according to the happiness literature, is to seek work you love. Those who find such a calling typically become deeply engaged in their professional lives. And engagement, in turn, leads to expertise, which in some fields, at least, leads to wealth. Finding work that you value for its own sake is thus not only a promising path to happiness, it may also increase your chances of becoming rich. But even if not, it will improve your odds of becoming an interesting person, someone who is attractive to both friends and potential mates alike.

One can follow that strategy anywhere if you really want to, even in places like Fargo, Iowa City, and Macomb. Furthermore, with the internet and modern supply chain management, we in the smaller metro areas (and micropolitan areas) can partake of the conveniences of modern life that make us wealthier just the same as folks from the coasts. That would not have been the case in the 1920s or even the 1960s. The fact that I can communicate these thoughts with you, my readers from New York to Australia, from the hamlet of Macomb, IL is itself an indication that we live in amazing times. It's difficult to measure it, but it makes me happy. And I count it as wealth.

Don't get me wrong. The picture is not entirely rosy. This is not a Panglossian "best of all possible worlds". But neither is the bottom falling out. When McDonalds is paying $8/hr (something that I last saw in Iowa City in about 1999 at the peak of the dot-com boom), that's something you can't ignore.

Hal Varian, writing on the Economic Scene (NY Times), thinks about how to improve the incentives for people to save.

One promising proposal has been to set defaults for enrollment in 401(k) plans so that employees are automatically enrolled in an appropriate plan unless they explicitly choose otherwise. Brigitte C. Madrian, an economist at the University of Pennsylvania, and Dennis F. Shea, from the UnitedHealth Group, have found that this simple policy increases participation rates dramatically.

Another suggestion is to provide matching grants to low-income individuals. Esther Duflo of M.I.T., William G. Gale and Peter Orszag of the Brookings Institution, Jeffrey B. Liebman of Harvard and Emmanuel Saez of the University of California, Berkeley, recently released a working paper examining the design of such a plan. ("Saving Incentives for Low- and Middle-Income Families: Evidence From a Field Experiment With H&R Block"; a nontechnical summary is available at http://www.nber.org/digest/may06/w11680.html.)

In this experiment, about 14,000 low- and middle-income families in the St. Louis area were offered a 20 percent match on their contributions to an I.R.A., a 50 percent match or no match at all. Individuals could make a direct contribution or allocate part of their tax refund to an Express I.R.A. account offered by H&R Block.

Only 3 percent of the individuals who had no match — the control group — contributed to an I.R.A. But 8 percent of those with a 20 percent match rate contributed, and 14 percent of those with a 50 percent match contributed. The amount contributed was four times as much as the control group for the 20 percent match rate and seven times as much for the 50 percent match rate.

The first option is a bit of an admission that people aren't always perfect rational optimizers (see also this post). I have no problem with it as long as people always have the option to change. For one reason or another, a lot of people never move off the default settings, so be sensible about setting the defaults. Good advice for software design and for policy.

The second option is the sort of thing you'd expect an economist to suggest. Are the policymakers listening?

As they say, read the whole thing.

UPDATE: Mark Thoma wishes that Varian would identify the specific market failure that necessitates government intervention. Part of it might, in fact, be myopia on the part of savers (a behavioral issue rather than a market failure). Brad DeLong once said as much. Surely this wouldn't be the only example of a government intervention meant to change behavior rather than correct market failure. (Not all such interventions are agreeable to me, but I'd give this the benefit of the doubt.) Furthermore, I would add that government intervention for a good reason to correct a market failure such as moral hazard and provide a social insurance program may have some negative effects on incentives to save. Again, I refer to Brad DeLong's posts (such as this one) where he not only addresses the need to increase savings in the context of the Social Security debate but also recommends making it the default option to put your tax refund into a savings plan (which is similar in spirit to the first option in Varian's article). I really do think that part of the problem of low savings is that we have an imperfect solution to a fundamental market failure and the low personal savings rate, especially among low and middle income Americans is one of the side effects. So while I like the ideas Varian describes and would like to implement them, we probably could do something better than adding epicycles on epicycles.

Via Phil at Market Power comes this article from the StarTribune.

Thousands of college students and parents are clogging phone lines and rushing to Internet sites in a scramble to refinance college loans before a sharp interest rate increase this weekend.

An almost 2 percentage point interest rate increase for federal student loans kicks in Saturday, and advisers say that not refinancing could cost thousands of additional dollars in interest in the decades after a student enters the work force.

...

"There are very few situations in which it is not advisable for a student who has outstanding loans to consolidate, because they will lock in" relatively low interest rates, said Sandy Baum, an economics professor at Skidmore College in Saratoga Springs, N.Y. Baum is also a financial aid analyst for the College Board education association that produces the SAT college entrance exam.

It is true that students who do not consolodate now will pay more, at least for a while. I'd quibble a little bit with the statement that it will cost "thousands of additional dollars in interest in the decades after a student enters the work force." That's not necessarily precisely true. The rates they will get now are not the lowest in history. If you refinanced last year, you got an even better deal. If interest rates ever get back to where they were about a year ago, then one could wait to refinance until then. It's even possible that sometime in the next "decades" that rates could even go lower, but I admit that would be a gamble.

But the way the student loan system works is that you only get one chance to consolidate. Think of it as if you only get one shot at refinancing your home mortgage. When do you do it? The problem is essentially one of determining when to exercise an option. Whenever the interest rate you get from the consolidation loan is less than the weighted average of your original loans, you are "in the money." But you may not want to exercise the option if you think that rates are going to go down in the near future. So how long do you think it will take for rates to get down to last year's levels again? Your answer will determine whether you think consolidation is a good deal. If you're a recent grad with an average loan balance just starting to make the full payments, you'll probably want to take the deal now. But every situation is different. Your mileage may vary, etc.

I don't have any more loans to consolidate. However, my story is instructive. I figured out early on that consolidation is like an option, so I figured out a way to hedge my bets. I had a number of loans from 4 years of college and some occasional smaller loans during grad school. I consolidated in stages over the years, finishing last year when rates were really low. Knowing that last year's rates were the best I would see in the life of the loan, I went "all in" and gave up any option of consolidating again. I ended up with a weighted average that is a bit higher than if I had timed things perfectly, but better than if I had gone all in right away. (Think of it as getting only one chance to refinance your house, and so doing it one room at a time to keep your options open.) Trust me, its still a better deal than I ever thought I'd get when I graduated from college. Plus, it was an interesting real-world exercise... a chance to practice what I preach.

So my take on this whole consolidation rush is a bit different from the media's. With the exception of those people who just took out loans this year and thus could not have consolidated last year, all of these folks could have done it last year. Either they thought the Fed would stop raising rates sometime in the last 12 months and that lower rates were on the horizon or they missed a really easy call. I think it was the latter.

And that's some real-world macro that has a chance of connecting with college students.

John Palmer sees the Palestinian Authority running out of money and ponders what might lie ahead.

My guess is that unless other [Arab?] nations cover the shortages left by canceled EU and Western aid, then within a year (and possibly just a few months), the PA will declare its independence from the New Israeli Sheqel and the Jordanian Dinar and start printing money to pay its debts. The effect will, of course, be to create massive and rapid inflationary pressures. These will be followed by ruthlessly enforced price controls and foreign exchange controls.

Whether it will play out this way depends on Middle Eastern politics and diplomacy. By comparison, predicting the Fed's June decision looks like a piece of cake. This bears careful watching. One hyperinflation in the world right now is one too many.

Liran Einav and Leeat Yariv have an interesting paper in the Journal of Economic Perspectives (Winter 2006). The title is, "What's in a Surname? The Effects of Surname Initials on Academic Success." Here's a tease...

We suspect the "alphabetical discrimination" reported in this paper is linked to the norm in the economics profession prescribing alphabetical ordering of credits on co-authored publications. As a test, we replicate our analysis for faculty in the top 35 U.S. psychology departments, for which co-authorships are not normatively ordered alphabetically. We find no relationship between alphabetical placement and tenure status in psychology.

Personally, I always go alphabetically. If it truly is a team effort (and I only co-author when it truly is a team effort), then order should make no difference. It makes no difference to me, at least. Apparently, this is not a universal opinion. I haven't had time to thoroughly critique it, but at first glance, it is an interesting paper.

...increases the premium people will pay to someone who can get the job done. CNN reports:

DOLORES HIDALGO, Mexico (AP) -- Barely 18, Jose belongs to Mexico's new generation of migrant smugglers -- young, savvy and happy to see Uncle Sam further tighten border security.

Why? It's good for business, he says.

Jose figures more migrants will seek his help if the U.S. Senate approves legislation to double the Border Patrol and put up a virtual wall of unmanned vehicles, cameras and sensors to monitor the 2,000-mile border with Mexico.

If you want to know what would happen next, just look to the drug trade. The article continues...

"The new generation of migrant smugglers are youths who see their clients as merchandise," [Mexican border expert Victor] Clark said. "Many of them abandon the migrants in the desert or give them drugs, or tell migrants they know the way when they don't, and they end up dying along with the migrants. Others have turned to violence to steal clients from other smugglers."

The Law of Unintended Consequences rears its ugly head yet again.

I'm doing some research this weekend. My computer is grinding away at the numerical analysis which gives me a chance to multi-task and check out what I've been missing.

First of all, the Senators' trip to China continues to get media play. Nothing new to talk about. You know what I think.

Rounding up all the rest of the weekend's news, Big Picture and macroblog do the honors. Do yourself a favor and check them out. Their impressive collections of links could keep you busy all day. Macroblog's post is almost all links with a few connecting words! Very nice.

FOMC this week. I will be in class when the press release will come out on Tuesday, so I'll comment later in the afternoon. The minutes from Bernanke's first meeting will be of some significance, but we'll have to wait a few weeks for that.

And with that, my computer program finished crunching its numbers, so it's back to work.

I doubt it will shake too many people from their prior beliefs, but you should definitely surf on over. It's in the free section--get it while you can. There may be no such thing as a free lunch, but if you can spare a few minutes, I think the marginal benefit will exceed the marginal cost of your time.

Wall St. Journal Econoblog link

While I tend to side with Roberts on this one, I must say that the discussion gave me some ideas that I intend to kick around a bit. Something to think about over spring break.

Mark Thoma (Economist's View) and Andrew Samwick (Vox Baby) square off in the latest Wall Street Journal Online Econoblog.

Key quotes... Thoma:

Globalization will continue to motivate firms to eliminate these costs in any case. As social insurance is separated from the worker-firm relationship, government and individuals will be left to pick up the slack. Where I believe Andrew and I may differ is the degree to which this insurance ought to be provided by government rather than through individuals interacting in the private marketplace. There are substantial problems -- market failures -- in the private-sector provision of health and retirement insurance that are not easily overcome with market-based regulatory schemes.

Samwick...

...We do several things wrong in the way we provide health insurance to non-retirees, and our first tasks should be to undo these mistakes.

The first mistake is to make insurance voluntary when we don't subsequently exclude those who need care from getting it at the public's expense. We should make health insurance mandatory, but we should do so by putting the mandate on the individual, not the employer. Those who cannot provide proof of insurance on their tax returns should be charged an amount that corresponds to an insurance policy in their area. Implementing this on the tax form allows for family resources to be taken into consideration.

Curious about what the other mistakes are? You know what to do.

I really enjoyed reading this Econoblog, and I'll tell you why. Mark Thoma and Andrew Samwick do an outstanding job of showing the Wall Street Journal readers how economists can have a debate on a controversial subject like this. The reader can clearly identify the points of agreement and disagreement. Mark nails the question: How much social insurance should be provided by the government and how much should be provided by markets. They both note the market failures in health insurance. Samwick calls attention to the way the tax code distorts the private insurance market. By identifying the questions and highlighting specific economic issues of incentives, efficiency, and equity, they generate a lot of light and surprisingly little heat.

The Wall Street Journal has a nice article on the economic impact (or non-impact) of the Super Bowl. (subscription required) Two blogging economists were quoted (King Banaian of SCSU Scholars and Craig Depken of Division of Labour)

"There are numerous studies by reputable economists showing that the Super Bowl has a significant positive economic impact on host cities," said NFL spokesman Greg Aiello, who's all too familiar with the critiques from Mr. Sanderson and other sports economists. "Businesses and city leaders know the Super Bowl draws thousands of people to their city who spend large amounts of money and that the Super Bowl gives the host city unmatched media exposure. Cities want the game because it has tremendous value. It's common sense."

Tell that to Phil Porter, a University of South Florida economist who has looked at the economic impact of six Super Bowls. He found that Miami-area hotel rates and occupancy levels increased only 4.4% for Super Bowl XXIX compared with the same period in the prior and following years. Similarly, he found that Super Bowl XXXIII, also in Miami, had no more than a $37 million impact on the South Florida economy. Economists Robert Baade of Lake Forest College and Victor Matheson of Williams College pegged it at $21 million to $32 million, about one-tenth of the NFL's claims.

...

The NFL's estimates, bought and paid for by the league, assume that every dollar spent around a Super Bowl is new money that stays in the community. But the economists argue that you can't merely look at the gross aggregate of Super Bowl-related spending.

"Most economic impact studies implicitly assume the hotel occupancy would have been zero without the event," says University of Texas economists Craig Depken and Dennis Wilson, who looked at the 2004 Super Bowl in Houston.

"The athletes, the chain hotels and restaurants receive money from the Super Bowl and take the money out of the area," notes King Banaian, economics chairman at St. Cloud State University in Minnesota. "This reduces the impact on the local economy."

Right. When these economists and others say that you can't just look at the aggregate, that's another way of saying that you have to understand opportunity cost. How else could the city have spent that money? How many people would have been in the hotels if they didn't have the Super Bowl? The list goes on.

What comes to mind when you hear the word Enron? Remember when they were just an ordinary pipeline company? Remember when what they did as a company started to get a little fuzzy? CNN reposts a Forbes article from 2001 that will take you back to those heady days. Read it and remember.

In Part I of this two part post, I laid out a specific example pulled from the headlines that highlights the opportunity cost of an act of compassion. In this post, I will try to generalize a little to see what we can learn from this.

When you hear the term "social safety net," what comes to mind? I tend to think of Social Security, unemployment insurance, or welfare programs. A social safety net is there to catch you if you fall through the cracks in your own support system. A social safety net is the government following the "Golden Rule" (Do unto others...) on our collective behalf. My ideal social safety net is part of the social contract I would design from behind Rawls' "Veil of Ignorance." These are some things that come to my mind.

But the social safety net is not free. As a concrete example, consider Social Security--part retirement plan, part safety net. Your benefits when you retire are related to your contributions, but are less than what those contributions might have received if invested in other assets. The reason is that Social Security also pays disability and survivors benefits. That knocks a couple points off your implied rate of return. That, my friends, is opportunity cost.

So it is with other things that governments do to protect us. Consider the example of fire protection I raised in the previous post. Fire protection is usually thought of as a public good rather than a social safety net, but the notion of opportunity cost is the same. And because it is closely tied to the concept of insurance, it is certainly a relevant comparison. Fire protection is very costly, and modern firefighters do much more than their ancestors, the fire insurance companies of a couple hundred years ago. Modern fire departments protect us against more than the loss of our home or business. They protect us from hazardous material spills and come to our aid in medical emergencies. A hazmat team is expensive, and if modern fire companies were financed only by homeowners insurance, I doubt that hazmat teams would exist, at least not in their present form. Government stepped in. We collectively choose to pay for a higher level of protection. Again, this has an opportunity cost. When a city needs to hire more firefighters, taxes must go up or something else must be cut.

But just as there is a cost, there are also benefits--in some cases benefits that extend beyond the individual. And many people would argue that it is part of the social contract that we have a responsibility to pay a share of the cost even when we do not enjoy a direct private benefit.

Measuring the private benefit of this blanket of protection is to ask the question of how much you would need to be compensated in order to voluntarily waive your right to that protection. But that does not measure the social benefit. It does not measure how much you are willing to pay to ensure that protection is there for your neighbor.

Of course caring for your neighbor is not the usual picture of the rational, utility maximizing, self-interested homo economicus (Adam Smith's Theory of Moral Sentiments notwithstanding), but consider the following scenario.

Suppose that your city is building a "free" public health clinic. You could measure individual private benefit by asking people how many times per year they would expect to visit the clinic. The number of visits per year times the average cost per visit is the total private benefit.

For some individuals, the private benefit would be zero. People with insurance would probably reveal a preference for seeing their private doctor rather than going to the county health department. Yet do they share in the social benefit from the clinic? To find out, you might ask someone who gets zero private benefit which they would prefer: 1) a guarantee that the clinic will remain open serving the community or 2) the clinic closes tomorrow, but the person gets a crisp, new $10 bill.

Would I be "irrational" if I turned down the $10? I don't think so. The reason markets fail in the presence of a positive externality is that people do not take into account the benefit of an action to others because their contribution to the total social benefit is so small. But if you asked people to reveal how much benefit they get from the collective action of others, you can get a rough estimate of the social value that would be lost due to the market failure.

I say, "rough estimate" because even this method is not without its pitfalls. If you survey people who obtain private benefit, they may give an inflated answer. Nonetheless, such studies can be done, if interpreted with caution. From the Minneapolis Fed (fedgazette):

Sports teams, for example, create a public good by virtue of the fact that they often engender community pride, interest and enjoyment outside of ticket-buying customers (what economists call externalities). "The magnitude of this benefit is unknown, and is not shared by everyone; nevertheless, it exists," wrote Roger Noll of the Brookings Institution.

In some cases, it might be hard to say more than "it exists," but even that does say something. In the case discussed in the separate articles by Landsburg and Frank, I would argue that a social benefit exists. But Roger Noll's comment above on a totally different issue would apply just as well here. I don't know the magnitude, and properly measured, it's probably smaller than most of us would initially think. Yet it must be put on the table for discussion.

Economic analysis, particularly through focusing on opportunity cost and the notion of "willingness to pay" can shed much light on everyday subjects like these. We dissect cases like this to separate out the social benefits/costs from the private benefits/costs. We prioritize elements of the social safety net based on their opportunity cost. We justify or criticize government intervention on the basis of costs and benefits that are seen as well as those that are unseen. Economists may not always agree, but we can usually identify the root source of our disagreements. We do all this because, as Frank says,

We cannot think intelligently about these decisions without weighing the relevant costs and benefits.

It all started with a piece by Steven E. Landsburg in Slate which asked the question: "Do the Poor Deserve Life Support?" The subtitle was, "A woman who couldn't pay her bills is unplugged from her ventilator and dies. Is this wrong?" Landsburg argues that it is not.

This brought forth a response from Robert Frank who wrote in the New York Times,

Many commentators have attacked his argument as morally preposterous. Well, yes. But it is also economically preposterous.

Bloggers Arnold Kling and Brad DeLong have also noted the exchange, and it is indeed noteworthy. So if you haven't read the Landsburg and Frank articles. Do so now, and come on back.

So here we have two top-notch, respected economists who find themselves completely at odds on this question. Both use economic logic and reasoning. The average person on the street might find each of them quite persuasive individually. Taken together, how do you make sense of them when they are so clearly opposed?

Let's dig in and see the source of the disagreement. Landsburg's main arugment is that the person in question probably would not have placed a high value on hypothetical "ventilator insurance" ex ante and therefore should not receive the benefit ex post. Landsburg writes,

...for the same cost, we could give each of those people a choice between ventilator insurance on the one hand or $75 cash on the other hand. If it turns out that I'm wrong and they all want the ventilator insurance, so be it. But why not at least ask them?

You can't do that with every government service. You can't offer people a choice between police protection and its cash value, because police patrols tend to protect entire neighborhoods at once, not just specific individuals. You might not want to offer people a choice between a flu vaccine and its cash value, because you'd really prefer to have vaccinated neighbors. But critical life support isn't like that; the benefits are targeted to specific individuals. There's no reason those individuals shouldn't be allowed to choose different benefits if they want them.

And Frank writes,

Even those who are not poor recognize that catastrophe is only one unlucky break away. One might lose one's job and be unable to afford health insurance, for example, or be stranded by a mountain blizzard and unable to afford a helicopter rescue. With such prospects in mind, most people favor collectively financed rescue efforts. That a poor person would not, or could not, buy private insurance against such contingencies is entirely beside the point.

Frank compares the life support situation to a helicopter rescue. Landsburg draws a stark contrast between life support and government provided services like police protection. Landsburg is right that you can't let people opt out of police protection. There is a free rider problem. If the rest of the neighborhood pays I still get the protection, so it would be individually rational to want to opt out. So the government provides the protection and requires payment in the form of taxes.

The way most cities are set up, the same is true of fire departments, but it wasn't always so. Long ago, insurance companies formed fire departments for the purpose of protecting their interests. Each building had a plaque indicating which company provided them with protection from fire, as well as insurance against loss. Presumably, people could choose their fire company on the basis of location, price, etc. I would guess that people could choose to have no insurance at all. In that case, I suppose that the companies who insured buildings on either side would work to prevent the fire from spreading but would not necessarily concern themselves with the uninsured building.

Today, our fire departments are usually agencies of city or county government, making them functionally similar to police departments. They respond to all calls for help, without regard to your insurance company, or even whether you pay taxes to that juristiction (as in the case of responding to an auto accident or medical emergency). Through many years of voting and policymaking, we have decided that this is a good system--just as most people would agree that public police protection is superior to a patchwork system of private security guards.

And yes, those public servants are the ones who rescue us from mountain blizzards, mine explosions, terrorist attacks, and a million other things for which writing individual insurance policies would be difficult if not impossible. The question is whether life support, of the type required in the article, is one of those situations.

Landsburg says that the benefit of life support is targeted at a specific individual. Well, so is the mountain rescue operation, at least once you have an "identified life" at stake (to use a term employed by Frank). So that isn't the real difference. The real difference is much more fundamental. The life support in this problem is not for the purpose of saving a life, but for the purpose of prolonging it enough to grant a dying wish.

One can try to measure the economic benefit of saving a life. One might even come up with a "willingness to pay" ex ante to save a life from mortal peril. And obviously society puts a high enough price on this as to employ rescue squads, search and rescue teams, and so on. But how do you measure the willingness to pay to grant a dying wish to say good-bye to a family member? Should the poor be priced out of this insurance market?

More to the point, would society be better off in a world where granting such consideration (within certain bounds of reason) was a social norm? Should taxpayers reimburse the hospital for providing a few more days of care in this case?

Unfortunately, this question is neither as objective, nor as simple, as asking whether society benefits from police protection or a national defense. Well meaning people can disagree. Answering in the affirmative does not come without cost for society. And yes, as Landsburg points out, it would mean that there would be fewer resources available to help the poor in other situations, perhaps more life-threatening situations. That is true. But we should also consider the social benefits of such a norm. Frank appeals to Adam Smith in arguing for a consideration of sympathy and empathy. The Theory of Moral Sentiments is the place to look for such discussions.

How much would you be willing to pay for a social norm such as this?

To be continued...

Christopher Elliot of the NY Times considers this weighty question:

United Airlines ... recently announced a logistics ploy it calls Wilma - shorthand for window-middle-aisle - that it claims will cut boarding times by four to five minutes, an eternity in the industry's on-time takeoff sweepstakes. The idea is to fill the window seats in economy class first, then the middle seats, then the aisle seats, thereby eliminating the free-for-all chaos that clogs the cabin when passengers are sent in by row numbers.

Not to pick on United, because it is, after all, flying under bankruptcy protection and Wilma could save it millions a year. But hasn't this already been tried?

Yes, it has. The now-defunct Shuttle by United tried it a decade ago, according to Michael J. Boyd, an airline consultant for the Boyd Group in Evergreen, Colo. Back then, he called it the product of "a deranged M.B.A." He feels the same way today. "It's not going to change anything," he said. "These initiatives sound good, until it becomes clear that you are boarding humans, and not cattle. The cattle will line up and get into a pen. People won't."

...

What is the fastest way to board a plane? "Back to front," said Robert W. Mann, an airline analyst in Port Washington, N.Y. That's because bottlenecks do not happen only in economy class. First-class passengers also can obstruct the boarding progress as they try reach into the overheads for their laptops or make their flight attendant run into the galley for a cocktail.

There is an economic observation to be made here. If all the airlines improve their boarding times by five minutes, I suspect that the new equilibrium would look a lot like the current one. Maybe they would all start boarding a couple minutes closer to take-off than before, but other than that, little would change. It just doesn't strike me as a money-maker.

Boarding from the back is my vote for the fastest way. The window-middle-aisle plan makes no sense. If a few window people arrive late from their connection, the time savings are lost.

Besides, if I had to guess at the ratio of minutes my flights have been delayed because of other problems (excluding weather) relative to problems in the boarding process, I'd guess that ratio to be about 20 to 1. I'd suggest some other time savings ideas--like reducing the number of keystrokes required for a ticket agent to issue a boarding pass. (Of course, I print my boarding passes on-line now, so I'm already doing my part.)

Start with Michael Mandel at BusinessWeek.

Game theory is no doubt wonderful for telling stories. However, it flunks the main test of any scientific theory: The ability to make empirically testable predictions. In most real-life situations, many different outcomes -- from full cooperation to near-disastrous conflict -- are consistent with the game-theory version of rationality.

To put it a different way: If the world had been blown up during the Cuban Missile Crisis of 1962, game theorists could have explained that as an unfortunate outcome -- but one that was just as rational as what actually happened. Similarly, an industry that collapses into run-amok competition, like the airlines, can be explained rationally by game theorists as easily as one where cooperation is the norm.

Tyler Cowen at Marginal Revolution replies:

I can think of possible responses:

1. Behavioral approaches will flesh out how humans actually behave. Game theory will end up with clear predictions, just give it time.

2. Computational approaches will flesh out how humans actually behave. Game theory will end up with clear predictions, just give it time.

3. Evolutionary approaches will flesh out how humans actually behave. Game theory will end up with clear predictions, just give it time.

4. Experimental approaches will flesh out how humans actually behave. Game theory will end up with clear predictions, just give it time.

5. The real world is in fact indeterminate or close to indeterminate. The indeterminacy and multiple equilibria of game theory are not a problem, but rather reflect how closely the theory mirrors reality. Yes you might prefer sharp, clear predictions, but tough tiddlywinks, you're not going to get them. Faithfulness to reality is more important than fulfilling abstract methodological strictures.

Any one of these answers would suffice and allow us to push full steam ahead, or in the case of #5 declare victory and go home. The problem is that we don't know which one is true.

The bottom line: Like so much of economics, the strongest argument for game theory is simply to chat with someone who doesn't know any.

Mandel, now posting from his blog, returns the volley,

I completely agree with Tyler's #5, about the essential indeterminacy of the real world, but I don't agree that game theory helps us think about it in the right way. The set of possible equilibria of a repeated game is far too broad to be useful. We can get good equilibria, bad equilibria, and everything in between.

Behavioral economics embodies uncertainty as well, since the reference level or status quo can be hard to determine. But in the end I feel more comfortable that I've learned something general about the way that people behave from behavioral economics (i.e. the principle of loss aversion) than from game theory.

There's also a broader question: What do we expect from economics-accurate predictions, falsifiability, or what? I sometimes get the feeling that economists are applying too low a standard.

Enter Russell Roberts (Cafe Hayek)

Here's one I'd suggest:

6. Game theory generates no predictions about the real world but it is a useful way of organizing your thinking about various real-world phenomena. It's a language that helps avoid mistakes or confusion.

That having been said, I think the kind of phenomena that game theory helps with are more limited than most of the profession seems to think. Competition reduces the role and importance of strategic behavior and makes game theory less useful.

Lynne Kiesling (Knowledge Problem) joins the fray,

But I do have a snarky follow-up question for Tyler: to what extent do you think that our colleagues are interested in understanding human action? What about the extent to which we economists are enamored with our tools, and engage in "math for math's sake" work? Just asking ...

For good measure, let's also include Daniel Drezner, who takes issue with a piece in Slate. Drezner says:

Kaplan's essay contains a grain of truth about the dangers of social science. Too often, theorists come up with great models of the world by assuming away petty inconveniences like bureaucratic politics, implementation with incomplete information, or the effects of rhetorical blowback. But before he throws out the baby with the bathwater, Kaplan might want to ask himself the following question: if policymakers choose not to rely on social science theories to wend their way through a complex world, what navigational aid would Kaplan suggest in its stead? Policymakers across the political spectrum always like to poke fun at explicit theorizing about international relations. The problem is that they usually rely on historical analogies instead -- which are, in every way, worse than the use of explicit theories.

Game theory, like any model building apparatus, is a way of keeping track of what's going on so that you don't contradict yourself. I certainly understand the frustration of Mandel and others over the non-falsifiability of models with multiple equilibria. (See also the story Roberts relates in his post.) However, I think a number of important real-world situations may be characterized by coordination failures and multiple equilibria. It is worth having a framework that can accommodate that, as long as you don't start seeing multiple equilibria behind every tree. It's not a theory of everything... at least not yet, and it may never be. It's one more tool in the toolbox, useful for identifying the effect of changes in the rules or institutions and making sure you don't violate your own assumptions.

Advanced information on the work of the prize winners from the Nobel Committee

Aumann's home page with links to working papers

Press release from University of Maryland

"Salute to Schelling: Keeping it Human" by Daniel Klein, Tyler Cowen, and Timur Kuran, Econ Journal Watch, April 2005

Richmond Fed interview with Thomas Schelling (Hat tip: Marginal Revolution)

See Marginal Revolution for more.

Clipped from the Nobel web site:

Press Release: The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel 2005

10 October 2005

The Royal Swedish Academy of Sciences has decided to award the Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel, 2005, jointly to

Robert J. Aumann Center for Rationality, Hebrew University of Jerusalem, Israel and

Thomas C. Schelling Department of Economics and School of Public Policy, University of Maryland, College Park, MD, USA,

"for having enhanced our understanding of conflict and cooperation through game-theory analysis".

Two very deserving individuals. A lot of people had Schelling as their first choice, and the case was very compelling. Schelling is the only Nobel winner with whom I really had a conversation (as opposed to just shaking hands with). He came to Iowa to give a seminar when I was a grad student. He met with a small group of grad students to talk about his work on strategy and conflict. I was either a first or second year grad student at the time I think, (which would make that about 10 years ago). I remember that he was very gracious and generous with his time to us.

Congratulations to both!

The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel will be announced on Monday.

Since it is such popular sport to take a guess, I'll venture a couple of thoughts. International economics should be due for a prize in the next couple years. Jagdish Bhagwati would be at the top of many lists in that field. Perhaps this will be his year. Some people have suggested Chris Sims for his work with VARs. I think he's an unlikely choice right now since Engle and Granger won the prize only 2 years ago. His time may come. Some say Robert Barro is a possibility. If it turns out that he has solved the equity premium puzzle, his day will come too. But again, it will be a while before macro is due for another prize.

Marginal Revolution has a thread going on the topic. One commenter there suggests Oliver Hart, Bengt Holmstrom, and Oliver Williamson for their work on contracting and the theory of the firm. That's actually a reasonable guess. I would applaud such a choice.

New Economist thinks Fama and French are deserving.

David Tufte at VoluntaryXchange picks Bhagwati, possibly to share the prize. He also runs through a number of other possibilities.

I've actually been picking Bhagwati for the last couple years, so I'm not going to switch now when international econ might actually be coming up for the prize again. But everyone mentioned in this post has a reasonable shot at the prize someday. Dark horse pick: Thomas Schelling.

Comments are open.

The latest WSJ Econoblog features Lynne Kiesling (Knowledge Problem) and John Irons (ArgMax). The topic is on how much the government should be involved with rebuiliding after the hurricanes. My favorite line is from Kiesling:

So given our 2005 knowledge, should we rebuild the 19th-century levees? Or can we come up with a better solution that reflects this new knowledge? The situation has changed, our knowledge has changed, but will our bureaucratic planning paradigm doom us to replicate infrastructure that is no longer the best response? We are more likely to get better decisions on these "public good" questions to the extent that we can match the incentives and information, and use a funding mechanism that doesn't distort that match. Sadly, such a proposal removes political power from officials of all types and at all levels, even as it removes the possibility of rent-seeking lobbying, so it is unlikely to sail through Congress!

Kiesling starts with a discussion of oil and gas markets which is a little bit of a digression from the main topic of rebuilding, but related to the overall response to the storms. At some point, we are going to need to have a serious discussion in this country about how we deal with disasters. There is no coordinated economic plan in place at all. We simply react, and not always all that well. We have no idea how that $200 billion earmarked for rebuilding will be spent. Some of it surely will be put to good use. It is appropriate for governments to provide public goods and infrastructure, etc. But the present approach worries me. The debate between Kiesling and Irons needs to be carried into the halls of Congress.

But don't hold your breath.

Check out Radioeconomics, an economics Podcast put together periodically by James Reese of the University of South Carolina Upstate. I'm listening to the latest offering--a discussion between John Palmer (The Eclectic Econoclast) and Phil Miller (Market Power).

There is also a discussion between Mark Thoma and Barry Ritholtz that you can listen to.

Radioeconomics is now number 91 on Apple's top 100 Podcasts!

Mark Thoma spots a debate between Senators Grassley and Harkin, both of Iowa about whether to pay for Katrina rebuilding using tax increase or spending cuts. In case it's not obvious to you who is on which side, read here. I want to address Mark's comments.

First, during the recovery period itself, there is no need to do either, something Grassley seems to implicitly acknowledge elsewhere in his remarks. If the goal is to stimulate the economy during this period, then deficit spending (borrowing) is needed. Offsetting spending on hurricane relief with reduced spending elsewhere or increasing taxes does not provide any short-run stimulus. Arguments about long-run economic growth and tax rates are being mixed up with arguments about the level of GDP in the short-run. Once the economy has recovered, then it’s time to pay the bills. At that point either an increase in taxes or decrease in spending can be used in theory since both reduce the deficit, though in reality tax increases will be needed since spending cuts alone cannot solve our deficit problem. This is where growth considerations come into play and, though there are certainly pockets of fat in government, cuts in spending large enough to dent the deficit will reduce essential spending on infrastructure and social insurance programs and harm rather than enhance our long-run growth prospects and economic security.

I don't totally disagree with Mark. Here's where I take issue with it. I don't find the long run growth argument all that compelling. Unless you can convince me that the government spending being cut is something that enhances aggregate supply as opposed to aggregate demand, then the long run multiplier is probably pretty close to 1. Not to mention the fact that you're just trading one type of spending for another.

If we're talking about one time events, then I can set up a simple opportunity cost question about whether disaster relief is a higher priority right now than a bridge to nowhere in Alaska. (But I wouldn't argue for permanent cuts to Medicaid on that basis.) Permanent tax increases probably wouldn't be necessary. Small spending cuts spread out over time, combined with short term deficits will plug the hole.

But if we're talking about permanent changes and asking for more Homeland Security or FEMA spending then the cuts in other programs would have to be permanent. Cutting the fat out of one highway bill won't be enough. In that case, I would want there to be a real debate about priorities. A tax increase might be more politically realistic in that case, especially if Congress deadlocks over priorities (almost guaranteed).

Of course, using 9/11 as a precedent, I'd be wary of using Katrina as a justification for large, permanent increases in spending. (I'm just sayin'.)

So here's a case where it makes a lot of sense to think about the problem in the context of an intertemporal budget constraint, no matter what your view of the appropriate size of government. Whether this most recent fiscal demand is a one time thing or a permanent shift in priorities is more important to me right now than whether to increase taxes or cut spending. Indeed, the answer to the former would inform my opinion on the latter.

Light posting day today. The weekend is nearly here, and I just gave a departmental seminar. Perhaps you will enjoy this column by Don Boudreaux (Cafe Hayek) in the Pittsburgh Tribune-Review.

The crux of the article is that it is not technology but "personal choice, voluntary exchange, freedom to compete and security of privately owned property" (to use, as he does, the Cato Institute's definition of economic freedom) that has the most critical impact on economic growth. After all, many countries have technology but not economic freedom. See also Stephen Parente and Ed Prescott's work for a more nuanced but not altogether inconsistent outlook.

Hat tip: Division of Labor

...A club that counts United and US Airways among its members. 4 of the 7 largest U.S. airlines are in bankrupcy protection.

Read more here.

UPDATE: expedia.com just sent me an e-mail advertising a low price tickets on, among other airlines, Northwest and Delta. Kind of makes you wonder. These folks aren't buying, but at least in the short term it's not likely to be a major hassle. It's not like when a small carrier goes bankrupt and all of a sudden shuts down. Like I said, United and US Airways are part of the club, and they're still going. They will restructure, but the airline industry has undergone what might be almost an irreversible change. We will be dealing with this for a long time to come.

Kash returns from his hiatus and tries to discern the "animal spirits." He's worried.

Even temporary problems can get magnified if they contribute to a broader change in psychology. And I think that the current situation contains the seeds for such a shift in sentiment. My personal odds for a recession in 2006 have just gone up, thanks to Katrina.

James Hamilton tries not to be too pessimistic, but finds it hard.

Could this be enough to tip the whole economic cart over? I'm not certain that it will. But it would seem foolish to deny the very real possibility that it could.

Macroblog presents a special mid-week edition of the fed funds probabilities and reports that sentiment for a November rate hike is weakening.

David Tufte thinks the damage total will be much higher than the media is reporting, and he's pretty familiar with the area.

The only estimates that have come out so far are insured losses. There are three problems with this. First, New Orleans is not a heavily insured city. Second, initial insurance estimates have been notoriously low for several disasters the last few years. Third, we've never had a disaster like this before.

Estimates of national wealth from the World Bank are $400K per capita in the U.S. Currently, with the failure to close the 17th Street levee break in New Orleans, the entire east bank of Orleans and Jefferson parish is at risk. Something like 800K live in that area. This places the total wealth of that are at $320 billion.

and...

On top of this, the GDP of the east bank is roughly $2.5 billion per month. They are talking a bare minimum of 2 months before people can even come back everywhere across the city, much less get back to a reasonable facsimile of earlier production.

Calculated Risk gives the rundown on the refineries.

MaxSpeak thinks it might be too late...

Oil refining capacity is on a very tight string. Any damage in the Gulf seems likely to wreak non-trivial damage on the economy. That sounds like an emergency.

But it may be too late to prevent a recession, given the heights to which oil prices have already risen. Is a recession an emergency? How much would releasing the reserve do to forestall gas price increases and recession?

Like I said last night, I am reluctant to speculate too much too soon about a recession. It's just too early. But all in all, the economics corner of the blogosphere has been (as evidenced by the links here) very reasoned in its assessment of the situation. My take is closest to Hamilton's. It would indeed be foolish to underestimate the possibility that this could be the straw that breaks the camel's back. For some time, I have been comparing the present situation to the mid-1990s, which was a time of monetary tightening, the early stages of a recovery, much anxiety over deficits of both the budget and the trade variety, and a general notion among economists and analysts that the economy was at a crossroads. Will the landing be soft or hard? That was the question then, and it is the question today. I have been of the opinion that if we are able to stay the course, we would be on a trajectory for a soft landing, perhaps even softer than in 94-95. My airplane analogy even got a notice from Brad DeLong. Well, to continue the analogy, this hurricane was indeed the sort of ill wind that would cause a pilot to make a last minute correction or things will get bumpy. I think it is reasonable to believe such a correction could take the form of a pause in rate hikes near the end of the year. I've been arguing that even before the hurricane, and I believe it even more strongly now. I know we'll be watching those fed funds probabilities very closely, eh, David?

Of course, that doesn't mean a recession is inevitable. After all, we had the Mexican peso crisis in late 1994 which some thought might derail our nascent recovery. It did not. Will Katrina be different? As of August 31, we simply cannot say. I think it is safe to say, however, that this is a very critical moment for the economy. It could swing either way. If we pass this hurdle, I think it bodes well for the future of the recovery.

In the immediate term, my thoughts and prayers are still with the people affected by Katrina.

UPDATE: David Altig posts an update on the fed funds probabilities, and all I can say is, "Wow." Altig writes,

In his email alerts, Stan Jonas -- who probably knows more about the federal funds rate derivatives than anyone -- says "Fed Done By December... Certain..."

I've been telling my students for years that this was going to happen and that when it does it will be significant.

Sounds like it's starting. (NY Times)

Here's the setup from the Sunday NY Times. The writer is speaking of an interview with Matthew Simmons, author of Twilight in the Desert: The Coming Saudi Oil Shock and the World Economy.

Simmons has a lot riding on his campaign -- not only his name but also his business, which would not be rewarded if he is proved to be a fool. What, I asked, if the data show that the Saudis will be able to sustain production of not only 12.5 million barrels a day -- their target for 2009 -- but 15 million barrels, which global demand is expected to require of them in the not-too-distant future? ''The odds of them sustaining 12 million barrels a day is very low,'' Simmons replied. ''The odds of them getting to 15 million for 50 years -- there's a better chance of me having Bill Gates's net worth, and I wouldn't bet a dime on that forecast.''

The gathering of executives took place in a restaurant at Chelsea Piers; about 35 men sat around a set of tables as the host introduced Simmons. He rambled a bit but hit his talking points, and the executives listened raptly; at one point, the man on my right broke into a soft whistle, of the sort that means ''Holy cow.''

Simmons didn't let up. ''We're going to look back at history and say $55 a barrel was cheap,'' he said, recalling a TV interview in which he predicted that a barrel might hit triple digits.

He said that the anchor scoffed, in disbelief, ''A hundred dollars?''

Simmons replied, ''I wasn't talking about low triple digits.''

Enter John Tierney, who takes a page out of the late Julian Simon's playbook and asks Simmons to make a bet on his claim.

Read it here. (NY Times)

I proposed to him a bet using what Julian considered the best measure of a resource's value: how it compares with the average worker's wage. I offered to bet that the price of oil would not rise faster than the average wage, meaning that future workers would be able to afford oil more easily than they could today.

Mr. Simmons said he favored a simpler wager, based on his expectation that the price of oil, now about $65 per barrel, would more than triple during the next five years. He said he'd bet that the price in 2010, when adjusted for inflation so it's stated in 2005 dollars, would be at least $200 per barrel.

Remembering a tip from Julian, I suggested that we use the average price for the whole year of 2010 instead of the price on any particular date - that way, neither of us would be vulnerable to a sudden short-term swing as the market reacted to some unexpected news. Mr. Simmons agreed, and we sealed the deal by e-mail.

Tierney told Julian Simon's widow, Rita Simon, who (as Tierney tells it) "wanted a piece of the action herself." They split the bet.

So, is $200/barrel in 2005 dollars on average for the calendar year 2010 realistic? I don't think so.

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.

UPDATE: King at SCSU Scholars makes a nice chart to go along with this story.

UPDATE #2: When writing this post, I was tempted to write, "I wonder what James Hamilton will say." Well, wonder no more. He rightly takes to task those who say that Simmons is putting his money where his mouth is. As Hamilton (and Calculated Risk-see comments below) point out, even if Simmons wins he loses because if he really wanted to make some money he would buy a bunch of futures contracts. Tierney, on the other hand, is simply picking up free money. Of course, Simmons is probably going to provoke just the response that he wants. $5000 is a small price for publicity, I guess.

From the Peoria Journal-Star

[Colin] Harley, 65, arrives today in South Dakota for the world-famous Sturgis Motorcycle Rally. But he won't arrive by bike but by air. When his plane touches down, his Harley will be there waiting for him.

Harley is part of a burgeoning breed of bikers who, because of time constraints, have their motorcycles shipped to Sturgis and other rallies. And a great many of those shipments are handled by the Federal Warehouse Co. in East Peoria.

"You have a lot of people who like to ride their bikes out there (to Sturgis)," says Jennifer Gibbs, assistant manager at Federal Warehouse. "But not everyone has the luxury of time."

Bike shipments are a touchy subject amid certain motorcycle enthusiasts. Some feel that the lore of Sturgis and other big rallies demands that true bikers make the trek to and from a gathering.

...

The one-way cost averages about $600, though coast-to-coast can run $750. Besides rallies, Federal sends a lot of bikes to museums and bike shows, plus handles many eBay sales.

...

Cross-country travel can put a lot of wear and tear on an expensive bike. More and more owners are opting to protect their investment by reducing on-road time.

Maybe that chips away at the legend of the scruffy, road-weary biker. But it only helps business at Federal Warehouse.

Applications of opportunity cost are, indeed, all around us. What a great example for class discussion as it includes both the time and the wear-and-tear aspects of the journey.

Definitely worth your time. This Econoblog installment is titled "Debating Job-Market Slack" and features Dave Altig of macroblog taking on Max Sawicky and Tom Walker of MaxSpeak, You Listen! First a quote from Sawicky and Walker:

Finally, rather than dwelling on discrepancies in labor force participation rates, it may indeed make sense, as David suggests, to consider the choices of workers and nonworkers. It doesn't follow, however, that those choices have been made enthusiastically.

Good point. While pgl of Angry Bear has been claiming that labor force participation and employment/population ratios have been lagging, I have admitted to being less concerned. I have been very intrigued by the whole situation, however, and posted some questions that have been raised in my mind and taken a preliminary shot or two at trying to figure out what is going on. If it appears that I've been dwelling on those rates, it's mainly because I've been trying to drill down into the demographic issues. In the end, I am most sympathetic to James Hamilton's approach and position. Undoubtedly the LFPR is a function of people's choices, but whether those choices are being made "enthusiastically" or not is a sticky wicket. Altig responds:

But at this point we may want to introduce another paradigm-shifting idea, the real business cycle concept that (in part) won the 2004 Nobel Prize for Finn Kydland and Ed Prescott. (A second mention for Arizona Sate University!) My simple-minded version of Kydland and Prescott's story goes like this: Sometimes the sun shines, sometimes it rains. We may like it better when the sun shines, but the rain, too, is part of the natural order of things. And there is nothing policy makers can or should do about it.

Whether you like the theory or not, that's a pretty nice statement of the theory. And then...

So, yes, a voluntary decision about seeking work or not seeking work is not the same thing as a happy decision. But it does not follow that all unfortunate circumstances are the appropriate objects of economic policy.

To which Sawicky and Walker respond:

Some unfortunate circumstances are the result of economic policy and others can be ameliorated in a way that actually contributes to efficiency. It would be irresponsible to do nothing in response to the former and unwise to do nothing in the latter circumstance.

Ah, but telling the difference is the tricky part. Back to Altig:

Perhaps it is because I am a child of the 1970s -- the decade in which I became familiar with the larger world around me -- that my instinct is to respond to this type of uncertainty with a certain reluctance to espouse activist policies unless the evidence pretty clearly speaks to the need. To my eye, that evidence is lacking for the moment.

On balance, I'd have to agree. Changing demographics and educational choices by young people account for some (though probably not all) of the lagging LFPR. Also, I'm not sure we totally understand the dynamics of very shallow recessions. The last two recessions have been more shallow than many previous ones and the job market has taken longer to recover. So let me leave no doubt as to where I stand. There are questions to be answered, to be sure. But changing demographics and other factors probably make the LFPR of the late 1990s something that will not be seen for some time.

Now Max and Tom might argue that, in the spirit of these comments, the conservative approach would be, for example, to ease up on the funds rate increases for now. They would find a lot of support for this among bloggers that I respect a lot -- Angry Bear, James Hamilton, and William Polley, to name just a few. Mark Thoma, on the other hand, emphasizes a different take on the cost-benefit analysis that works to the opposite conclusion. And so it goes.

Thanks for the mention. While I would welcome a pause in the rate hikes, the labor market is not my primary concern. However, it is on my radar screen. Given that the last recession was pretty shallow and payroll employment has been slower to recover than in previous expansions, I admit to being a little concerned about how far to push rates before letting the economy catch up. The macroeconomy deals with policy lags more slowly than the financial markets, after all.

But let me wholeheartedly agree with Max and Tom's plea to "look at the long-term trends." In not too many years the particulars of this business cycle will be a distant memory. The exact level at which the federal-funds rate "pauses" will be of little matter. I really suspect the same will be true of the federal deficit. What will matter is the set of policies that are put in place to maximize human capital development and unleash the seemingly boundless potential of the American people. With that in mind, your next stop should be this interview with James Heckman, who discusses the really big potatoes in thinking about how workers fare.

Yes. Read the Heckman article. Definitely.

It is true that the particulars of this cycle will be forgotten in a few years. What words to people use to describe the 1990s economically? Boom. Longest post-war expansion in history. Yes, even "bubble" comes to mind. But how soon we forget that in the fall of 1995, there was a bit of discontent in the air. GDP was still growing at a decent pace, but people were saying on the news how those statistics don't measure the way people really live. (As I was looking through some things today in preparing for classes next week, I found a page of notes that I took while watching Nightline back then.) Stories of mass layoffs still dominated the news.

And yet, Bill Clinton was re-elected one year later in a landslide. The economy of the 1990s was a sucess story and whether you think he had a little or a lot to do with it, Clinton got a lot of the credit. But my point is that in the fall of 1995, it wasn't a sure thing. As I have said repeatedly, that's about where we are now. It's not a sure thing. Layoffs still make headlines. GDP growth is stable and positive, but does the person on the street care? The parallels are there.

And to those who say that the media is spinning the economy to hurt the President because of a liberal bias, I respectfully disagree. As I said, I have notes on broadcasts and newspaper clippings to show that the media didn't give Clinton a free ride either. The media likes a story, and for the economy that means accentuate the negative--no matter who is in the White House. In 1995, I told my classes not to believe everything they heard. And now?

But I still hope the Fed pauses in December.

UPDATE: MaxSpeak blogs a postscript to the debate from Jared Bernstein.

Remember this?

Via Reuters:

The Treasury said it was considering semiannual auctions of a 30-year nominal security beginning February 2006. It announced suspension of the 30-year bond in October 2001, with the last auction having taken place in August that year.

Not that surprising, really. Everyone who has refinanced their house in the last few years knows that locking in a low interest rate for 30 years is a good thing.

They'll make an announcement August 3. I think it will be affirmative. They wouldn't admit they were considering it unless it was actually going to happen.

And so they are. David Andelman of Forbes writes about it, concluding thus:

Indeed, for the bond fund manager, the arrival of the shiny new 30-year Treasury only complicates matters. The duration of these bonds inevitably introduces more uncertainty, and uncertainty breeds volatility. "The 30-year Treasury, at least right now, isn't offering fund managers dramatically more yield than the 10-year Treasury," says Scott Berry, bond fund analyst at Morningstar. "But they could be getting considerably more volatility."

That said, it's unlikely then that many fund managers or even savvy individual investors will be waiting in line at midnight for the Treasury to open the 30-year window. So will anyone be there?

Absolutely. Pension fund managers, for instance, are in love with the long-duration bonds. So much so that there are even 100-year municipal bonds issued by some far-sighted U.S. locales, while 50-year euro bonds are also in big demand. Pension managers love these long-maturity bonds because only rarely do they have to trade them. If they're on the hook for a pension booked today for a 25-year-old fireman who won't be collecting until he turns 65, well then a 30- or 50-year bond looks very nice indeed. The fund manager knows just how much his investment will be paying at every step along the way.

Might I also refer you to what Brad Setser said back in May.

This special series on class in America by the New York Times is excellent.

Excerpt from one story:

Far more than people who remain in the social class they are born to, surrounded by others of the same background, Ms. Justice is sensitive to the cultural significance of the cars people drive, the food they serve at parties, where they go on vacation - all the little clues that indicate social status. By every conventional measure, Ms. Justice is now solidly middle class, but she is still trying to learn how to feel middle class. Almost every time she expresses an idea, or explains herself, she checks whether she is being understood, asking, "Does that make sense?"

"I think class is everything, I really do," she said recently. "When you're poor and from a low socioeconomic group, you don't have a lot of choices in life. To me, being from an upper class is all about confidence. It's knowing you have choices, knowing you set the standards, knowing you have connections."

Intrigued? Read the whole thing.

Becker:

So my conclusion is that the estate tax should go, or at least have greater reduced rates, since this tax has little effect on inequality in a knowledge economy, encourages costly avoidance behavior to take advantage of various tax loopholes, raises only a modest amount of government revenue, and reduces incentives to form family businesses and other entrepreneurial activity. Estate taxes do not even tax the right base if the aim is to reduce the effect of inheritances on inequality in the personal distribution of income and wealth. The energy and political capital spent on supporting high estate taxes is better spent on trying to raise opportunities to children from poor families by improving their education, training, and health.

Posner:

I agree with Becker that inheritance taxes are preferable to estate taxes and that consumption taxes are preferable to income taxes. However, I do not share his strong opposition to the federal estate tax.

Worth reading.

According to Hal Varian (NY Times):

TAX systems are like septic tanks: they need to be cleaned out every 10 years or so.

And also:

Some might want to see marginal tax rates increase with income; some might like to see them stay relatively flat. But, as the authors point out, there is no coherent theory that advocates the "crazy quilt of blips" implied by the current rate structure.

Read the whole thing.

It's true. If it wasn't so maddening, it would be funny. But there's nothing funny about the inequalities present in public schools today.

Attorneys representing students from the Shawnee Mission district say the story "Harrison Bergeron" shows that a world of forced equality would be a nightmare, so unequal funding of public schools is OK.

Their legal brief says capping local taxes on schools was unconstitutional, and they cited the 1961 story, which depicts a future society where everyone is made equal by forcing impediments on anyone who is better.

"Nobody was smarter than anybody else," the attorneys quoted Vonnegut as writing. "Nobody was better looking than anybody else.

But in a telephone interview Wednesday, Vonnegut told the Journal-World that the students' attorneys may have misinterpreted his story.

Ya think?

"It's about intelligence and talent, and wealth is not a demonstration of either one," said Vonnegut, 82, of New York. He said he wouldn't want schoolchildren deprived of a quality education because they were poor.

"Kansas is apparently handicapping schoolchildren, no matter how gifted and talented, with lousy educations if their parents are poor," he said.

...

The court has ruled that the $2.7 billion in school funding is inadequate and distributed unfairly. The Legislature has approved a $142 million increase and allowed local districts to raise property taxes nearly $500 million more.

Critics say the increase is not enough and the local property tax options will widen the disparity between wealthy and poor districts. The court will hear oral arguments on the new legislation Wednesday.

Attorneys representing 40 students from the Shawnee Mission school district in Johnson County filed a brief supporting the Legislature's new law, and went further, saying there should be no limit on how much local districts could raise in taxes for local schools.

Any attempt to cap local taxes for schools is unconstitutional, they argue, "because it impermissibly infringes on individual liberty and related fundamental rights and usurps local school board authority to supplement public education over and above the suitable level."

OK. In principle I don't see anything wrong with their argument that local districts should be able to raise as much as they want. This isn't the problem. The problem is when the wealthy districts use their power in the state legislature to diminish the state funding to extremely low levels. Implicitly saying to the less wealthy areas, "Don't count on the state, raise the money with local taxes. Look at us! We're doing it!"

Alan Rupe, an attorney representing plaintiff school districts on the opposing side, said the Shawnee Mission brief was "well-written" but that he disagreed that local districts should be allowed to raise as much as they want.

The opposing attorney understands this point.

"I would classify this as the Johnson County viewpoint of the world," Rupe said. "This kind of viewpoint exists when there is not adequate funding for all schools," he said.

Rupe said that he didn't oppose the use of some local taxes for schools, but that under the current system local taxes were used for essentials in schools and that was not fair to poor districts that couldn't raise much in local taxes.

"We don't want to cut off any mountain tops. We want to raise the valleys so kids in poor areas come up to the mountain tops," he said.

We don't want to cut off the mountain tops. We want to raise the valleys. Beautiful. But the political cards are stacked against it.

I don't mean to suggest that there's an easy answer. There is not. But I think it's pretty extreme to quote Vonnegut's science fiction where...

In the story, smart people have to wear radios that emit distracting noises, pretty people must wear hideous masks, and athletic people are weighed down with bags of birdshot.

Comparing this to subsidizing public education missing the mark.

Readers are free to draw analogies between this story and my Social Security as insurance post.

Oh, and a shout out to my friend Alan Bjerga who writes for Knight-Ridder's Kansas newspapers (and with whom I had a spirited discussion of Thomas Frank's What's the Matter With Kansas last summer.

I wonder what he thinks about this.

Via Reuters:

The Treasury said it was considering semiannual auctions of a 30-year nominal security beginning February 2006. It announced suspension of the 30-year bond in October 2001, with the last auction having taken place in August that year.

Not that surprising, really. Everyone who has refinanced their house in the last few years knows that locking in a low interest rate for 30 years is a good thing.

They'll make an announcement August 3. I think it will be affirmative. They wouldn't admit they were considering it unless it was actually going to happen.

UPDATE: Brad Setser has more, including this very sensible conclusion:

But even as the Treasury is (rightly) reconsidering the risks that arise from the combination of a rising debt stock and a shorter-maturity on that debt stock, demand from central banks for Treasuries may be shrinking somewhat, albeit from an extremely high level. Central banks right now are all talking about diversifying the composition of their dollar reserves, and put less of their still growing reserves into the Treasury market.

That supports the case for resuming issuance of the thirty-year bond. It might bring new demand into the Treasury market even as central bank demand fades. Since central banks generally prefer shorter maturities, a shift in the Treasury's issuance pattern would help to match the bonds the Treasury issues with the bonds the market most wants.

But it is at least possible that the Treasury could end up increasing the supply of long-term debt in market just as demand for those Treasuries starts to fade a bit. Who knows, that might even put pressure on rates and some hedge fund might get caught with too large a leveraged bet … (Note the complaining at the end of this New York Times article). Is it likely a surge in long-term Treasury issuance will change the dynamics of the market? My guess: No, not on its own. But it might interact with something else in the market in an unpredictable way.

My bottom line: the Treasury should have started issuing more long-term debt – be it ten year notes or longer term bonds -- back in 2003, even if there was a cost advantage to issuing more short-term debt at the time. The Treasury does need to take steps to reduce its own refinancing risk. But it is at least possible that it may not be able to do so in 2006 without putting more pressure on the market than it expects ...

The comments on his post are interesting too.

David Altig of macroblog:

I'm not sure I had ever contemplated what the day would look like when 3.1 percent growth was considered bad news, but now I know for sure.

He's got a lot of quotes from a number of sources detailing the good (not much), the bad (quite a bit), and the ugly (well represented), so check it out.

Kash at Angry Bear has a pessimistic, but fair, review of the numbers complete with charts. He concludes with:

That is not a horrible growth rate, but it is a bit disappointing to those who hoped for another year or two of strong economic growth in the US before this phase of the business cycle was over.

Right. Not horrible. Disappointing? A little, but not for the 3.1% number itself. The inventory part is a little troubling since it might indicate weakness in coming quarters. Imports are also a drag on GDP, and those numbers don't appear to be improving quite yet.

So I find myself in a rather odd position. I used to think that anything over 3% is doing well. I always tell people that one statistic doesn't make a trend. Yet, I won't tell you that this is great news either.

I take a little comfort in the fact that the advance estimate has typically been revised upward in the last few quarters. In fact in each of the last 5 quarters, the annual revision (or final estimate for the 3 most recent quarters) has been higher than the advance estimate. (page 5 of this link) I don't think that's a guarantee that the final numbers will be higher, but it keeps me from cashing in all of my chips yet.

Real GDP growth did cool down without causing a recession in 1995. (But then, you knew I was going to say that, right?)

The new information this report give me is that we need to watch things carefully to see if the inventory buildup is a problem. We also need to watch the trade numbers. That will be useful in seeing if this is the beginning of something more. What I hear in everyone's remarks is that this unambiguously lowers the forecast for Q2. Absent a marked fall in the price of oil or a slowdown of import growth, that is probably a correct assessment.

Apparently seats in law school classes were up for sale at NYU. I highly recommend that you read the entire article. If you're a professor you might be simultaneously intrigued, amused, and slightly disturbed (depending on your sensibilities towards the efficiency/equity tradeoff) all at the same time.

If you understand the Coase Theorem--and I mean really understand it at a deeper level than the econ 101 version--you'll know why I think this part is the best. The author of the article does understand the Coase Theorem.

[Vice Dean Barry] Adler, who was also Wilson's first-year contracts professor, would not cede the economic argument. He acknowledged that banning cash transactions might lead to inefficiencies—say, if Wilson had found a student holding a spot in Neuborne's evidence class who would have been happier with a less popular evidence class and a $200 dinner at Il Mulino, the old-world Italian restaurant down the street from N.Y.U. But the law school was also concerned with the distribution of wealth among its students. As Adler correctly observed, legal rules affect not only how resources are allocated, but who winds up spending how much. By barring the sale of classes, the law school aimed to avoid putting pressure on better-off students to buy the classes they wanted, and, even more importantly, pressure on poorer students to sell their valuable seats. "There's nothing inconsistent with Coase's Theorem there," Adler insisted.

The opportunity for empirical research was not lost on law and economics professors. Oren Bar-Gill, who teaches a behavioral law and economics class at N.Y.U., was quick to point out flaws in the putative free market for class spots. "In a Coasean world, one would think it makes sense to allow trading cash for classes, because both parties are better off," he explained. "But you also have to take into account the ex ante effects of the rule." Specifically, Bar-Gill feared that students would initially bid in the lottery not for the classes they wanted but for the classes most likely to fetch a high price on Coase's List. Then "bright but not so rich students" would avoid N.Y.U., knowing that many spots in the best classes would eventually be sold to their wealthier peers. Or, Bar-Gill mused, poor entrepreneurs might choose N.Y.U. over its competitors precisely because they could expect to earn pocket money by selling their class picks. As a result, many students would end up not getting the classes they wanted, and N.Y.U. would end up losing the students it wanted.

As the class-selling episode drew to a close, different people drew different morals from the story. Adler announced that the school was "looking at ways" to make a waiting list possible. Neuborne claimed that he was "furious about the practice." He said, "It cuts me out of the profit. If any student wants favorable treatment from me, the student must deal directly with me in a cash transaction."

I wonder what Coase would say about all this?

By the way, the web site Legal Affairs, whence comes this article, looks interesting enough to bookmark.

Hat tip: Newmark's Door

...on the list of top paying college majors in the class of 2005.

Kash at Angry Bear doesn't know why, but he thinks we should care about it.

I have no good explanation for this seemingly bizarre (dare I say irrational?) behavior. Financial markets do overreact sometimes, and at times they go through unexpectedly large swings as a result of new information that was actually unsurprising, such as the release of the FOMCs minutes last week, or the FOMCs statement in March. I think that such movements are often hard to explain if you believe in the perfect rationality of investors (rational overshooting models notwithstanding).

Should we care? It's tempting to dismiss this new collection of bearish stories as no more than hype, or the most recent "flavor of the month" in ever-fickle investor sentiment. So I'd like to say no, we don't need to care. Except for this one inconvenient, insurmountable fact: developments in financial markets, such as interest rates and asset prices, can have strong and lasting effects on the real economy.

He's right about the reason we should care. And it's nice that someone else thinks that the FOMC's statement and minutes were "unsurprising." In light of all that, I would have expected the 10 year to stabilize around its mid-March level (around 4.5%). We're below that now. It could be just overshooting, or it could be earnings worries. We probably won't know for sure for a few weeks.

In the meantime, watch and wait. But don't ignore it.

This CNN article has more on the story.

UPDATE: Another CNN piece interviews former Fed Governor Laurence Meyer. He doesn't think the sky is falling.

UPDATE: Paul Krugman thinks we're already having a mild case of stagflation.

Roubini's new site is at http://www.rgemonitor.com. Bookmark it and check it often.

If you are a student of macro or international economics at any level, you will probably find useful information for your research at Roubini's site.

As an aside, there is an incredible amount of high quality economic scholarship and commentary available for free on the internet today. Roubini's www.rgemonitor.com is one very good example, and he has links to so many others. Economics should appeal to any student wanting to understand what is going on in the world. With the amount of statistical data, academic papers, and discussion available to those of us who teach this stuff, economics classrooms can be much more lively and interesting than the stereotype.

Why, you lock in a low fixed rate if you are a borrower, of course!

The Treasury would like to do the same thing. Series EE savings bonds will have fixed 20 year rates. Read it here.

Coming at a time when interest rates are near historic lows, this is not a development likely to help savers. It's more likely to doom Mom, Pop, and the typical newborn or bar mitzvah boy recipient to years of sub-market returns.

If, as analysts expect, interest rates continue to move up for months or years, this could make Series EE bonds so unattractive as to spell disaster for the program, suggested Jack Quinn, of http://savingsbonds.com, a non-government affiliated Web site that analyzes savings bonds.

"Maybe they are trying to gut this program," he said.

Ouch.

The Federal Reserve reports that the tightening of monetary policy may be starting to have some effect. However, rates are still quite low on new car loans. Revolving credit continues to outpace nonrevolving credit as it did for the latter part of 2004, and by quite a healthy margin (or unhealthy margin, depending on your point of view).

The numbers are here for those interested.

From Reuters:

"World-class regulation, by itself, may not be sufficient and, indeed, might even worsen the potential for systemic risk if market participants inferred from such regulation that the government would be more likely to back GSE debt in the event of financial stress," Greenspan said.

But he proposed a solution. "We at the Federal Reserve believe this dilemma would be resolved by placing limits on the GSEs' portfolios of assets, perhaps as a share of single-family home mortgages outstanding or some other variation of such a ratio," the Fed chief said.

In a related story,

WASHINGTON (Reuters) - U.S. regulators on Wednesday outlined a fresh series of accounting missteps at mortgage finance giant Fannie Mae in a further blow to the already reeling company.

"OFHEO's (The Office of Federal Housing Enterprise Oversight) special examination of Fannie Mae has revealed a number of significant new accounting problems at the enterprise," OFHEO Director Armando Falcon said in remarks prepared for delivery to a House Financial Services Committee panel.

As with previous accounting problems his agency uncovered, the new concerns reflect Fannie Mae's "tendency toward overly aggressive interpretation" of accounting rules, and in some instances, "willful disregard" of standards, Falcon said.

UPDATE: Kash at Angry Bear voices concern. Can't say I disagree.

This headline is more clever than what you usually get from Reuters.

"Treasuries Stalled, Lacking Data Fuel"

Of course the headline writer could just have a sense of irony in that the market just hasn't figured out which way the spike in oil prices will turn bond prices. Oil...fuel.... get it?

An early spike in crude oil above $58 a barrel was considered to have mixed implications for bonds.

On the one hand, rising energy prices can act as a tax on the consumer and a drag on the economy and thus could be considered a positive for bonds. The rise in oil was also pressuring equities, which could make bonds look more attractive in comparison.

On the other hand, a further sustained increase in energy prices could feed through to inflation, a major threat to debt that pays a fixed rate of interest.

I will ignore any jokes about one-armed economists.

UPDATE: I almost forgot to clip this quote for you, from the same article...

Indeed, the current week is almost barren of meaningful data. As if to fill the gulf, Fed Chairman Alan Greenspan appears no less than three times this week, starting on Tuesday with a speech on energy.

That'll give us something to talk about.

I'm feeling much better today, resuming a somewhat normal schedule. (Thanks for the well wishes, Mark!)

Here's a link from Kash at Angry Bear showing that personal savings continues to disappoint. This is a difference between 1995 and 2005. Kash thinks it makes the soft landing scenario less likely. On the margin, yes, I agree that it does, but not because low savings rates are inherently bad, but because of the other things that tend to accompany low savings.

Check out this from the archives of December 2004, and I'll have some more on this later.

Final estimates of 4th quarter 2004 real GDP growth came in at 3.8%. That is the same as the preliminary estimate released last month.

The growth rate of the price index for gross domestic purchases (a measure of inflation) was revised up to 2.9% from 2.8%. As you can see from the chart, the growth of the gross domestic purchases deflator spent all of 2004 above 2%. Excluding food and energy, the picture was somewhat better, but still averaged over 2% for 2004 and considerably higher than in the last couple years.

Click the chart to enlarge.

Also see the NY Times.

Probably not nationwide, but things like this worry me: (NY Times)

Premonitions of a bubble on the verge of popping do not ruffle those who are bullish on real estate. In Miami, Ron Shuffield, president of Esslinger-Wooten-Maxwell Realtors, predicted that a limited supply of land coupled with demand from baby boomers and foreigners would prolong the boom indefinitely.

"South Florida," he said, "is working off of a totally new economic model than any of us have ever experienced in the past."

Oh dear.

And on the radio news (the news, mind you) was a one line quote from some broker or banker (I forget which) who said that with interest rates rising it might be time to look into an adjustable rate mortgage.

Penny wise and pound foolish. What are these people thinking?

Next week, watch this space for a comparison of the 1994 fed funds tightening cycle to the present one.

From Reuters (and cited at macroblog):

In a somewhat disappointing signal on the factory sector, the Commerce Department said on Thursday orders for durable goods -- pricey items meant to last three years or more -- edged up 0.3 percent in February. This was well below the 1 percent gain expected on Wall Street.

But in the Wall St. Journal:

"If you take the last three months compared to the same period a year ago, new orders are up 10% for durable goods, so we're still seeing relatively strong activity," said Daniel Meckstroth, chief economist of the Manufacturers Alliance/MAPI, a policy-research group in Arlington, Va. This included price increases that somewhat distorted the comparison, he added, but prices of machinery were up only about 2% from a year earlier.

Maybe this is the real story (same article):

David Greenlaw, an economist for Morgan Stanley, said the main disappointment in the numbers was the pullback in shipments. Shipments of manufactured durable goods dropped $3.4 billion, or 1.6%, to $53.6 billion in February, following four consecutive monthly increases. "In this environment of stronger orders," he said, "you wouldn't expect so much of a pullback in shipments."

Meanwhile, new home sales (mentioned in both articles) continue to fuel talk of a housing bubble.

I meant to respond to this earlier, but am just catching up. Macroblog reported on the increase in capacity utilization. In a comment over there, PGL speculates on the rate that is consistent with full employment. Here are some quick stats on capacity utilization. Since 1967, the mean has been 81.4% and the median 81.9%. Since 1988 (chosen somewhat arbitrarily to include the peak before the 90-91 recession), the mean has been 81.0% and the median 82.1%. The peak in the latter period was 85.1%. As the chart below shows, the speed of the recovery of capacity utilization has been about on pace with the last recovery, but the level at its nadir was lower this time (i.e. we have more ground to make up).

Looking at the 3 month moving average of the changes in the capacity utilization rate shows that the recovery has been, in fact, quite steady, with fewer fits and starts than after the last recession. But again, we did (and still do) have more ground to make up.

From MSNBC

WASHINGTON - An index designed to forecast future economic activity rose a middling 0.1 percent in February after a decline of 0.3 percent in January, the Conference Board reported on Thursday.

Still, the February increase was the third in the last four months, and Conference Board economist Kenneth Goldstein said the trend was "pointing to (economic) growth this spring."

The business-financed research group said its Composite Index of Leading Economic Indicators advanced to 115.6 in February from 115.5 the previous month. The index had risen 0.3 percent in both November and December.

Goldstein said the statistics were "reflecting an economy that is continuing to improve."

The index is designed to predict economic activity over the next three to six months.

In Washington, meanwhile, the Labor Department reported that the number of new people signing up for unemployment benefits last week declined for the first time in a month — an encouraging sign that the jobs market may be gaining traction.

The department said new applications for unemployment insurance dropped a seasonally adjusted 10,000 to 318,000 for the week ending March 12. The level of 318,000 was the lowest since late February.

The last time new filings for jobless benefits fell was in the week ending Feb. 12, when they dipped by 1,000.

But...

NEW YORK - U.S. consumers became less upbeat in early March as rising gasoline costs made Americans more uneasy about the economy, a report said on Friday.

The University of Michigan said its measure of confidence had slipped to 92.9 so far this month from 94.1 in February, according to market sources who saw the subscription-only report.

"It sounds like there's a bit of a negative reaction to higher oil prices but the level of confidence is still more than high enough to keep consumer spending growing solidly," said Jim O'Sullivan, senior economist at UBS in Stamford, Conn.

The decline took analysts by surprise, since a recent burst of hiring had prompted many to forecast a slight gain to around 95.0.

The survey's expectations component eased to 83.6 from 84.4, while sentiment on current conditions dipped to 107.3 from 109.2.

Kash at Angry Bear has more on rising oil prices.

From the Peoria JournalStar:

PEORIA - When Scott Stanard ordered his usual sausage, egg and cheese biscuit combo Monday morning, he got two policemen on the side.

Stanard said the staff at McDonald's, 3600 N. University St., called police after he handed over a $10 bill that they said was a fake.

"I kept wondering why they weren't giving me any change," said Stanard, who sat in the drive-thru lane in his work van for several minutes before deciding to pull up and park.

"I knew I didn't do anything wrong - I got it from Family Video," he said, more upset from the embarrassment, and the fact that he didn't get his food.

Two officers arrived, talked to him and went in the restaurant to get the alleged funny money.

"(The police) said it was old - a 1950s series $10 bill - and the markers they use don't work on old money," Stanard said.

And the conclusion of the article:

In many instances, police will send suspected counterfeit money to the Secret Service for close scrutiny.

In Stanard's case, [Secret Service agent] Pingolt suspected the officers were able to tell the $10 bill was old and wouldn't stand up to the marker test. Hence, Stanard was not arrested, Pingolt said.

Stanard said police took the $10 bill, telling him he could pick it up later if it was real. If the bill turned out to be fake, it would be destroyed.

Despite still being peeved at the McDonald's management, Stanard was pleased Tuesday. He got his money back.

If the bill was in good condition and from the 1950s it might have had some collectable value. Of course now it probably has a big marker stain on it from those counterfeit detecting markers, making it worth...$10.

At least the police exercised some common sense and didn't haul the guy off in handcuffs as sometimes happens.

First, look at this from Cafe Hayek:

The Ohio state government will soon require all auctioneers operating in that great state to be licensed. This licensing requirement goes into effect on May 2. Here’s the whole story; just below is a relevant excerpt from it:

Besides costing $200 and posting a $50,000 bond, the license requires a one-year apprenticeship to a licensed auctioneer, acting as a bid-caller in 12 auctions, attending an approved auction school, passing a written and oral exam. Failure to get a license could result in the seller being fined up to $1,000 and jailed for a maximum of 90 days.

This licensing requirement is stirring up controversy because, as written, it will prevent ordinary Ohioans from using eBay. Supporters of the regulation deny that its intended reach is so vast.

And there's this from the state where I reside.

Actually auctioneer licensing is not uncommon. In the midwest, there is a lot of crossover between auctioneering, appraisal, and real estate. All of which typically require some form of licensure. It's the eBay connection that has people up in arms.

This reminded me of something I heard on the radio a couple days ago that takes occupational regulation to a new extreme. So I did a quick search and found one newspaper reporting on it. It's from the Minneapolis Star-Tribune, and I think you can read the this article if you register on their site (free registration).

BATON ROUGE, La. -— In Louisiana, not just anyone can sell a bunch of pretty flowers. You have to have a license.

U.S. District Judge Frank Polozola ruled Wednesday that the state can keep its unique law requiring florists to pass a test and get a license to work on their own. Would-be florists had argued that the law unconstitutionally bars them from entering the occupation of their choice.

About half of all applicants fail the test, which includes a written exam and one in which they must create four floral arrangements in as many hours. Unlicensed "floral clerks" can only work in a shop which also has a licensed florist.

"There are few occupational licensing laws as crazy as this one in this country," said Clark Neily with the Institute for Justice, a libertarian nonprofit law firm in Washington, D.C. Neily said he will ask the 5th U.S. Circuit Court of Appeals to overturn the ruling.

Neily has argued that the question of who has floral talent should be left to the market: people whose arrangements are ugly would soon find themselves without customers.

Priceless.

The economy added 262,000 jobs in February. I've been hoping for 200,000 but I didn't want to get my hopes up too much. We've had a couple months of under 150,000 and another would not look good.

So, how does this affect the chart I showed a few days ago?

Click the graph to enlarge.

As you can see from this version (which begins in 1989 so you can see the recent activity a little more clearly), February's numbers did bump us up just a bit. There was a net change of 1.8% from Feb. 04 to Feb. 05 compared to 1.7% for Jan. 04 to Jan. 05.

Slowly....inching....up.

Oddly, the unemployment rate increased to 5.4% from 5.2%. Since the unemployment rate comes from the household survey, this might be a result of the small sample size. This could very well reverse itself next month. Don't base any conclusions on a one month change in the unemployment rate--in either direction.

See also: Angry Bear. They have two posts. In the latter, PGL remarks that some reporters don't know how to interpret these numbers. Based on my read of the BLS news release, I'd say he's right.

UPDATE: PGL points me to MaxSpeak who also interprets the change in the numbers correctly. Max also adds this,

Stepping back, the post 2001 recovery still compares badly with previous ones. This one had the dubious benefit of tax cuts; the previous one had tax increases. This is not a strong testament to the power of marginal tax rates, Alan.

Many of the tax cuts were aimed more at capital formation than job creation. Depending on your point of view, that makes Max's criticism more or less biting. Personally, I'd like to see more research along the lines of Groshen and Potter (2003) to try to figure out the reason for the "jobless recovery," which according to my chart is mostly evidenced by the odd little hiccup in the curve in 2003. Something happened in there that had a much larger impact than the particular tax cuts Bush enacted. Structural change? Uncertainty over Iraq? Both? Other?

Anyway, the employment data is better today than yesterday. However, I'm holding off on declaring victory until my chart crosses the 2% line and stays there for 3 months.

UPDATE: Re: The exchange between PGL and Max in the comments of MaxSpeak

The civilian labor force numbers for the last 3 months: Dec. 148,203, Jan. 147,979, Feb. 148,132. So since December, there is been little change in the actual numbers or the rate. The gain in the labor force in February is in the number of unemployed workers. That could mean we undercounted them in January or some people who had dropped out of the labor force are returning. Take your pick. We can't tell from one month.

In the last day or so I graded one set of midterms and wrote another which I gave today. (You know what I'm doing this weekend.) That leaves less time for blogging. Thus, we have these quick hits from the past day's news and blogs. I'll post more on some of this later.

Stumbling and Mumbling asks what the blogosphere is really all about and decides:

I think we should regard it as a new form of 17th century coffee-house, a venue where men met on equal terms to exchange news and ideas.

Perhaps so. And the real beauty of it is that it knows no geographical boundaries. The author of Stumbling and Mumbling is British. I came to small town Illinois from small town Minnesota. You could be sitting anywhere right now reading this. Yet here we are.

Next up, Brad DeLong points us to a Financial Times article on productivity. Angry Bear has more, and a chart. You could also check out macroblog. I'll have more on this later.

On the budget front, this headline lays it out there, "Greenspan Says Federal Budget Deficits Are 'Unsustainable'." Here's a taste of what you'll read in the article,

"When you begin to do the arithmetic of what the rising debt level implied by the deficits tells you, and you add interest costs to that ever-rising debt, at ever-higher interest rates, the system becomes fiscally destabilizing," he told lawmakers. "Unless we do something to ameliorate it in a very significant manner," he added, "we will be in a state of stagnation."

White House officials played down Mr. Greenspan's remarks, noting that he had placed top priority on reduced government spending and that Mr. Bush had vowed to reduce the budget deficit by half by 2009.

"The president does have a substantial deficit-reduction package," said Trent Duffy, a White House spokesman. "His budget is a continuation of that policy, and he looks forward to working with Congress in cutting that spending down. Likewise, the president agrees that the long-term budget is the issue, which is why he's trying to lead a national discussion and reform movement to save and strengthen Social Security."

But then,

WASHINGTON (Reuters) - President Bush said on Thursday he would focus for now on the financial problems facing Social Security, signaling a shift in tactics amid a slide in support for his private account plan.

There was so much more happening Thursday, like a thought provoking WSJ article by Greg Ip.

Job figures come out today. Lately, 150,000 has been the number to beat. That has to rise. 200,000 would be so much better. I think it will be close, but these things are hard to predict.

PGL at Angry Bear made this post on Social Security, but my response will have to wait.

So much for the roundup. Extended analysis on Friday.

Fed Governor Mark Olson gave this speech yesterday. Check out the charts at the end; they are quite amazing. Bottom line, asset quality did not deteriorate nearly as much in the most recent (2001) recession as they did in the 1990-91 recession.

Risk management has certainly improved, but banks should not become complacent. As Olson puts it:

The more favorable experience in the more recent period speaks well for the credit-risk management at smaller institutions, even in the context of a mild recession. That said, it also means that it has been a decade and a half since many lenders have seen a serious overall downturn in asset quality. We know from surveys of senior lenders that lending standards have eased overall. Some easing is normal for this phase of the business cycle, but this easing is always of concern to regulators. Some lenders have recently expanded their offerings of interest-only mortgages and mortgage loans with maturities beyond thirty years. In this context, prudent lenders should weigh their alternatives carefully before compromising established underwriting standards or pricing in the face of competitive pressures.

That's probably good advice.

UPDATE: Posted the wrong version but caught my error a few minutes later. This is the correct version.

There was clearly a slowdown in 2003, but the rate of increase appears to be back on track somewhat. The last couple months look like it's trying to decide which way to go. This Friday, the payroll numbers for February will be released. I will be posting an update to this chart which for better or for worse, might be just as interesting as the raw numbers.

UPDATE: I just crunched a few numbers that you might want to chew on this week. Since May, the percentage rate increases have been 1.2, 1.3, 1.3, 1.5, 1.5, 1.6, 1.6, 1.7, 1.7. Growth is steady but slow. To really look like we're back on track, we would probably want (at least) 1.8% growth for the previous 12 months. That would require over 200,000 jobs (depending on how you prefer to round your figures, I'm being generous). We only saw that kind of growth 4 times last year, but we need to see more of it. 150,000 this month (like we had in January), would put us further behind where we should be at this point in a recovery.

Still no specifics on when this will happen or how soon it will lead to any actual move on the exchange rate. However, China did announce that they will allow insurance companies to invest overseas, providing a relief valve for currency to leave the country. This as a part of generally increasing the amount that can be traded in the capital account.

Read the Reuters article.

To refresh your memory, here is my post from a month ago when the advance numbers came out. Note the chart at the bottom.

Here's today's news release. Real GDP was up 3.8% (annual rate) for the 4th quarter of 2004. That's considerably higher than the advance number of 3.1% and even higher than the 3.5% that was expected by analysts a month ago. It's even a little bit higher than what analysts were expecting earlier in 2004. If the economy can maintain this rate for a few quarters, I think a lot of people would be happy. Whether that is likely is a post for another day.

Where did the increase come from? Well, a good part of it undoubtedly came from the undercounting of exports to Canada in the advance figures. Ooops! The rest, according to the BEA is due to increases in inventory investment as well as the category for equipment and software.

Angry Bear has a nice chart which shows that while residential investment is growing more slowly, nonresidential investment is increasing at a pretty good pace, with only a minor hiccup in early 2004.

Harvey Rosen is the new CEA chair. Rosen is already a member of the CEA, so someone will need to be appointed to take his spot as he moves up.

BLS News Release

Angry Bear and macroblog provide today's commentary.

The market cheered a little bit anyway.

Oh, and what's this? I almost forgot. From the Reuters article linked above:

Markets will look for the release at 2 p.m. (1900 GMT) of the Federal Open Market Committee's minutes from its Feb. 1-2 meeting for clues about future rate hikes.

I'm going to read the minutes. Expect an update to this post within an hour or two.

UPDATE: After the procedural part of the minutes:

At this meeting the Committee engaged in a broad-ranging discussion of the pros and cons of formulating a numerical definition of the price-stability objective of monetary policy. A staff presentation on the topic included a review of the potential costs and benefits of introducing such a definition as well as of other countries’ experiences. In the subsequent discussion, meeting participants uniformly agreed that price stability provided the best environment for maximizing sustainable economic growth in the long run, but expressed a range of views on whether it would be helpful for the Committee to articulate a specific numerical definition for the Federal Reserve's price-stability objective––either a single figure or a range. Those who believed such a move would be on balance beneficial cited, for example, its usefulness as an anchor for long-term inflation expectations, as a vehicle for enhanced clarity of Committee deliberations, and as an additional tool for communications. Several of those who saw greater potential drawbacks were concerned that such a shift might appear to be inconsistent with the Committee’s dual mandate of fostering maximum employment as well as price stability or that it might inappropriately bias or constrain policy at times; in any case, with inflation expectations well-contained over recent years, the benefits of announcing a specific inflation objective were not likely to be large. The Committee decided to defer further discussion.

Too bad we have to wait 5 years for the transcripts.

The committee also seems to feel that inflation is being held in check for now.

Core consumer prices decelerated over the past few months, while overall consumer prices were buffeted by movements in energy prices. The rate of increase in core prices in the twelve months ending in December was somewhat higher than the very low rate that prevailed during the year-earlier period; the overall index also accelerated, with about half of its advance accounted for by a sharp rise in energy prices. Measures of inflation expectations were little changed over the intermeeting period. With regard to labor costs, the employment cost index decelerated in the fourth quarter; the slowdown was attributable to wages, which gained only slightly, while benefit costs rose a bit faster than in the third quarter.

And you knew that they would mention this...

The Committee’s decision at its December meeting to increase the federal funds rate had been fully anticipated in financial markets, and reaction to the attendant statement was muted. The release of the minutes of the December meeting on January 4, however, triggered a significant upward revision in the anticipated path of monetary policy: Investors apparently read them as expressing more widespread concern among Committee members about inflation pressures than had been the case previously. Market participants viewed the generally favorable incoming data on economic activity as consistent with their expectations of firmer policy. Interest rates on intermediate-term Treasury securities rose in response to the revision to policy expectations, but longer-term yields were little changed over the intermeeting period.

The forecast for '05 and '06:

As part of its continuing effort to improve its communications, the Committee had earlier decided to add one year to the forecast period so as to make the projections more useful to the public. The forecasts of the rate of expansion in real GDP were concentrated in the upper part of a 3½ to 4 percent range for 2005; for 2006 the forecasts were in a slightly lower range of 3¼ to 3¾ percent, with a central tendency at 3½ percent. These rates of growth were associated with a civilian unemployment rate in the range of 5 to 5½ percent and a central tendency of 5¼ percent in the fourth quarter of 2005 and 5 to 5¼ percent in the fourth quarter of 2006. The rate of inflation, as measured by the core PCE price index, was expected to remain fairly stable, with forecasts concentrated in the lower portion of a 1½ to 2 percent range for both this year and next.

This is the only thing I could find that expressed any concern about inflation. It's near the end, and makes me wonder if the regional banks are more hawkish than the board at the moment.

However, several participants suggested the possibility of an upward skew to the distribution of inflation outcomes, especially if there were appreciable further declines in the foreign exchange value of the dollar or in structural productivity growth; already some participants were hearing anecdotal reports from firms of an increased ability to pass cost increases through to product prices, perhaps because of increasing confidence in the outlook for the economic expansion.

I would think that the participants who are hearing anecdotal evidence from firms are the bank presidents.

This sums it up:

All members judged that a further quarter-point firming in the target federal funds rate was appropriate in light of current overall accommodative financial conditions and the continuing outlook for solid economic growth and diminished slack in resource utilization. A higher nominal federal funds rate was seen as needed to contain risks of increased cost and price pressures, but even with this action, the real federal funds rate was generally seen as remaining below levels that might reasonably be associated with maintaining a stable inflation rate over the medium run. The pace of policy moves at upcoming meetings, however, would depend on incoming data.

Most of this we knew already.

UPDATE: The status quo is apparently good. A market strategist quoted in the article says,

There's nothing in here when I read these things that jumps out at me and strikes me as something different or new.

Yeah.

UPDATE: Yet another article, here the writer feels that the minutes indicate more tightening, which would be good for the dollar. Maybe, but this is not "news." The minutes say clearly that

The pace of policy moves at upcoming meetings, however, would depend on incoming data.

In other words, expect 1/4 point at each of the next three meetings unless we get some signals to quicken or slow that pace. Today's CPI numbers did not contain such a signal, in my opinion. The current pace of rate hikes seems consistent with the amount of inflation pressure evident in today's data.

Read here. Brad Setser has been posting a lot about the dollar, and in the last 24 hours about the news out of Korea that I mentioned yesterday. For a minute, I toyed with the idea of giving that post a clever title like, "It begins," but I thought that would be a little too dramatic. I wonder what Setser would have thought of such a title.

Let me be clear about where I stand. I don't think this should be over dramatized, which is why in the end I opted for a less clever, more boring title for that post. However, it does give one pause. And though Setser is not bashful about showing concern:

News about what any of these four central banks [Taiwan, Korea, Russia and India] intend to do is hardly marginal news in my book. Three of the four -- Russia, India and Korea -- have now indicated a desire to either diversify their reserves or to spend their reserves on "infrastructure." Some say Taiwan has made similar noises as well, though Taiwan's central bank officially denies any such intent.

But he ends with a ray of, well, I'll call it hope.

To my knowledge, at this stage, we have no real way of knowing whether Asian central banks are purchasing fewer dollar assets (relative to the increase in their reserves), or just purchasing fewer Treasuries. In one scenario, Asian central banks are buying euros and other currencies. In the other scenario, they are just buying a broader range of (higher-yielding) dollar-denominated assets, and doing their purchases in ways that the US data does not pick up as cleanly.

I'll call it hope because if they are simply diversifying their purchases of dollar assets, the news is far less troubling. We'll know eventually. Such things show up in the balance of payments in time. Of course, if they're not picking up other dollar assets, we'll see the signs.

My gut feeling? Foreign demand for dollar assets shifted dramatically from private assets to Treasury securities beginning in 2001. (I'll try to find a data link later.) This might be the pendulum swinging back, but like I (and Setser) said, we won't know with certainty for a while.

David Altig and Alex Tabarrok are in the Wall Street Journal Online's Econoblog today. (Subscription required)

David links to this post of mine, making this my first inbound link from the Wall Street Journal. Pretty cool stuff for an assistant professor from Peoria who started blogging just a few months ago.

Anyway, the post he links to is where I observed that the Retirement Savings Accounts proposed by the President would apparently replace the Traditional and Roth IRAs presumably simplifying the tax treatment of savings and encouraging the same. I haven't seen anyone else mention this (though I'm sure by now word must be getting out--certainly after today it will), and I think it deserves some discussion. In principle, I have nothing against the idea if it simplifies and encourages saving. Of course some details would have to be worked out concerning how to deal with existing IRAs, but I'm pretty sure that's doable. The issue I have with it is that it's hard to imagine anything simpler than a Roth IRA. Maybe the best thing to do is to simply expand on that concept. Absent anything else on the table, that would be the first thing I would suggest.

If you're here for the first time via the Wall Street Journal site, welcome!

The Bank of Korea (home of the world's fourth largest reserves) signals a desire to diversify. UPDATE: Brad Setser has more.

Tomorrow brings the release of the January CPI, so it will probably be a quiet day for the dollar as traders await tomorrow's news. This will give us more of a clue as to which way the Fed might be heading at the next two or three meetings.

Read here.

Inflation pressures appear to be easing. I just hope they don't become complacent. The road ahead is long and winding. Read here.

...but it does get reflected in the implied probabilities on fed funds futures.

If you haven't seen them at macroblog yet, go there now. If a picture is worth a thousand words, this is worth three grand.

Quick interpretation: We're looking at the next three FOMC meetings here. The market believes that a 25 basis point move is almost certain at the next one (March). By the May meeting, the market considers it most likely that the rate will be 50 basis points higher than it is now. Most likely, two 25 b.p. moves. However, the probability of a 75 b.p. move by that time increased from about 10% to about 15%.

But by July, more uncertainty creeps in. Until very recently, a lot of people might have thought that one of the next three meetings would bring a break in the action--a momentary pause in the rate increases. That probability has taken a hit in the last few days (blue line on his 3rd chart). It is looking very likely that the rate will be 75 b.p. higher in July than it is now. The probability of a full point hike between now and then is over 20% according to the futures market. That could be accomplished by a 50 b.p. hike in one of those three meetings, most likely May or July.

The PPI data macroblog cites would be seen to be the proximate cause, but it's been building in my mind for a while.

We'll keep an eye on this.

Paul Krugman's latest NY Times piece gets it partly right. First, the not-so-good:

But privatization "as a general model," he said, "has in it the seeds of developing full funding by its very nature." Nice metaphor, but what does it mean? Clearly, he was trying to create the impression of links where none exist.

Swing and miss. Private accounts must be fully funded. (There are no credible proposals to the contrary.) Ergo, if fully funding Social Security is a goal, private accounts represent a means to achieving that goal. Granted, it's not the only way, but it is a way. Seems to me that's the link he [Greenspan] was going for, and it's correct as far as it goes, whether you agree with private accounts or not.

He does get a couple of hits though:

Privatizers claim that financial markets won't be disturbed by all that borrowing because the Bush plan prescribes offsetting cuts in guaranteed benefits for the workers who open private accounts. Mr. Greenspan, who does know a thing or two about markets, put his finger on the reason why those prospective future benefit cuts wouldn't offset current borrowing in the eyes of investors: "Well, the problem is that you cannot commit future Congresses to stay with that."

Valid point in general, so it's a hit. However, I think decision day on this is still many years in the future. The financial markets will not pull the trigger until and unless private accounts are unsuccessful to the point that Congress will be tempted to break the commitment to lower benefits. If you are confident about private accounts, you won't worry about this as much. If you don't think private accounts will deliever the goods, it's an entirely rational point to raise.

Yet the chairman managed to avoid admitting the obvious - that borrowing on the scale the Bush plan requires would substantially increase the risk of a financial crisis. And the headlines didn't emphasize his concession that crucial critiques of the Bush plan are right. As he surely intended, the headlines emphasized his support for privatization.

Two ideas in one paragraph. The first sentence belongs with the paragraph which preceeded it (above). The last part is correct. The headlines did emphasize his [Greenspan's] support for privatization. No doubt about that. Is it what he intended? Well, you could argue that he's been a central banker long enough to know what the headlines would be if he said certain things. The fact that he said them anyway is circumstantial evidence in Krugman's favor.

I can't really comment on the last part of his column directly, though I wish I could. I'll explain why and do the best I can.

One last point: a disturbing thing about Wednesday's hearing was the deference with which Democratic senators treated Mr. Greenspan. They acted as if he were still playing his proper role, acting as a nonpartisan source of economic advice. After the hearing, rather than challenging Mr. Greenspan's testimony, they tried to spin it in their favor.

But Mr. Greenspan is no longer entitled to such deference. By repeatedly shilling for whatever the Bush administration wants, he has betrayed the trust placed in Fed chairmen, and deserves to be treated as just another partisan hack.

I did not see the hearings. I was working on more pressing matters on Wednesday, and on Thursday I was teaching. C-Span sadly has not rebroadcast the hearings, at least not to my knowledge (and I have checked their website every day). Often they replay these in the evenings or later in the week, and I'm very disappointed that they haven't done so this time. I can say that from previous hearings that I have seen on C-Span, the treatment was anything but deferential (at least since the recession) from the Democrats. One of the reasons I watch them is for the entertaining way in which the Democrats verbally lash him and he responds in such a soft-spoken, even-handed way.

However, I did find this quote on Rueters:

"I do have to express skepticism that telling workers losing their jobs ... 'Do not despair. Private accounts are coming' will be less a morale booster than I think you implied," said Rep. Barney Frank, a Massachusetts Democrat.

I suppose you could deliver that line in a deferential manner. It could also be delivered with the implication that he's a partisan hack. Unfortunately, I did not see the delivery, just the words.

Lucas, Robert. "Making a Miracle" Econometrica 61(2), March 1993 pp.251-272.

Lucas, Robert. "Some Macroeconomics for the 21st Century" Journal of Economic Perspectives 14(1), Winter 2000 pp. 159-168.

With some of my lecture notes based on Parente and Prescott's Barriers to Riches.

Here's an article from BusinessWeek that is worth a look. I'm going to hold off on commenting on it now for two reasons. First, local readers can hear me talk about this and other economic news on the 3D Morning Show with Dan, Doc, and Dave on 1470 WMBD this Thursday at 8:30am. Second, my ECO 222 students (who are, I suppose, a subset of my local readers and who are encouraged to tune in) will discuss this in class.

(ECO 333 students, this isn't your reading assignment--you'll have something else next week. But still feel free to read the BW article and tune in on Thursday.)

Blogging has been light the last couple days. There's a bit of a lull in the economic news now after getting GDP data, job numbers, and a budget all in the space of a few days since the end of January. The blogosphere seems to be getting a little tired of Social Security, though I think things will heat up later in the spring as Congress (maybe?) starts debating the particulars. And the budget was good for a few days of headlines, but really I ask you, what did we see last Monday that we didn't already know? (except perhaps that the Bush initiatives might mean the end of Traditional and Roth IRAs)

But the lull ends on Wednesday when Alan Greenspan goes before a Senate committee, then over to the House on Thursday. For a preview of coming attractions, read here, here, here, or here. I would guess that it will be archived on C-Span video so you can watch it at your leisure. If so, I'll give you the link. The text of Greenspan's remarks will be posted at the Fed's website, but you really have to listen to the questions to get the full impact. It's always a good time.

And it only happens twice a year, so enjoy!

Not sure if these are available without a subscription or not, but here's one on the tsunami. There's nothing in here to suggest that the aid will spur these economies on to higher growth (unlike some articles we've seen). The focus is on the problems in spending the aid money efficiently. One line seems to sum it up.

There is also a risk that the authorities may over-react, and introduce ill-considered new policies.

Indeed.

And then there is this one on the fall of AT&T. The article summarizes a few of the mistakes that AT&T made following the breakup and how they led to their aquisition by SBC, one of the "baby bells." It's only a brief summary. The whole story is much too long for one magazine issue, but here is one choice quote:

First, AT&T underestimated how important wireless communications would become. At the time of the break-up in 1984, AT&T relied on a report by McKinsey, a consultancy, that claimed there would be fewer than 1m wireless phone users by 2000. In fact, there were 740m.

And this:

"The main lesson is that it is very hard to change a culture that has evolved for a particular type of environment," says Andrew Odlyzko, a former Bell Labs researcher now at the University of Minnesota. AT&T grew up believing that communications comprised voice calls charged by the minute and the distance. But data subsumed voice, web traffic burst through the network via always-on broadband connections and distance is dead.

You'd think that people would have more sense than this.

The December 26 tsunamis destroyed three-quarters of the country's coastline, wrecked the road and railway network and initially left a million people homeless, but there followed an aid windfall from abroad.

Analysts said the avalanche of assistance from global lenders and the post-tsunami reconstruction across the devastated regions will kick-start economic growth now expected to cross five percent next year.

There will be a dip in the gross domestic product in 2005 as an immediate effect of the tsunami, but from next year the reconstruction effort will emerge as a growth engine, the analysts said.

Methinks someone is confusing wealth and spending. (Isn't that what it really comes down to?) Disasters create spending but destroy wealth. Trust me, the effects do not cancel each other out.

Ok. I have addressed this before, but it just keeps coming back. (You just can't get rid of this stuff--my work will never be done.)

At least they don't refer to the people quoted in the article as economists. They probably couldn't find any economist who would be complicit in their "broken windows" story.

If widespread destruction is so great for growth, then why don't we...

Finish that sentence with its logical conclusion and it sounds pretty stupid, doesn't it?

I know most of my readers (economists) are familiar with the point. But students, please take heed. Don't be like those "analysts."

And thank you for allowing me to vent. This sort of thing really irritates me.

Link via Market Power

UPDATE: I read this after I made my post. Don Boudreaux completes my sentence for me. Apparently this sort of thing irritates him too.

Becker and Posner weigh in on Social Security. Becker supports private accounts. Posner's focus is less on the private accounts, per se, and more on the separation of the pension system from a welfare program. Read both.

Brad DeLong, in critiquing Ed Lazear's article on Social Security in The Economists' Voice exposes what he likes and what he doesn't like about private accounts.

Kash at Angry Bear notes that there is nothing in the budget about reforming the AMT. He says that this could be a back door way of repealing the tax cuts. His graph from the CBO seems to agree.

The budget is out. The good stuff (summary tables) is here. As of 10:30, the pdf version was not posted. I'm guessing they will be there soon, but for now the html will do.

Let me give you some things to chew on.

From the section on the ownership society:

Even with all the positive changes the President has signed into law, the Federal income tax code still discourages economic growth in many ways. For example, the income tax continues to discourage saving for many taxpayers, and so the President has proposed Retirement Savings Accounts, which would replace the complex array of retirement saving incentives currently in the tax code, such as IRAs, Roth IRAs, and similar saving vehicles. The President has also proposed Employer Retirement Savings Accounts to simplify the saving opportunities individuals have through their employers.

The President also proposed Lifetime Savings Accounts that would, for the first time, allow individuals to save on a tax-preferred basis for any purpose. While important to all Americans, Lifetime Savings Accounts are especially important to low-income individuals and families who need to save, but cannot afford to lock up funds for retirement that may be needed for an emergency in the near-term. The President also proposed Individual Development Accounts that would give extra financial incentive to certain low-income families to set aside funds for major purchases, such as a first home.

I had to read that twice. He says "replace" IRAs and Roth IRAs. The Lifetime Savings Accounts and Individual Development Accounts are noble ideas. See below.

For generations, the tax code has encouraged Americans to spend first and save second. These proposals would level the incentives to save and consume, thereby promoting a culture of saving in America that is essential to future prosperity.

Then he better make sure that whatever is replacing the Roth IRA will actually achieve the goals of increasing saving for the middle class, and that it is progressive (i.e. gives incentives and tax breaks for low income families). If he can do this, I'm on board. But the Roth IRA is such a good idea that I would be careful about what I replace it with. I can think of ways to change the rules for a Roth IRA that would accomplish his objectives (tax incentives for low income familes, reduced penalties for early withdrawl, etc.) But that really changes the program. The fact that he is proposing something totally new to replace the Roth and the traditional IRAs says that this is just one step in a major tax code reform.

Your opinion on that will be determined by more than just what's in the document we saw today. That's for sure.

As for all the spending cuts. Good luck! However, I do think that the revenue projections are a little conservative. They were in the mid '90s too. I think conservative projections also partially explains the fact that the deficit is lower now that it was projected to be at this point a year ago. Click here to see that the rebound in receipts, though not complete, has begun.

Discuss.

The federal budget will be unveiled on Monday.

I'll be here.

I suppose the headlines will be something about the Republicans touting the fiscal restraint and deficit reduction in the budget while the Democrats will complain about the President's misplaced budget priorities, cuts in social programs, etc.

Come on back and discuss it on Monday.

In the meantime, enjoy the Super Bowl. I don't have a horse in this race, so the game is not a big deal to me. I've always liked the commercials though.

I will predict that the headlines afterwards will be more about the game than the halftime show (unlike last year). I make no serious predictions about the game though. It's hard enough predicting macroeconomic variables!

Two articles from Reuters, here and here.

From one:

LONDON (Reuters) - U.S. Treasury Under Secretary John Taylor said on Saturday that China was taking all the necessary steps toward introducing a flexible currency exchange rate that will benefit itself and the global economy.

"The Chinese continue to emphasize their commitment to move to a flexible exchange rate, and we have seen steps that are consistent with a move in this direction," Taylor said at the conclusion of a Group of Seven finance ministers' meeting.

A senior U.S. Treasury official said later that much of the preparation seemed to have been completed for China to ease its currency peg. "Most of the pieces are in place and largely ready to go in that direction," the official said, but added that the timing of any action by China remained uncertain.

And from the other:

BEIJING (Reuters) - China's yuan is not substantially undervalued given the country's balance of payments, but it will manage capital flows with the aim of eventually making the currency convertible, China's central bank governor said.

But Zhou Xiaochuan, who made the remarks in an interview with the official Xinhua news agency, said China would follow its own timetable for currency reform, according to the needs of its development.

In other news, the sun rose today.

Remarks like this have been going back and forth for a long time. I worry a little bit about one thing. China seems determined to do things on its own timetable, and that's fine. But by saying that over and over again, I think it heightens the symbolic importance of any change in that position later, no matter how slight. Any change in the wording of their position is going to be parsed like a Federal Reserve press release.

A year or two ago, I thought I could envision a set of circumstances that would lead to the Chinese government moving the peg. Today, I find that harder to do. Inertia is a powerful force. Every time we see articles like these, it gets harder to overcome that force.

Let's close out the workweek with this.

One of the biggest challenges in teaching economics is the interpretation of statistical results. Mostly, I'm talking about interpreting regression analysis.

Brad DeLong posts this on his blog today--an assignment on interpreting regressions. Of course, out of courtesy we will make no comments on the answers. (His students need to do it for themselves.) However, I must say that I am glad, no, make that thrilled to see that someone else take the distinction between statistical and economic significance seriously enough so as to craft an assignment around it. According to the assignment, it should be credited to Martha Olney. Kudos to both. I've got to get that article so that I can do the assignment myself. I'll probably be using this sometime, with attribution of course.

Greenspan singlehandedly moves the currency market. From Reuters:

NEW YORK (Reuters) - The dollar rallied against most currencies on Friday after Federal Reserve Chairman Alan Greenspan said market forces and tighter U.S. fiscal policy should stabilize and may cut the U.S. current account gap.

The euro fell to its lowest level in almost three months below $1.2900, although its heavy losses against the yen also dragged the dollar lower against the Japanese currency.

"I think the Chairman's taking a much more sanguine view on the current account deficit than he's taken for some time," said Robert Sinche, head of currency strategy at Bank of America in New York.

"He's taking a longer-term view, laying out a set of conditions under which the current account deficit can improve this year and next," Sinche said.

News reports like this are so bland. Want to know what he said? Read here. A few key passages follow.

Arguably, however, it has been economic characteristics special to the United States that have permitted our current account deficit to be driven ever higher, in an environment of greater international capital mobility. In particular, the dramatic increase in underlying growth of U.S. productivity over the past decade lifted real rates of return on dollar investments. These higher rates, in turn, appeared to be the principal cause of the notable rise in the exchange rate of the U.S. dollar in the late 1990s. As the dollar rose, gross operating profit margins of exporters to the United States increased even as trade and current account deficits in the United States widened markedly. But these deficits have continued to grow over the past three years despite a decline in the dollar, whose broadly weighted real index is now much of the way back to its previous low in 1995.

I seem to remember someone talking about 1995 a while back. Oh, yeah! Back to Greenspan:

To understand why the nominal trade deficit--the nominal dollar value of imports minus exports--has widened considerably since 2002, even as the dollar has declined, we must consider several additional factors. First, partly as a legacy of the dollar's previous strength, the level of imports exceeds that of exports by about 50 percent. Thus exports must grow half again as quickly as imports just to keep the trade deficit from widening--a benchmark that has yet to be met. Second, as is well-documented, the responsiveness of U.S. imports to U.S. income exceeds the responsiveness of U.S. exports to foreign income; this difference leads to a tendency--even if the United States and foreign economies are growing at about the same rate--for the growth of U.S. imports to exceed that of our exports. Third, as of late, the growth of the U.S. economy has exceeded that of our trading partners, further reinforcing the factors leading imports to outstrip exports. Finally, our import bill has expanded significantly as oil prices have risen in recent years.

To be sure, the lower dollar has undoubtedly boosted the competitiveness of U.S. exports and the profitability of U.S. exporters. These factors help explain the considerable increase in exports over the past couple of years. Yet the positive effect of the dollar's decline on exports and on the trade balance has been offset by the other aforementioned factors.

Besides market pressures, which appear poised to stabilize and over the longer run possibly to decrease the U.S. current account deficit and its attendant financing requirements, some forces in the domestic U.S. economy seem about to head in the same direction.

The voice of fiscal restraint, barely audible a year ago, has at least partially regained volume. If actions are taken to reduce federal government dissaving, pressures to borrow from abroad will presumably diminish.

That is all he said about fiscal policy. Some might say even that is too much. As for actions taken to reduce government dissaving--that's a big "if." The Reuters story elevates it to the lead paragraph. It will certainly be interesting to see if this takes hold anywhere else in the media or the public debate. Remember, you heard it here first.

Greenspan concludes:

The interaction of a wide range of economic forces, which adjust at national borders to create what we call the current account balance, has proved difficult to predict with any precision, primarily because of the difficulty of forecasting exchange rates. These same forces have lessened our ability to anticipate the consequences of a buildup of either a surplus or a deficit.

In addition, numerous issues that have arisen with respect to the adjustment of the U.S. current account remain unresolved. One is the effect of Asian official purchases of dollars in support of their currencies. Such intervention may be supporting the dollar and U.S. Treasury bond prices somewhat, but the effect is difficult to pin down. Another issue is the influence of still-growing globalization, arguably one of the key factors that has facilitated the financing of the U.S. current account deficit. There is little evidence that the growth of globalization has yet slowed.

The dramatic advances over the past decade in virtually all measures of globalization have resulted in an international economic environment with little relevant historical precedent. I have argued elsewhere that the U.S. current account deficit cannot widen forever but that, fortunately, the increased flexibility of the American economy will likely facilitate any adjustment without significant consequences to aggregate economic activity. That argument will be tested, I suspect, by possibly new twists and turns that will emerge in a seemingly ever-more complex international economic and financial structure.

References to footnotes have been taken out. Read the whole thing, it's worth your time. The conclusion pretty much agrees with things I have been thinking and writing on this blog in the last few months, at least about our flexibility and response to market forces. It's an optimistic outlook, to be sure. I just hope it's right.

From the Bureau of Labor Statistics:

Nonfarm payroll employment increased by 146,000 in January and the unemployment rate decreased to 5.2 percent, the Bureau of Labor Statistics of the U.S. Department of Labor reported today. Job growth continued in several service-providing industries, while manufacturing employment declined over the month.

146,000 is barely enough to keep up with population growth. The fall in the unemployment rate could be due to a few more discouraged workers leaving the market. It's always a little unclear because the household survey uses such a small sample.

I think it's a little early to call this a slowdown. This report, as uninspiring as it is, really is pretty neutral. The problem is we don't want neutral right now. We need a couple good months of more than just marking time.

Kash at Angry Bear has an interesting chart that is worth your attention.

...don't hold your breath.

From the article:

China is heading for a confrontation next week when finance ministers and central bankers of the Group of Seven industrialized nations press Chinese leaders to loosen the connection of about 8.3 yuan to the dollar.

Stay tuned.

Real GDP grew at an annual rate of 3.1% in the 4th quarther of 2004 according to the Bureau of Economic Analysis. Press release here. This is lower than than was expected and down about a point from the 4% rate in the 3rd quarter.

The street was expecting about 3.5%, and forecasts were for even lower in 2005Q1. Here's a link to a St. Louis Fed article that explains why. Business economists and forecasters have been concerned about investment for months now. In November, the forecasters were looking at 3.7% for the 4th quarter with about a 3 point drop in the growth of business investment (from 13 to 10%). By this week, the expectations had diminished further.

From the same St. Louis publication comes this chart which I look for every quarter and find extremely useful for visualizing the components of GDP and whether they are contributing to growth or acting as a drag on growth. (Click to enlarge.)

It is clear that the slowdown in investment (10.3% growth for nonresidential fixed investment, down from 13%) is partly to blame, but look at exports. Exports suffered their biggest decline in 2 years and represented a negative contribution to GDP growth. This Reuters article mentions the trade deficit, but not exports specifically. (Note: Macroblog links to another article that does.) Imports increased significantly, but the growth rate was well within its normal range, especially this early in an expansion. As Dave at macroblog points out, the export news isn't much of a surprise, but the chart shows that it makes a difference. PGL, commenting at macroblog, mentions that government spending grew little, and again the chart bears out the tiny contribution to overall growth.

The Reuters piece also tells us that Treasuries rose on the news, bringing the yield down to 4.14% from 4.22%. Will this have any impact on the FOMC meeting next week? The IEM seems to think not. The current price of the "up" contract is still over 98 cents. The price of the "up" contract for March is close to 93 cents.

Also, from macroblog, a good thing to keep in mind:

Furthermore, there is this reminder from the Commerce department report:

The Bureau emphasized that the fourth-quarter "advance" estimates are based on source data that are incomplete or subject to further revision by the source agency ... The fourth-quarter "preliminary" estimates, based on more comprehensive data, will be released on February 25, 2005.

From the same St. Louis Fed publication referenced above (National Economic Trends), we have this:

It's true that lately, the final and annual revisions have added a few tenths to the preliminary estimate. (Update: That should be advance and preliminary estimates.)

Phil at Market Power tells it like it is.

Once more for the record, I don't think that Social Security is in "crisis." I've said so before. However, the system will need some kind of adjustment in the next few decades. Almost no one disputes that.

So wouldn't it be nice to take prudent steps now that might have a long run payoff? (One doesn't have to think that the system is in crisis to agree to that.) I'm not sure that the plan that is being discussed is exactly what I want. My ideal plan would probably be more cautious in some ways and more daring in others. I would just like to preserve the insurance aspect of Social Security while improving the rate of return to younger workers and leaving the return to retired (and nearly retired) people unharmed.

But for now, chew on this NY Times Magazine article by Roger Lowenstein.

Even though I disagree with much of it, and it has some problems (see below). I did learn a thing or two. Read it, but read it critically.

Here's an amusing part, even though it hurt a bit:

Politicians and other commentators tend to speak about these long-range trends, or at least about Social Security's finances, with an air of precision. This is almost amusing, since few economists can predict the swings in the federal budget even a year in advance.

I pointed out in an op-ed a few years ago that the cumulative forecast error in the federal budget from about 1997 to 2001 (based on a 1997 forecast) was almost half as large as the annual budget itself. The difference between the Social Security Administration's optimistic and pessimistic forecasts can be almost as bad. Forecasting is hard. We all know that. That shouldn't stop us from trying, though.

Then there's this:

Conservative economists say the figure [how many people would be below the poverty line if they didn't have Social Security] is irrelevant: if Social Security didn't exist, people would save more. This may be true of economists, but what about the rest of us? The argument illustrates the ideological agenda of those who favor privatization: they want to change people's behavior.

That paragraph is confused. Start at the end. Those who favor privatization want to change people's behavior. (Imagine! I mean, certainly no other policy advocate ever wanted to (gulp!) change behavior!) But... the only people who would save more if Social Security didn't exist would be the economists. And yet that doesn't stop policymakers from trying to coerce the non-economists to conform to their desired behavior.

That just doesn't make sense.

Mr. Lowenstein has a low opinion of our (the economists') ability to forecast, but apparently he thinks we would be the only ones smart enough to save more for retirement if Social Security were not there.

The Lucas Critique is like the Law of Gravity--you don't have to know how and why it works for it to affect you. (I should put that on a bumper sticker!)

One rationale for privatization is that workers would get a better return on their money in Wall Street securities than with Social Security's dowdy old Treasuries.

I don't think I'm taking this out of context. (It's on page 8 if you want to see for yourself how it fits into the whole article.) He seems to be doing one of two things, either he's totally missing the boat concerning how Social Security works or he's comparing "privatization" with "fully funded Social Security." Lowenstein seems quite knowledgeable about Social Security, so I don't think it's the former. Yet, the article certainly doesn't hold up a fully funded system where workers actually have claim to government bonds as an option. Truthfully, I'd take the return on "dowdy old Treasuries" in a fully funded system over pay-as-you-go Social Security any day. I even made a post a few days ago that said I would like to see TIPS as a safe choice for private accounts.

Just heard on NBC Nightly News that demand for limos in Washington is so great that they had to bring some down from New York.

They didn't say anything about the prices. How much compensation do you think would be necessary to induce limo services to drive down to DC for the week?

Not that there is any lack of money flowing in the nation's capital this week. The NBC story was on all the lunches and dinners for members of Congress and the administration that are paid for by lobbyists and corporations. Is there too much money in politics? Yes, but I don't like the alternatives either.

Macroblog quotes from another article on the early release of the minutes. The quote reminded me of a link I've been meaning to post. The article quotes William Poole, St. Louis Fed President, on the issue of transparency which reminds me of a couple of good speeches he has made on the subject. Both were reprinted in the St. Louis Fed Review. You can read them here and here.

Macroblog has also had a series of posts on forecasts for 2005 that are worth checking out.

In other Fed news, the Beige Book was released today. I immediately skipped down to read about prices:

Inflationary pressures remained largely in check in December and early January. While many manufacturers and builders continued to report small increases in input costs, price increases for final goods and services were generally modest.

In manufacturing, input prices rose modestly in most districts, but Boston and Minneapolis reported that some input prices rose sharply. Manufacturers of nondurable goods in the Cleveland district noted that prices for raw materials continued to rise, while prices for durable goods inputs were steady. Prices charged by manufacturers increased modestly in Kansas City, New York, and Richmond, and remained in check in Atlanta and Chicago. Increases in the costs of building materials were mixed by district. Modest to sharp price hikes were widely reported in Atlanta, Kansas City, and Minneapolis, but material prices were flat in Cleveland and New York, and eased somewhat in San Francisco.

Overall, price inflation remained relatively steady in recent weeks. Reports from Atlanta, Boston, Chicago, Kansas City, New York, Richmond, and San Francisco reported that price increases remained largely in check. Contacts in Dallas noted that many firms were unable to pass rising costs along to the customer due to stiff competition, and Chicago noted that competition in the retail sector is expected to limit price increases.

Much is being made about the Bush administration's proposal to shift from wage indexing of social security benefits to price indexing. See, for example, here.

And there is the now famous Peter Wehner memo that has been posted on many blogs, including Brad DeLong. One paragraph reads:

It's worth noting that wage indexation was not part of the original design of Social Security. The current method of wage indexation was created in 1977, under (you guessed it) the Carter Administration. Wage indexation makes it impossible to "grow our way" out of the Social Security problem. If the economy grows faster and wages rise, this produces more tax revenue. But the faster wage growth also means that we owe more in Social Security benefits. This has produced a never-ending cycle of higher tax burdens, even during periods of robust economic growth. It is the classic case of the dog chasing his tail around the tree; he can run faster and faster, and never make any progress.

Given all the discussion of the shift to price indexing, I thought I would look at how wage indexing came about. The memo is correct. It did happen in 1977. The following is from the New York Times, May 10, 1977 (page 55):

Inadvertently, as it turned out, Congress in 1972 created what virtually all analysts regard as an overly generous inflation-adjustment formula for calculating the initial benefits of newly retired persons. It takes account of both wage inflation and price inflation.

Breaking that link is called "decoupling." Mr. Carter proposed that Congress do this by eliminating price rises from the calculation of initial benefits and by using a wage-ratio formula that would maintain the ratio of benefits to final pre-retirement earnings at the present 45 percent. Thereafter, benefits would escalate with the Consumer Price Index, as they do now.

Without decoupling, the Administration said, by the year 2020 some retired persons might be drawing benefits at a 60 percent ratio. Some might draw more than 100 percent of their earnings in their last working year.

And then there is the September 10, 1977 New York Times (page 8):

In addition the Republicans also proposed a new formula for calculating initial benefits of retired persons that would undo the over-compensation for inflation that Congress adopted in 1972. All sides agree that this formula must be changed.

...

Joseph A. Califano Jr., the Secretary of Health, Education and Welfare, criticized the Republican decoupling formula on the ground that it would lead to initial retirement benefits in the future 6 percent below what the present formula would produce.

The Republicans have said as much. They maintain that such an adjustment is fair because the 1972 formula led to an increase in benefits that was 6 percent greater than the increase in the cost of living.

However, the Republicans contend that no one who retired before the formula was changed would suffer a reduction in benefits, nor would any future beneficiary have to accept less than he would have been entitled to under the pre-1972 formula.

So, yes it was during the Carter administration, but it was bi-partisan. And truthfully, in looking at the news accounts of the time, people were much more concerned about the changes in the payroll tax rates than the change in the indexing method. The bottom line is that between 1972 and 1977 inflation caught Social Security between a rock and a hard place. Wage indexing was a way to reduce the burden on the system caused by inflation. It worked. Then the pendulum swung back in the other direction. Today, we find ourselves in an equal, but opposite situation.

In any case, wage indexing was not a plan to expand benefits. Quite the contrary, it was a plan to slow the growth of benefits in a time of high inflation.

Tyler Cowen at Marginal Revolution has a defense of the Bush proposal to freeze benefits in real terms. I'm not sure I'm ready to, as he puts it, "push the 'yes' button" on this just yet. That said, a compromise might be in order here. The formula does not have to be all or nothing in either direction. Honest folks on both sides should take a look at how to moderate the increases in benefits without reverting to what some might see as Draconian cuts. As Tyler suggests, the big problem is medical care, and there are probably better ways to solve that problem than by growing Social Security. I'll give it a cautious "yes" with a heartfelt plea for compromise.

My only problem with the change is the extent to which it may affect workers not yet at retirement, but who have read their annual statement from Social Security and used it in their retirement planning. I would be much more comfortable with an indexing change that affects new workers or very young workers so that accurate expectations may be formed. Ideally, if the private accounts are only phased in for the younger workers, I would start the indexing change there as well. Expectations matter. Start reform with the young, and if it works, expand it over decades.

Argentine representatives are on the road trying to sell their debt swap to international investors. I don't know what to say, other than that there are no winners in a situation like this.

Dave at macroblog posts an excellent response to my question on voluntary private accounts for Social Security. He concludes his post with the following:

The rub, of course, was that the results from this type of exercise depend -- sometimes critically -- on the assumptions that are made. Modesty (or self-defense) requires me to conclude that making a definitive judgment about the true return to the typical private account, for example, is just a bit beyond the rank of your standard well-meaning policymaker. The solution, so it seems to me still, is to make participation voluntary, and let people sort themselves into the plan that they deem best. If our guess is right, we will see a systematic sorting of younger people into the privatized system, and the pay-as-you-go world will slowly fade away. If they don't, well maybe the critics of privatization are right.

There will, of course, be an element of trial-and-error in all of this. Those in the privatized system still have to help pay the freight for the existing pay-as-you-go liabilities, and it will not be immediately apparent what tax rates settings will do the trick. That will be revealed in time, and adjustments will have to be made. But being a good conservative commentator, I live by a simple creed. Give the market a chance. It will probably give you the right answer.

Well said. The part about those in the privatized system paying the freight for the existing pay-as-you-go liabilities (including those young workers joining the system who choose pay-as-you-go over private accounts) is exactly what I'm concerned about. The more people who opt out of private accounts, the more freight there is to pay. I have confidence in the ability of the government's actuaries to work this out through a combination of the Law of Large Numbers and trial and error, but I think a split system would add significantly to the cost of administering the system as well as lowering the overall returns to the participants.

If the idea of voluntary accounts is to give people a choice over where to put their contributions (with the existing system being the safe choice), I would take a different approach. Give people the option of putting their contribution into TIPS (Treasury inflation protected securities). Risk would be extremely low, and the return would almost certainly dominate that of the pay-as-you-go system. If the government could guarantee that the return from TIPS would dominate what they would have received in the old system, we could dispense with the old system right away at least for brand new workers contributing for the first time.

I think this is the right kind of debate to have. I am looking forward to seeing more specifics from the administration and more discussion of the finer points.

UPDATE/CLARIFICATION: When I say "dispense with," I don't mean the whole system, of course, since the administration is only suggesting that part of the payroll tax would be allowed to go into the private accounts. In effect, what I want is for that portion of the payroll tax to be permanently and totally detached from the pay-as-you-go system.

UPDATE/CLARIFICATION: I'm assuming about a 1.8% real return on pay-as-you-go Social Security as suggested by Gokhale and Lansing. Real yields on TIPS less than that over a long period would be pretty unlikely--if it ever happened, we'd have more problems than just Social Security.

I see that the Bush administration's Social Security proposal makes the personal accounts voluntary.

The President favors voluntary personal accounts as part of a comprehensive solution to give younger workers the option to save some of these payroll taxes. Personal accounts give younger workers the opportunity to receive higher benefits than the current system can afford to pay, and provide ownership, choice, and the opportunity for workers to build a nest egg for their retirement and to pass it on to their spouse or their children.

Those who do not choose to have a personal account would continue to draw benefits as Americans have long done from the Social Security program.

Personal accounts will provide Americans who choose to participate with an opportunity to share in the benefits of economic growth by participating in markets through sound investments.

See... This is what happens when economic policy goes through the political sausage maker. "Voluntary" sounds so nice and politically correct. It's less threatening, perhaps.

But having voluntary private accounts makes it sound like you're comingling a fully funded and a pay-as-you-go system, doesn't it?

Will someone please explain to me how today's young people who choose to stay in the existing pay-as-you-go system can expect to someday receive the same level of benefits that are paid today if some in the generation after them are in a fully funded system?

Higher taxes, I suppose. How does this fix anything?

And doesn't this make the actuarial accounting of the system more nightmarish than it already is?

I'm generally not opposed to doing something to improve the system. (see previous post) However, the voluntary aspect of the proposal on the table sounds like trouble to me. I have to this point seen no evidence that my concerns have been thought through by the administration.

Any thoughts?

Yes and no. Consider these two claims:

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.

Even the AARP might agree with my first claim, although the latest out of the White House sounds like they might take issue with my second claim. In any case, these two claims are fairly well accepted by economists, policymakers, and pundits on both sides of the debate. So what should be done?

Let's get one thing straight. I would not be in favor of any reform that would mean a reduction of benefits for today's retirees. I don't think anyone would favor that. Hence, it won't happen. Today's retirees need not fear. Whatever reform takes place, it will (possibly) help future retirees (today's kids and those not yet born--I fear that I may even be too old to benefit, more on that later).

I also would leave the disabilty and SSI benefits pretty much the way they are. What we are talking about here is the basic retirement aspect of Social Security.

I tend to agree with macroblog on this one:

I fully concede that you cannot take any old private-account scheme off the shelf and claim that it dominates the current system. But I think it should also be conceded that it is conceivable that a privatized system might dominate, if properly constructed.

And then he recalls some research that he and Jagadeesh Gokhale did on the issue.

If we allowed people below some critical age the opportunity to shift to private accounts, while at the same time taxing them to pay promised liabilities to those who remain in the system, would it be in their interest to do so? Our answer: yeah, maybe.

I've been a supporter of their (Altig and Gokhale's) idea since before there was a macroblog. I read their research from the Cleveland Fed when it first appeared in the mid 1990s. Read here for one of their articles much like the Cato piece referenced above. Read here for one by Gokhale and Lansing from about the same time. The latter has nice historical graphs, but it is getting a little dated.

Articles like these convinced me about 9 years ago that Social Security could be fixed if we really wanted to. We just haven't wanted to. In 1996, Altig and Gokhale reckoned that transitioning everyone under the age of 43 to a privatized system could potentially be Pareto improving. In the 1997 Cato piece, they put the cutoff at age 32. At the end of the summary of that piece, they say if we wait until 2011, only those under the age of 20 could move to the new system. We're halfway there. As I suggested above, I think it's too late for me.

The reason why the window is closing on this type of reform is that in the next few years the Social Security surplus will begin to shrink. Because Social Security contributions have been added to the government's general fund for some time, the disappearance of these funds will be noticed. In order to support the benefits of retirees and those near retirement (all those baby boomers), we will need to draw on more of the current contributions (from younger and younger workers). Once the Social Security surplus is gone (2018, by their own estimate), the transition becomes more difficult and costly. I don't see how anyone can look at the figures and the charts and fail to see that the time do something that would be Pareto improving is sooner rather than later.

Good solid economic growth with some fiscal responsibility will extend the life of the system for decades even if we do nothing. We don't have to do anything (except maybe raise the retirement age by one year every decade or something similar if life expectancies keep rising). But if it is possible to do something Pareto improving, I think we should do something.

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.

Via Marginal Revolution:

Robert Heilbroner, author of Worldly Philosophers: The Lives, Times and Ideas of the Great Economic Thinkers and among the most influential economic historians of the 20th century, has died in New York. He was 85.

Dr Heilbroner, who had suffered for the past three years with Lewy Body disease, a rare Alzheimer's-like illness, died of a stroke last Wednesday, according to his son, David.

Financial Times Obituary

BERKELEY – Nobel Prize winner Gerard Debreu, emeritus professor of economics and mathematics at the University of California, Berkeley, died Dec. 31 in Paris of natural causes. He was 83.

Read more here and here.

Debreu, with fellow Nobel winner Kenneth Arrow, wrote the very famous book "Theory of Value" in 1959. The book is quite thin, only 100 pages according to the Times obituary. It is, however, the most densely packed book I have ever read. These 100 pages are essentially the subject of the first semester of Ph.D. level microeconomics. Seldom required reading anymore because others have expanded upon the basic material, it should still be read by any serious student.

The Heritage Foundation just came out with its annual Index of Economic Freedom. The U.S. is slipping in the rankings a bit. This due mostly to countries like Chile, Australia, and Iceland improving along a number of dimensions of economic freedom. Chile, in particular, has shown dramatic and steady improvement over the last decade. And look at Estonia. Impressive.

I downloaded the entire dataset from the Heritage Foundation website to see if there are any other observations that can be made.

Here's what I found:

Low scores are good (click here to see how the scoring works).

There does not appear to be much convergence. In fact, about all you can get out of this is that the countries that are already in good shape are getting better (note the numerous data points between -0.1 and 0 on the vertical axis for countries scoring between 1 and 2.5. Countries with scores above 2.5 go in both directions with no real discernable pattern.

Despite losing our top 10 status, the U.S. is still in good company. The message to us should be that the company we keep is striving to improve. Our scores have been practically constant. If that continues, we will continue to slip in the rankings.

However, it is disturbing to see the vast majority of countries that find themselves in the middle of this list are not showing definite improvement as a group. Indeed, many are moving in the wrong direction.

Thanks to Marginal Revolution for the link.

Here's a great article on the current account from the Cleveland Fed.

Macroblog pulls out the thesis from the article itself:

This Economic Commentary offers a hitchhiker’s guide to the U.S. current account problem for those who want to follow along, but are not inclined to take the wheel. I show how foreigners finance our propensity to import, stopping long enough to make the connection between our budget and current account deficits. I explain why growing current account deficits and expanding inflows of foreign savings are not indefinitely sustainable, and why big deficits imply big corrections. Throughout the trip, however, I emphasize that we simply have no basis for determining when, how fast, or how jarring any adjustment might be. Those who claim a definitive word on that topic may just be spinning their wheels.

Macroblog then offers,

I suppose that last comment applies to me as well.

Me too.

Elsewhere, Macroblog has a very reasoned discussion of the current account (with which I wholeheartedly agree and which lines up pretty well with some of my own posts on the subject).

From the final paragraph:

None of this to say that the reversal of our current account deficits will occur seamlessly, or without some sort of disruption to the U.S. economy. The process I have described could certainly have many elements that make the road from here to there a rocky one. I just don't know.

I'll buy that. I can't sit here and tell you that deficits (current account or otherwise) don't make me at all nervous. I do, however, think that some of the media coverage ignores the larger picture. (See my previous post. I still can't overlook The Economist's implication that capacity utilization is in imminent danger of being overstretched at 78%.)

Meanwhile, Brad Setser has a nice post on why the dollar hasn't fallen farther, faster. It's the Bretton Woods two hypothesis. Read it. (Hat tip: Marginal Revolution)

Remember that children's book from a few years back? You had to find the character "Waldo" among a sea of distracting images. In his recent book A Term at the Fed, Laurence Meyer describes Fed speeches as a "Where's Waldo?" exercise. If you've ever read one, you know what he means.

I like to do the same thing with news stories once in a while. Pick a "gloom and doom" story about some aspect of the economy and find something in it that could be used to make the case that things aren't so bad. The Economist is a good place to play that game these days. It's time for the weekly installment of the doomed dollar.

These record [current account] deficits are adding to America’s foreign debts at an alarming rate. But as yet, America still earns more from its foreign assets than it pays on its foreign liabilities. That is about to change. As interest rates rise, refinancing America’s debt will become more costly. Goldman Sachs forecasts that net foreign-investment income is likely to shift to a sizeable deficit during 2005, growing thereafter. The investment bank estimates that, if America’s current-account deficit remains steady as a share of GDP and interest rates average 5% in future, net foreign debt-service payments will reach 4% of GDP by 2020—a significant drag on American living standards.

No, that's not the "Where's Waldo?" paragraph. I just thought it was an interesting choice for a forecast scenario. Raise your hands all who think that today's current account deficit will remain steady as a share of GDP until 2020. Okay, moving on.

The dollar’s decline may force America to embrace thrift, argues Goldman Sachs. As the dollar falls, foreigners will demand more American goods. This will put pressure on America’s manufacturers, which are already operating at 78% of capacity. As supply is stretched, inflationary pressures will build. The Federal Reserve will raise interest rates, curbing domestic demand, and thus creating room for an export boom. The higher interest rates will thus promote the saving America has so sorely lacked.

I think I caught a glimpse of Waldo. 78% isn't exactly an all time high. See for yourself. And, of course, the writer seems to discount the possibility of supply increases over time (implication by omission). If you want to find a time when capacity utilization was at a pretty high level (almost 85%), go back to the beginning of 1995. Not exactly the strongest dollar in history. Interest rates had been going up the previous year and weren't quite finished rising. Personal saving had begun its fall. Yet, a lot of commentators regard 1995 as the early stage of a pretty good run. Hardly the end of the world.

Here's Waldo!

If Japan’s finger is on the trigger, the European Central Bank (ECB) seems prepared to sit on its hands. Jean-Claude Trichet, president of the ECB, has lived with strong currencies before. As president of France’s central bank in the years before euro entry, he was dubbed “the ayatollah of the franc fort” for his unflinching support of a strong national currency. Indeed, for much of 1995, a weighted basket of the franc and the 11 other currencies that formed the euro was worth almost as much against the dollar as it is now.

Indeed. 1995. Need I say more?

The next paragraph is good, but it goes downhill to the end.

In his press conferences, Mr Trichet has made it clear that recent rises in the single currency are unwelcome. But he has dwelt at greater length on the danger of rises in energy prices. His chief duty, as he sees it, is to convince firms and workers that inflation will remain well contained, despite the oil price spike of the autumn. It is a confidence game: if he can convince them an inflation spiral won’t happen, then it won’t. The strong euro will actually add to his credibility, by curbing the price of imports.

Yes.

Besides, the hard men of hard money believe that weak currencies make life too easy for firms and politicians. Devaluing the currency provides an unsatisfying alternative to deregulating and restructuring the economy. An overvalued currency, on the other hand, leaves uncompetitive firms and tentative politicians with “no place to hide”, as Eric Chaney of Morgan Stanley puts it. They must reform or perish.

Only if there is some commitment to the strong currency. So was this our problem at the end of the '90s? Uncompetitive exporters had to reform or perish? Tentative politicians had "no place to hide"? Discuss.

“You cannot devalue your way to prosperity,” says John Snow, America’s treasury secretary, somewhat hypocritically. The year to come may reveal whether Europe can revalue its way to the same end.

Somewhat hypocritically? Snow hasn't really "devalued" the dollar. The dollar has depreciated on the market, and we have (wisely) allowed that to happen. If I were a long term speculator (with a time horizon of 10 to 20 years), I'd say that last paragraph is just silly.

I've been refraining from commenting on this until now. It's one of those stories that seems too outrageous to be true--unless, of course, you fly regularly. In that case, you will believe anything outrageous about air travel. It started with the alleged "sick-out" at U.S. Airways on the Christmas weekend. Lots of missing baggage handlers then resulted in a sea of luggage in Philly that has to this day not been dealt with. Next time I fly and the agent asks if I'll be checking my bags, my response will be, "You've got to be kidding." Oh wait, that's what I've always been thinking even if I haven't said it.

The alleged "sick-out" in itself would be a story, but there's more...

The company took the unusual step Tuesday of asking employees around the country whether they would be willing to travel to Philadelphia International Airport between now and Jan. 3 to work as unpaid volunteers supplementing the airport's regular staff.

The company stressed that employees already scheduled to work this weekend would be paid their regular rate, but said it hoped to find volunteers willing to donate time greeting passengers, answering questions, serving coffee, directing foot traffic through the terminals and lending a hand in baggage claim. [article here]

Ever seen the U.S. Airways check-in line at Philly? The only questions they'll get will be "How many hours before I get to the front?" But I digress.

The whole idea is wishful thinking. U.S. Airways has about 2 weeks left before someone starts painting "for sale" signs on their airplanes. (Got a few million dollars in spare change?) These employees are about to be ex-employees. And yet, management wants them to volunteer their New Year's holiday helping travelers. Since a lot of travelers are in a disagreeable mood at the airport to begin with, and since anyone with U.S. Airways on their ticket is going to be a little edgy right now anyway, this isn't something I'd volunteer for. (Besides, Iowa is playing football.) If management is that optimistic as to hope that any workers are going to volunteer for this duty, they might even believe that their planes will be flying on January 16th. (Only if they can work out a last minute deal.)

Basically, what you have here is a finite repeated game being played between workers and the company. The game will terminate when U.S. Airways flies off into the sunset. As that date approaches and becomes more certain, the employees would be expected to expend less effort, not more. Hence, the "sick-out." As an economist, I'm not really surprised by the fact that it happened. To those who say the workers shot themselves in the foot, I say only if you believe U.S. Airways was going to come out of bankrupcy. (That doesn't make it right--just understandable.)

Bottom line: I think you'll have to get your own coffee if you're flying in and out of Philly this weekend.

Alan at Ozblog on keeping up with the Joneses.

Looking forward to part 2.

From Cafe Hayek:

This time, it is none other than the New York Times displaying ignorance. Alas, the article is no longer freely available. Don Boudreaux does the honor of correcting the record.

It bears repeating again and again: a current-account deficit is not synonymous with debt. Nor are all dollars that foreigners do not spend on U.S. goods and services loaned to Americans. Many of these dollars are

- held as cash reserves

- used to purchase American real estate

- used to purchase shares in American corporations

- used to create, maintain, and expand foreign-owned firms located in the U.S.

Gotta love it. Faithful readers will recall that goofy reporting on the value of the dollar is one of my pet peeves. Goofy reporting on the trade deficit is right up there on my list, and usually related to the former.

Boudreaux does a really nice job of smashing the myth with his post.

It didn't take long for the broken window fallacy to surface in relation to the tsunami tragedy.

In part:

The regions hurt most by the tsunami did not have much in the way of heavy industry, and many people there lived off the land as farmers and fishermen.

Still, while the cleanup from the devastation will be a daunting task, the resulting economic activity might actually be a boon for the region, said Kathy Bostjancic, a senior economist at Merrill Lynch. With the expected outpouring of economic aid for rebuilding, the economies of the affected countries could actually rise. From the Daily Breeze.

Dingel states that Bostjancic might really mean that it is the injection of foreign aid that is the benefit. That is really giving the benefit of the doubt. We've seen these comments too many times before. I would add that if Bostjancic meant it is the foreign aid that is the "boon," then she should at least say so.

Still...

The injection of foreign aid will not bring about any long term growth to the poverty stricken regions affected by the tsunami. At best it will provide a short term demand stimulus, no supply stimulus whatsoever. Any positive effect on the national economies from the aid will likely be offset by the devastating loss in tourism dollars.

Expect more of this in the days to come. It's sad because some people who read things like that will actually believe it.

This is great! Via Newmark's Door comes word that the Statistical Abstract is online.

I graduated from college in 1994, just over 10 years ago. The single best thing that has happened for academic economists since then is, in my humble opinion, the proliferation of free data online. I can get material for my classes in half an hour that would have taken an afternoon at the library, and perhaps an interlibrary loan request when I was in college. That's quantifiable progress.

The consensus is that the trade deficit will widen by a couple billion dollars. Too much more than that would send the dollar reeling, but I'm not really expecting any surprises--good or bad.

Update: More than a couple billion, it was up by about $4 billion. The bond market was not pleased. Of course, all was forgiven the next day.

Some investors said the market's gains were due in part to continued relief that the Federal Reserve had sustained its pledge to be measured in raising interest rates and reiterated its sanguine view on inflation.

Or they might have been picking up bargains after Tuesday's fall. Who knows? Writing stories on the bond market is sort of like writing stories on which way the wind is blowing.

Here's an interesting take from Stumbling and Mumbling. In part:

Did I learn nothing at all at university? I’m prompted to ask by the increasing tendency – of which the BBC is part – to blame the falling dollar on the US’s budget deficit.

This view not only flatly contradicts efficient market theory – we’ve known about the federal government’s red ink for ages – it also contradicts the standard exchange rate models we learnt in the 1980s. These are the Mundell-Fleming-Dornbusch models. In these, a fiscal expansion strengthens the currency, because it boosts economic activity and raises the demand for money.

And later...

More respectably, some people are using the weak dollar to draw attention to the fact that Americans will have to increase their savings sometime.

And herein lies the problem. If or when Americans do start to save more, the resulting slowdown in demand could weaken the dollar still further, and cause even more trouble for people exporting to the US.

Read the whole thing. The part about savings is something that I haven't heard anyone else say out loud. I wrote about personal savings a few days ago, but from the perspective of explaining why it is so low. The author of the quote above is saying that it would get worse if people saved more. I say people save less because it's a rational equilibrium response (consumption smoothing, etc.) that keeps the situation from getting worse. We're on the same page, really. (It goes without saying that I think the author has little to worry about on that score--at least for the forseeable future.)

The real question here is whether or not it is the US budget deficit that is driving the dollar down. I too, would have to say "no," although in the grand scheme of things it is far from irrelevant. Here's another quote from the same post (listing potential problems with the standard models and the relationship between dollar and deficits):

2) Deteriorating creditworthiness. If foreign investors take fright at rising government debt, they’ll sell bonds and trigger a fall in the currency. Again, though, this hasn’t happened, at least not yet. These figures show that foreign private investors (never mind central banks) bought $167.3bn of US government debt in the 12 months to September.

One word. China. And that may change, but it's really unclear if and when. So are speculators overestimating the chances of this? I'd say it's a distinct possibility. (Reference here, particularly my quoting of DeLong's advice to the Secretary of the Treasury.) If so, is there a correction coming? Yes, but not until interest rates come back up in the U.S. That's the real reason. Speculators might be rationally expecting all that monetary stimulus (as well as the fiscal stimulus of deficit spending) that has been in place for 3 years now might finally start to result in inflation. If for some reason the economy stalls at that point, the result could be low real rates and high nominal rates which would essentially confirm the speculators' worst fears. That hasn't happened yet.

And that's why I think the death of the dollar is being exaggerated.

Oh, and by the way, the dollar isn't that much lower (according to the major currency index) than it was in the early 90's. See for yourself. The late '90s were the abberation, methinks. (I know, I know, try telling that to students wanting to spend January in London.)

Hat tip to Newmark's Door.

Read here. Reuters reports that the "Old Lady" is expected to keep interest rates unchanged. The announcement will come in the early morning hours for those of us on this side of the Atlantic.

Twenty economists in the Reuters poll said the BoE is now done with tightening and the next move in rates will be down, if not for some time. But 23 others said there is at least one more hike to come.

The pound is very strong right now (much to the chagrin of my students planning a January interim in London). If the economists predicting rates to go down in the UK are right, and if the Fed continues to tighten, this will help arrest the dollar's decline.

Not that this news really changes anything. I'm still holding to my prediction of about another year of slow decline in the dollar, mainly because it will take that long for the Fed to get rates up to a neutral position. And I hope it does take a while for that to happen. Brad DeLong and Tyler Cowen indirectly touch on this at the Wall St. Journal today. Mainly, it is one of DeLong's goals for the Treasury Secretary.

Convince foreign-currency speculators that large leveraged bets that the dollar will decline rapidly are risky, and so try to make the forthcoming decline in the dollar gradual and orderly rather than rapid and accompanied by spikes in long-term interest rates.

Precisely.

Meanwhile, in other news, the ECB, which really does not want to lower interest rates any further, is worrying about inflation. Again. Soon, this will cease to be news.

It's a difficult situation for everyone. In the long run, the US needs to get interest rates up about a point or so, but until GDP growth (and job growth) is firmly on track it seems dangerous to be pushing for higher rates too quickly. Europe doesn't want us exporting inflation to them. Exchange rates are the pressure release valve.

America spending money and racking up deficits fighting an unpopular war, Europe worried about our inflation spilling over the Atlantic...sound familiar? It's similar to the situation that led to the demise of Bretton Woods. The dollar devalued suddenly because there was no pressure release valve. As bad as The Economist is making it seem, it's not as bad as the '70s. Not by a long shot. Let the dollar continue its gradual slide until interest rates get back (closer, at least) to equilibrium. That is much better than the sudden devaluation when we broke from Bretton Woods and better than the devaluations in Latin America and Asia in recent years.

I think that we can avoid that outcome if the John Snow follows DeLong's advice. I hope Snow is listening.

Update: Rates did remain unchanged in the UK.

Tomato prices are going up, and in some places they are in limited availability. The reason: those hurricanes in Florida earlier this fall which destroyed half the nation's tomato crop. The higher prices are expected to persist for a few more weeks until the next crop is harvested.

Supply and demand. The supply decreased, and as a result the price rises while the quantity traded in the market falls.

The higher price induces some people to temporarily give up eating tomatoes if they are not willing to pay the higher price. This frees up the more limited quantity of tomatoes for those who value them more highly.

I really hope this is rectified quickly because I so enjoy large amounts of ketchup on my hamburgers. I don't want the local Steak n Shake to start charging for the extra ketchup packets at the drive-through. But, I would rather have them charge me a nickel than have them run out. The latter has happened to me a couple times this fall. It's very disappointing to hear that they have run out of ketchup.

Supply and demand. It's everywhere.

The blogosphere just got a credibility boost of Nobel proportions. The Becker-Posner Blog is up and running. Gary Becker is a Nobel prize winning economist from the U of Chicago and Richard Posner is a federal judge and Chicago Law School senior lecturer whose scholarly writings have focused extensively on the law/economics nexus.

All I can say is: Thank you, Gentlemen.

I heartily encourage my readers to join me in becoming regular readers of the Becker-Posner blog.

This isn't good.

A related story is here.

Is this related to what I've been writing on the euro lately? You bet. Look here for a story on EU expansion. Look especially where it says that Hungary needs to do more to fight inflation. (And look at the size of their deficit.) This latest news won't help.

This is as blatant as FDR packing the Supreme Court. It really hurts Hungary's chances of joining the EU.

There's a larger story about the EU and expansion that is brewing, and it will continue to get bigger. This blog will keep you posted.

Tyler Cowen quotes The Economist. Yeah, The Economist is banging the gong on the dollar again. I sense a theme developing.

Anyway, here's Prof. Cowen's take:

My (cautious) take: The Euro area is rich in accumulated bank accounts but running a massive long-run deficit, most of all on human capital. Plus what will happen when countries start rejecting the EU constitution in their referenda? And don't currency markets have some tendency to long-run mean reversion, suggesting the dollar will make a comeback someday? So I say no, the Euro will not become the world's reserve currency. That being said, every prediction I have made about the Euro has been wrong to date. I said it wouldn't happen, it can't last long, and it won't rise in value. That is 0-3, must I now step away from the plate?

Right on. As for his predictions, I suddenly feel a little better about being off on today's job market numbers. But seriously, I understand his skepticism of the euro. I have felt for a long time that Europe is not an optimal currency area, at least not now. Just look at the disparity between the former East and West Germany. Read this if you have any doubts. Add a few more former communist countries into the mix and you've got a recipe for trouble.

And yet, the euro is rising like a hot air balloon. That said, I think the dollar probably will drop further before going up, maybe sometime mid to late 2005. A year of growth in the US together with uncertainty about Europe's economic future will bring about the mean reversion to which Prof. Cowen refers.

In the meantime, brace yourself for more articles like the one in this week's issue of The Economist. I hope I'm right about this one and that Tyler improves his record to 1 out of 4.

From the Wall St. Journal today (subscription required):

"IBM is really focused on high-growth enterprise business opportunities," said Mark Stahlman, an analyst at Caris & Co. IBM manages "around return on investment capital. I would suspect the PC business does not come out very well in enterprise growth and return on capital calculations," he said.

Steven Milunovich, analyst at Merrill Lynch, said in a report that the divestiture of the PC business should be "a moderate positive for IBM" boosting its return on capital and profit margins.

Without a PC business, there is some risk that IBM could lose control over corporate accounts to the benefit of H-P and Dell, he added, but IBM might try to mitigate any expected revenue decline by continuing to distribute IBM-branded PCs made by Lenovo.

"If IBM is exiting PCs, management is likely making a long-term call that PCs are commodities," Mr. Milunovich said.

PCs are commodities. That's for sure. IBM has the resources to continue to innovate, and that's what they intend to do. They can be a lot more profitable by selling their business services where they can (as economists would say) charge a higher markup over marginal cost.

The service industry gets a bad rap too often. The Chinese can make computers for a very low cost. Let them. We get cheap computers; they get decent jobs. People in India can write decent software. Let them. Meanwhile, our bright young kids should be designing business solutions. We should be designing systems that allow hospitals to use technology to streamline patient care and systems that do a million other services to society.

Tell me, where are the latest and best improvements to our quality of life coming from? Assembly lines or talented, skilled, and smart service providers?

Only 112,000 new jobs last month. I was expecting at least 250,000. I can take a little comfort in the fact that this took everyone by surprise, but still, what happened?

Here's one theory. The BLS adjusts for seasonal variation. If the hiring in mid-November in advance of the Christmas season was lower than normal, that would, because of the seasonal adjustment, cause the payroll employment gain to be slightly understated. I'm pretty sure that could explain away part of it, but not all of it. The auto industry is hurting and businesses everywhere are trying to do more with less.

Maybe we need to temper our expectations given the magnitude of structural change in the economy? See this article for some important insight.

According to CNN, analysts are expecting around 200,000 new jobs for November. They also say we need about 150,000 per month to keep up with population growth. This article goes into even more detail with a consensus around 222,500. This article featuring quotes from Janet Yellen is even better.

Given the way that the economy is picking up some traction, I'm inclined to look to the high side of the consensus. We're still below where we should be on the jobs front, and I don't think we should forget that. As we return to potential GDP, I think the job market still "owes us" a couple of stellar (300,000+) months. For my prediction I'll say 250,000 to 280,000 as a likely range, but with higher probability on being above that range than below it.

Less than 225,000 would be a little disappointing, but I don't forsee any reasonable outcome that would keep the Fed from raising rates at their December meeting.

Of course now that the election is over, it might not get quite as much attention as before, but this blog will keep an eye on things.

Households saved about 0.2% of their income in October, the 2nd lowest level on record. Wall St. Journal article here (sorry, subscription only).

But don't despair. The Beige Book says that the economy is humming along. Well, they don't use the word "humming." That would be very un-Fed-like. Nonetheless, the overall picture is good, but not perfect. Auto sales are flat to down in most places--which explains the continued 0% financing on which I commented earlier.

But really, friends, what is there to say about the low savings rate that hasn't been said already? It could be interpreted as good news. Low savings could mean that people are less worried about the future and expect incomes to be higher and not lower. Of course, for obvious reasons, a low savings rate is bemoaned by many as contributing to our rather uncomfortable balance of payments position. Par for the course, these opposing views separate the bulls from the bears.

Today, the bulls won.

The laws of algebra, however, will not be repealed. In open economy macro, we have a little saying: I+G+X=S+T+M which is often expressed as (X-M)=S+(T-G)-I. Ok, it looses something in the translation. (I'd promise no equations in my blog, but I would be bound to break such a promise sometime!) It means that the trade deficit equals the shortfall of national savings relative to investment. This is not negotiable. It's a fact. Let's review more facts:

1. We're running a budget deficit (fact...we'll not debate the pros and cons of it here).
2. Despite the falling dollar, Chinese goods (and those of other countries) are still pretty cheap--and we like cheap. Oh, and the dollar is expected to fall further (possibly leading to somewhat higher inflation).
3. The economy seems to be finally hitting its stride as many of us have been predicting it would. Investment should (at long last) start to recover. Indeed the last few quarters have been good (though the most recent quarter was a little cooler).
4. Interest rates remain low--still a couple points below what would be neutral for growth by my reckoning. Not that there's anything wrong with that for now.

Macroeconomics final exam question (multiple choice since I'm so nice): Predict personal savings based on 1-4 above.
a) above average
b) average
c) below average

I just love how a little bit of economics makes the news less mysterious. Savings will stay low until interest rates return to "neutral" and the dollar bottoms out. Believe me, you don't want that correction to come too suddenly.

The WTO approved sanctions on the US for a little known trade regulation called the Byrd Amendment. The Byrd Amendment allows the US to impose "anti-dumping" tariffs on goods that are sold here at low prices (dumping=pricing below cost). By itself that would not be quite as objectionable to the WTO, but the Byrd Amendment goes one step further in giving the proceeds of those tariffs (that is, tax revenue) to the American companies competing with the offending foreign firms.

Tariffs are seldom a good thing for the economy as a whole, but the benefits are concentrated in the hands of a few while the costs are diffused over everyone. This makes them politically difficult to remove. How much more so when the benefits are so tangible and physically handed over from government to firm? Sorry, but I don't see how giving corporations a cut of our spending on imports (isn't that what tariff revenue is?) will help them in the long run. It's windfall profit. It's not going to change their behavior.

The retaliation will be significant and could come early in 2005. Not that we haven't had warning. According to the article linked above, the US has had 2 years to comply.

The major beneficiary of the policy has been steel (which means that anyone who buys steel in their manufacturing process has been subsidizing the troubled US steel industry , but pasta producers and candlemakers have also benefitted.

Ah, the candlemakers. Read here, please. This one's over 150 years old. Time to move on, Congress.

I saw the Chevy commercial again (the one with Suze Orman). Apparently it is for 2005 models, but the 0% is not available for all lengths of the contract. My guess is it would be 0% for 3 years on 2005 models with the option to buy your next car at the same terms.

So really it's not that different from the 0% for 6 years that someone else is touting.

Still...

I just saw an ad tonight for auto financing at 0% for 72 months. Chevy is rolling out a program (endorsed by Suze Orman, no less) where you can lock in a low rate not only for the car you are buying now, but your next Chevy as well. You must buy your next car within the term of your current loan, and I seriously doubt that it would be very easy to qualify for a 0% for 60 month loan under this program on a 2005 model, but probably on the 2004 models that they are trying to get rid of.

If you're willing help them dispose of their inventory, you might be able to essentially lock in 0% for 10 years. At least that's my understanding from their web site. See my update here (after I saw the commercial again).

Am I the only one who is a little worried about all this? Read this recent story on the decline in auto sales. The last company to get too aggressive with financing didn't fare so well. Remember when Mitsubishi was giving 0% and no down payment and no payments for a year to just about anyone? Well, the Big 3 aren't exactly being that silly, but still, it gives one pause.

Now, here's a thought. These 0% deals might just be the new normal. We've been at this level since shortly after 9/11. That's a long time, and people are used to it. No one wants to be the first to raise those financing rates, especially in an auto market that is lukewarm at best. (Think: kinked demand curve model of oligopoly.) In that case, 0% is here to stay, at least for the forseeable future. It will almost take another shock (e.g. a bout of inflation) to dislodge us away from this equilibrium.

Take notes, folks. This could get interesting.

From the article mentioned in the previous post.

Just the increase in the debt ceiling over the past three years is nearly 2 1/2 times the entire federal debt accumulated between 1776 and 1980.

I could give you a laundry list of reasons why this sentence is potentially misleading to the uneducated reader and ultimately irrelevant to the matter at hand, but I won't.

First of all, it's closer to 2 1/4 than than 2 1/2 times more, but now we're splitting hairs.

The appropriate comparison for the first Clinton administration is as follows: The debt ceiling rose by 2.9 times the total amount of federal debt accumulated from 1776 to 1972 (eight years earlier).

The second Clinton administration was much better. The debt ceiling only rose by 70% of the total amount of debt accumulated from 1776 to 1976. However, all told, the 8 years of Clinton added as much to the debt ceiling as the entire amount of federal debt accumulated from 1776 to 1985.

Before you ask why I'm comparing all 4 years of these terms and the article says they are only looking at the last 3 years, that's because they really are looking at the whole 4 year Bush term. There was no increase in the debt limit during the first year, only in the last three. They don't tell you that. I did.

The point here is not to put down or raise up the Clinton presidency (or for that matter the Bush presidency). As you can see, his two terms were like night and day when it came to the budget (for a number of reasons).

Can you see that playing these sorts of games with statistics doesn't tell you anything and could be very misleading?

I wouldn't accept this lame excuse for analysis from a college freshman. If you don't understand compound growth, you'll be sucked in by statements like those above.

This is barely worth mention, but here goes. Congress raised the debt ceiling and the president signed it into law. This has so many people from both sides of the aisle up in arms. Read here.

From that article:

By passing such a huge increase in the debt limit, with no strings attached, Congress has effectively given the Bush administration a blank check to continue running large deficits, said Stephen S. Roach, chief economist at Morgan Stanley. "An open-ended license for this kind of fiscal irresponsibility is a recipe for disaster," he said.

Ok. Let's tell it like it is. The debt ceiling is like the credit limit on your credit card. Of course, you have control over how much you borrow on that card, but suppose you also had the authority to control your own credit limit. Now, tell me what significance that credit limit has (other than perhaps being symbolic)? The debt limit is meaningless!

I have always hated the fact that we have to go through this business of raising the debt limit all the time. It takes the focus off the real problem. The mere mention of the debt limit puts the focus on an arbitrary number and takes the focus off of the budget priorities. Finger pointing about who is to blame for the arbitrary number is not productive at all. Why don't we get back to work figuring out how to reduce that number?

But we won't have that debate today, and that should disappoint concerned people of either party persuasion. Democrats and moderate Senate Republicans should push hard to restore some sanity to the budget process which is spinning out of control. Deficits, in and of themselves, are not necessarily a big problem. However, a process that allows things like the prescription drug bill to pass without any discussion about how to pay for it in the long run is a process that is broken. I favor some discretion in the budget, but in the current economic environment, you cannot ignore long term implications. Health care continues to grow as a percentage of GDP, and any discussion thereof must take that into account. If we want prescription drug coverage, we need to figure out how to pay for it or we shouldn't do it.

Demographics, the saying goes, is destiny. In a simpler time, Congress didn't really need to worry about its implications for budgets. Those days are over. But please, let's have a rational discussion and not repeat what happened this week.

I posted on this earlier but didn't have time to finish the thought. One of my first thoughts was, "With hindsight, was this predictable?" Yes. Now, let me address whether this is a good idea.

I think some people are more optimistic than I. This isn't going to increase "synergy" or any other buzzwords like that. What we have here are two old-style retailers who have been marginalized by Wal-Mart. If Sears sold off its Craftsman tools and DieHard batteries, they could pretty much pack it in. These stores, like Woolworth's and Montgomery Ward, are a product of another time. The way I see it, they have one more chance to change their business model before it's (blue?) lights out.

Sears used to be the "World's Largest Store" (Ever wonder where the call letters for Chicago's radio station WLS came from? Click here.) Those days are gone, and they aren't going to be able to beat Wal-Mart at that game, not even after merging with Kmart. I'm not going to make any suggestions about what they have to do to save themselves. Such suggestions are a dime-a-dozen. But whatever they do had better be good or it's over for them.

All those Kmarts are sitting on some nice real estate that I'm sure Wal-Mart would be interested in. And I'm sure that some mega-specialty stores are salivating at all those mall anchors that Sears owns. Think about it.

The Economist has a rather pessimistic article on the dollar this week. Are they right?

Unfortunately, the answer is, "possibly, yes," and there is a very real chance that they could be right on. Economists started looking for a dollar slide a few years ago. From 2002 to the start of this year, it looked to be proceeding apace. Then, this year, the downward trend stopped, prompting some to think it was over. It's not. Asian central banks are buying up dollars to manage their own exchange rates. As a result, we in the US haven't been getting the proper price signals to tell us to slow down the borrowing. There are two scenarios possible: 1) the dollar slide resumes after the election (regardless of the result), interest rates start to rise slowly and steadily, economic growth causes tax revenues to rise and the deficit is brought under control or 2) the trade deficit continues to rise every month, GDP growth stagnates, and Asian currencies revalue. Scenario 2 isn't pretty, and it could happen.

It doesn't have to though. What we really need is for foreign investors to invest in productive assets rather than government bonds. In the last few years, they have been financing our deficits rather than engaging in direct investment. If you look at the trends in the balance of payments in the last few years, the picture is quite dismal, though the second quarter shows a tiny glimmer of improvement. I'll update this story when the 3rd quarter numbers come out (in mid December) if not before. This is the real story, and the real source of trouble if things start to turn south. Keep an eye on this developing economic story.

Taggert Brooks has another good one.

Taggert Brooks posts a gem.

The flu vaccine is in short supply. When a shipment comes in, predictable but unintended things happen. Case in point, my local county health department was giving out flu shots yesterday. The usual rules apply--only those in high risk categories. They were given to those people on a first-come, first-served basis. So, the predictable, but unintended outcome was that you had a bunch of senior citizens and parents with babies camping out in the cold starting at 2:30am for a clinic that opened at 9.

Thankfully, someone opened the doors a little early to shorten the suffering.

So what is the appropriate way to ration this limited supply? Left to the market, the price of the vaccine would simply go up, but for a number of reasons (some good, some not) we have decided that it is unacceptable to do that. The alternative we seem to have chosen is to have people line up at 2:30am--and these are the high risk people.

The trouble is that even if you limit it just to the high risk people, you still have to ration the vaccine. There doesn't seem to be anything in place to identify the highest of the high risk patients. Without such a mechanism, there is no guarantee that the vaccine will really go to those who need it most ("need" being identified with vulnerability to the flu). Instead it goes to those most willing to stand in line at 2:30am. Apparently that is more acceptable.

Marginal Revolution discusses the vaccine shortage. This is a clear case of a market not working because it was not allowed to work from the get-go. How long will it take before people realize that this will happen again unless some meaningful changes are made?

So Jon Stewart goes on CNN and rips the hosts. OK. But that's not the big story. The New York Times tells how the incident became instant fodder for the blogosphere. The point is that CNN missed an opportunity to promote themselves by giving away free downloads of the video from the program.

"What's fascinating about the Jon Stewart takedown of 'Crossfire' is not just what he said, but how his message got distributed," Jarvis wrote. "The really stupid thing is that CNN didn't do this themselves: 'Hey, we had a red-hot segment...you should watch; here, please, look at this free download because it will promote our (hosts) and our brand and our show and give us a little of that Stewart hip heat.' That's what CNN should have done. Instead, they'll charge you to deliver a videotape (what's that?) the next day."

CNN media representatives said they were not surprised by the massive response, based on "Crossfire's" ratings and Stewart's own visibility. They had no comment on the company's policy of distributing its programming via mail, as opposed to online. The CNN.com site does offer short clips of some of its programs.

The new media community filled the void. The article continues...

In addition, Jarvis pointed out that the Internet serves as a sort of unofficial index of other media outlets, giving people the ability to access almost any report transmitted on television, radio or in print news.

"Welcome to the future of TV!," Jarvis wrote. "In old TV, a moment like this came, and if you missed it, you missed it. Tough luck. In new TV, you don't need to worry about watching it live--live is so yesterday--because thousands of peers will be keeping an eye out for you to let you know what you should watch, and they'll record it and distribute it."

That's the power of a network, and I'm not talking about CNN.

Finn Kydland and Edward Prescott received The Bank of Sweden Prize in Economic Sciences in Memory of Alfred Nobel for 2004. (Commonly referred to as the Nobel prize by everyone except Nobel purists.) This is a good choice. I'm very partial to their 1977 JPE paper on time consistency. They also had the groundbreaking 1982 Econometrica paper which is a classic in the stochastic general equilibrium literature.

A while back the Minneapolis Fed printed an interview with Prescott. Well worth reading.

Job numbers were not what was expected or needed. Should be an interesting evening.

But anyway, my prediction of the annual revision was (barely) closer than Mankiw's! I said 200,000, he said 288,000. It was 236,000.

Did you ever hear the one about the three econometricians who went hunting? The first one shot, and the bullet went 10 yards in front of the deer. The second one shot, and the bullet went 10 yards right behind the deer. The third one jumped up and shouted, "We got it!"

I was interviewed by WMBD TV today. The subject was oil prices. When you're reading on the Internet that oil hit $53/barrel and the phone rings, sometimes you just have a feeling about who's on the other end. Anyway, a couple things I mentioned that didn't make it into the story (at least not at 10pm which was the only newscast I saw) were that the price of oil in 1980, if it were adjusted for inflation, would be close to $80/barrel and that today we use about 1/3 fewer BTUs per dollar of GDP than in 1980.

That is not to say that $53/barrel will be without pain. I am worried about the situation in Nigeria and Russia, not to mention the Middle East. There could be a perfect storm brewing. If we can catch a break, maybe prices won't go too much higher as we go into the winter. If we don't catch a break and everything goes wrong that can go wrong, it will be a long winter indeed.

September job numbers come out on Friday. The payroll number will get a lot of attention; anything under 200,000 will mean uncomfortable questions for Bush on Friday night. Anything over 200,000 will cause Bush to point to the future with optimism while Kerry reminds everyone of the dismal numbers in previous months. (Really, this sort of predicting is too easy!) Another important number coming soon is the annual revision. Greg Mankiw thinks that payroll employment will be revised up by as much as 288,000 for the year (with a margin of error of +/- 140,000 -- that sort of predicting isn't much harder!) Objectively speaking though, Mankiw is probably right. Economists who follow this sort of thing realize that there is usually a positive revision in the first couple years of a recovery. 2003 was the year the jobs recovery started to get off the ground, so I would expect about 200,000 based on past experience. Mankiw might be a little optimistic, but my estimate is in the same range as he gives.

The reason for this is that while the payroll survey is a much better measure of jobs than the household survey, the payroll survey tends to miss newly created companies and self-employed workers for a while. Eventually, the new firms work their way in the survey, but in periods when more new firms are being created than usual (such as the early part of an expansion), it underestimates the actual number of jobs.

Whatever the revision ends up being, it will be exaggerated by the Republicans (assuming it is positive) and dismissed by the Democrats. If it ends up being close to my estimate, I won't give it much thought either way since I've already figured it in to my own assessment of the employment situation.

One of the last economists of an era. The profession is richer today because of his contributions.

Read the NY Times obituary.

Time for a little thinking out loud.

The "blogosphere" is a network, as the previous entry points out. Networks have been the subject of considerable study in economics especially since the arrival of the modern Internet. One lesson stands out: the value of a network grows more quickly than the size of the network.

This idea has often been expressed as Metcalfe's Law, which states that the value of a network is equal to the square of the number of users. As a rule of thumb, that's fine, and it certainly is easy to remember, but in reality it might be far more or less than that. Metcalfe's Law is based on the observation that the number of 2 way conversations in a network is equal to N(N-1). That is, if you have N telephones in the network, each of those N telephone users, can call one of the other (N-1) users. Hence, there are N(N-1) 2 way conversations that are possible.

This "Law" says nothing, however, about the social value that is created by these connections. If you have a phone that you use only for emergencies, it doesn't add as much social value to the system as a phone that is used frequently to connect you with many friends and business contacts.

So what is the value of the "blogosphere"? There are about 4 million blogs listed on Technorati. Thousands have only a handful of readers, while a handful of blogs have thousands of readers. This isn't a standard telephone. Popular blogs are like a 50,000 Watt radio station, capable of selling advertising, and maybe even able to compete with traditional media. Most are probably less significant than the bulletin board over the company water cooler.

Figuring out the value of the blogosphere is not a trivial problem that can be reduced to Metcalfe's Law.

But as events of the last few days illustrate, there is something new going on. Bloggers became part of the story about the CBS documents. Some might say that it's premature to call this a "revolution", but clearly Joe Trippi doesn't think so.

Think about this: you can go to a news aggregator and subscribe to all your favorite newspapers and blogs. Then, every morning, you listen to the largest conversation in the world -- a party line for the ages-- filtered to give you just the keywords you want, and you have a voice in that conversation.

What is the value of that?

To be continued...