Tuesday, December 18, 2007

Gift Ideas for the Economic Educator (What I’ve Been Reading)

One of the books I promised to review was Alan Greenspan’s memoir, The Age of Turbulence: Adventures in a New World. Well, I finished it. It took a little longer than I thought, but only because I lack all the reading time I had when I was commuting in Chicago. (You can get a lot read in an hour plus on a train.)

If you’re an econ teacher or a student of recent history, and you’ve not read this book, I strongly encourage you to do so. Don’t be afraid of Mr. Greenspan’s reputation for confusing statements. In this book, he is quite clear. However, if you listened to him as often as I did during my career at the Fed, you can hear his voice. This is no ghost-written biopic. This is the man and his thoughts.

The first part of the book is largely biographical – following Mr. Greenspan from his boyhood in New York, through college and into private practice and public service. Once there, we view world events and world leaders through the experiences of one who saw many of them. From the Roosevelt administration in World War II, to the current President Bush, Mr. Greenspan met and advised many leaders and potential leaders. And he provides a candid assessment of each.

But it is the second part of this book that I found most interesting, and that I believe will be of the most value, particularly to economics teachers. It is in this part, that Greenspan gives his views of many of the economic hurdles ahead of us. He talks with the clarity and intellect which was a hallmark of his analysis. I found much in the second part of the book to think about and to share with students. And I suspect you will as well. Where Greenspan excels in is explaining the economic concepts as they apply to the issues. And although you may not like what he has to say, his explanation remains valuable. Likewise, his analysis is timely. I was frequently struck by the recent data that he put in the book. For a book released in September of 2007, I was struck by the number of references to information from the spring of that year. It is apparent that the book went to press quickly, but only after up-to-date and relevant information was included. This book is a must have for the economics teacher and Fed watcher on your shopping list. (Shop now, the retailers seem to need a shot in the arm.)

I invite others who have read the book to share their reviews. And if you’ve not yet read it, please come back when you have. I welcome your thoughts.

Monday, December 17, 2007

Celebrity Marketing - One Student Gets It

There was a great letter to the editor (link no longer operative) in the Sunday, December 16 issue of the Richmond Times-Dispatch. The writer, an 11-year old named Armani, bemoans the role that celebrity plays in marketing, accurately pointing out how consumers, young consumers in particular, are drawn to purchase products because some sports or entertainment figure has affixed their name.

When we teach financial literacy, we try to get our students to look past the marketing glitz and try not to pay for the name. (Actually, when you think about it, you're acting as a walking billboard for some corporate entertainment conglomerate -- they should pay you.) We talk about the underlying value of the product and try to get our students to ask "Is there something that will function as well at a lower price."

Here we get to basic economics and the concept of utility. I've posted on the concept before, but it never hurts to review. Utility comes in three types: form, place and time. For most products, we're asking our students to evaluate the product's form utility. What we have to make sure we understand is that the endorsement itself is a type form utility to these students. It's because the item has the name of some movie/video/sports/music persona attached that, in the student's mind, it has additional value. It is this concept that financial and economic educators have to get students to understand. The additional value gained by a name is usually miniscule and temporary. It will be replaced in short order by another name, another face, another fantasy that really has no real impact on everyday life.

This takes me back to the letter mentioned at the beginning of this post. While there is some irony in the fact that it takes a student named Armani to make the point, Armani understands. I predict, this youngster is already ahead of the pack, and I suspect will pull farther ahead in years to come. Good luck, Armani.

Your comments are welcome.

Friday, December 14, 2007

Financial Markets and the Fed

Mike Fladlien over at Mikeroeconomics posted a comment to my entry yesterday on the new Term Auction Facility (TAF) announced by the Federal Reserve and other central banks. And while his question doesn't pertain to the TAF, it is a good question. I'll take a stab at answering it.

Mike asked why the stock market would react negatively to the Fed's dropping of the target Fed Fund rates. And by my observation, there are two groups of investors who would drive such an action: those who think the Fed didn't do enough, and those who think the Fed did too much.

The first group is composed of investors/traders who thought the Fed would lower rates by more than 25 basis points. They believe that the primary concern at this juncture is a recession or, at the very least, a significant slowing of the economy. A reduction by more than 25 basis points would stimulate the economy and would make stocks more valuable. Consequently they took positions in stocks based on their expectations. This is what is meant when you hear commentators talk about a move being "priced into the market." When the Fed did not deliver on their expectations, the relative value of their holdings changed, and they sold off their stocks.

The second group is composed of investors/traders who thought the Fed should not lower rates at all, or maybe even should consider raising rates. To this group, the economy seems to be moving along relatively well, and their primary concern is inflation. They see that a lowering of rates is tantamount to faster growth of the money supply, which leads to inflation. In their view, when the Fed lowered rates, it added fuel to the fire which only means the Fed will have to reverse course and begin tightening. The tightening will slow down a growing economy and could cause raise the threat of recession higher.

Now you may ask, what about the group that is somewhere in between? My response is to think of the Goldilocks story; only one party thought things were "just right." And that person was definitely in the minority in a bear environment.

I welcome other views and explanations, especially from people more knowledgeable about the market than I am.

Globalization and Your Feet - Revisited

On November 27 and 28, NPR's program All Things Considered ran a very good, two-part program on globalization as it impacted the sock industry in Alabaman and Honduras. I posted on both parts on November 28 and on November 29 respectively.

Today the Aplia Econ blog did a good post on the same subject, offering some classrooms to use in class. Give it a look and share your thoughts.

Thursday, December 13, 2007

Fed Announcement and Your Classroom

Yesterday, the Federal Reserve System, in cooperation with a number of other central banks, announced a program that would provide additional liquidity to a financial system under strain because of the U.S. sub-prime issue.

They announced the creation of a Temporary Auction Facility (TAF). This facility is meant to provide a channel for banks to borrow funds from the Fed. At this point, you (or your students) may ask how it differs from the primary lending facility (discount window). I will try to offer some possible answers based on what I understand from reading the statement.

Similarity to discount window: The TAF is open to financial institutions that can access the primary lending facility, i.e. those financial institutions deemed to be in good financial condition.

Similarity to discount window: Loans from the TAF are collateralized. This means that the borrowing institutions must put up high-quality (read low-risk) securities as collateral for the loan. This is the same as at the discount window.

Difference from discount window: The term or length of time for loan from the TAF is different. Discount window loans are very short term (frequently overnight). TAF loans will be for periods closer to one month.

Difference from discount window: The process will be based on auction, as opposed to simple application. At the discount window, if you show up and have proper collateral (and you're a qualified institution), you get the loan. At the TAF, there will be an auction for the limited supply of funds. There will be a minimum bid price (rate of interest), and it will be competitive - higher rate bids will have a higher likelihood of being accepted. There will also, as I read it, be non-competitive bids. Financial institutions submitting this type of bid will pay an average rate based on the accepted competitive bids. This is similar to the way the Fed and the Treasury conduct auctions of Treasury securities whenever the Federal government needs to borrow money. In those circumstances, the Fed acts as the Treasury's agent, helping to collect bids and distribute securities.

One of the more interesting institutional aspects of the statement, as I read it, is that the Fed is leaving the door open for the TAF to become a more permanent aspect of its lending channels. That decision will arise out of this temporary experience as well as public comment.

The long and short of it, I don't think you need to change the "three tools of monetary policy" to "four" quite yet. On the other hand, if your students are participating in the Fed Challenge competition this year, you might want to watch further developments on TAF and its ability to provide liquidity. The issue could make an interesting one for judges to ask in Q&A.

I sincerely hope a number of my former Federal Reserve colleagues, who have access to more information than I do, will comment with any corrections or clarifications. I would also direct you three blogs that frequently do a good job of Fed-watching. The first belongs to a good colleague of mine at Western Illinois University, Dr. William Polley. The second is one that has only been around since September but is still very interesting. It is hosted by a portfolio manager in New York named Marc Shiver. The last is by former Dallas Fed President and current Distinguished Fellow at the National Center for Policy Analysis, Bob McTeer. I suspect all of them will have far better insights to offer than I have.

I look forward to comments.

Here's a speech by New York Fed President, Tim Geitner that explains the TAF.

Tuesday, December 11, 2007

Thoughts on Subprime - Somewhat Disjointed?

Recently, a number of my colleagues have contacted me about the sub-prime issue. I've directed them to my posts of December 6, November 21, and November 27 because they all contained some interesting links that could provide some insights to their discussions and debates. Then, probably because it's been on my mind, I find a number of items that relate to the topic. They appear disjointed and unrelated, but somehow they fit together for me.

The first was a post by Arnold Kling on TCS Daily that appeared yesterday (December 11). Arnold expresses concerns about the current state of the housing market. Specifically, he mentions how the link between income and housing prices got out of whack, with one source talking about people with no money down being okayed to purchase houses with prices equivalent to 10 times income -- rule of thumb is somewhere between three and four, and Arnold actually suggests six, which I personally wouldn't find comfortable.

He further explains that as long as that ratio is allowed to stand, the housing market cannot correct. Another way he explains it is that allowing buyers to remain in a transaction they cannot afford postpones the downward correction needed to bring housing prices closer to equilibrium - the point at which the quantity supplied (see current inventory of unsold homes) meets quantity demanded. He concludes that the political desire to keep people in homes that they cannot realistically afford (see planned freeze of ARMs on sub-prime mortgages) does not solve the crisis.

Jump to the second item. Today's issue of The Wall Street Journal has article titled "Mortgage Pain Hits Prudent Borrowers". The authors note that part of the fallout of the sub-prime mess is that lenders (Fannie Mae and Freddie Mac) are now adding fees to new loans, effectively raising the price of mortgages, even if the borrower has good credit and meeting what one hopes are more stringent requirements. This article caught my eye largely because in a class I'm teaching, the rescue plan on current mortgages came up as an example of an effective or binding price ceiling.

My thinking was that by freezing the rates below market, one would essentially create a shortage of funds for mortgages. This is why many critics feel that the proposed rescue plan would not solve the current "credit crunch." Demand would be higher than would be expected in market equilibrium, as current mortgage holders would have no incentive to get out of a mortgage that may be inappropriate. And the supply of loanable would be lower than would be expected in market equilibrium as lenders would be unwilling to lend unless they could receive proper compensation - maybe in the form of additional fees. Take this further by shifting losses in one sector to a potential profit-generating sector. As the article points out, the prudent borrowers are paying the cost of less prudent borrowing and/or lending.

This takes us to the third item. One thing I do when I read is keep a journal of passages that seem to speak to me, providing insights into personal circumstances, historical events, or economic principles among other things. A few years ago, I read Umberto Eco's Foucalt's Pendulum. I find that any of Eco's books contain ideas that are thought-provoking. But as I thought about sub-prime, something motivated me to check out my journal, and I ran across the following passage:

"Take stock-market crashes. They happen because each individual makes a wrong move, and all the wrong moves put together create panic. Then whoever lacks steady nerves asks himself: Who's behind this plot, who's benefiting? He has to find an enemy, a plotter, or it will be, God forbid, his fault."

Now, while we're not talking about stock-market crashes, I think the quote is relevant because the sub-prime situation is one of our own making. There were wrong moves made by everyone: borrowers, lenders, government. Many of the parties were motivated by good intentions (there's road paved by them, somewhere), and others were motivated by greed, and others were just plain uninformed or wanted to believe there was such a thing as a "free lunch." (This takes us back to Arnold Kling's initial thought that people who were borrowing the equivalent of 10 times income should perhaps have known better.) Regardless, the proposed rescue plan is an attempt to shift blame. The finger-pointing is our attempt to find the "plot" and the "plotter". As Eco implies, the last thing we want is to realize it's our own fault.

I would think that had we as a nation done a better job providing our young people with economic and financial education, some of this could have been avoided. As I often tell my students, when you see a problem, point at what you believe to be the source of the problem, then realize three other fingers point back at you.

I look forward to your comments.

Friday, December 7, 2007

Globalization and the 787 - Revisited

Back in July, I posted on the Boeing 787 and how it represented a great example of "globalization" in business. The Boeing "Dreamliner" can be used as a good example of how many firms, working together should be able to work to produce a single product. Boeing's strategy of outsourcing the subassemblies, and then shipping them to a final assembly point, combines concepts of comparative advantage, with ideas like "just in time" delivery. And all of this goes into producing a very complex piece of technology.

A story on page one in today's edition of The Wall Street Journal (subscription required) provides an update on my original post. It would appear that things are not as dreamy as originally planned. It seems that many of the contractors have not been able to deliver the goods. In some cases, the subassemblies arrived at the plant in a state that many parents have confronted on Christmas morning - "further assembly required" or with instructions written in a foreign language. Other subcontractors sent part of the work to other subcontractors (evidently unknown to Boeing) who were unable to deliver on time. And at least one contractor had unexpected delays when it ran into obstacles building a plant to build a specific component.

Does this mean that globalization, international trade, and outsourcing are failing? I don't think so. The lessons learned from this tie back to something I discuss with my students - the role of economic institutions in trade.

Any trade, domestic or international, is impacted by rules (formal and informal) and organizations that impact decisions. We often lump these rules and organizations under the concept of economic institutions. If you read the article, you'll see one company had to deal with replacing/replanting a 300 year-old olive grove. Another problem involved issues of documentation that had to go through layers of communication. I found this last to be particularly ironic having read The World is Flat by Thomas Friedman. Friedman talks about how communication technology makes globalization possible; but evidently the benefits of this technology can be trumped by bureaucracy (another economic institution?).

I don't think this means that globalization/trade/outsourcing are failing. I do think this is an example of how we don't quite have a handle on it, yet. I suspect the overall strategy for the Dreamliner is a good one. There are just a few nightmares to work through, first.

Your comments are appreciated.

Thursday, December 6, 2007

Help Me Understand This...

On my way into work this morning, I was listening to a news broadcast. The item was about the proposed freeze on adjustable rate sub-prime mortgages. It contained two statements supporting the freeze by one of the many, many Presidential candidates. One of the statements seemed plausible. The other seemed considerable less so.

The first statement was that something in the neighborhood of $30 billion in mortgages will adjust each month during 2008. This seems plausible.

The second statement was that the adjustments would result in average mortgage payment increases in the magnitude of 30 - 40%. Now, I recognize I'm not a mathematician. But for the average adjustment to be that severe, that would indicate that sizeable number of those loans are "interest only." I understand that in a standard mortgage (believe me, I understand) that much larger portion of the initial payment is interest (as opposed to tax escrow, PMI, or payment on principal). Regardless, it seems that an upward adjustment that even doubled the interest rate shouldn't result in that significant a bump in the payments unless you were paying off an "interest only" mortgage.

Another aspect may be that the characterization applies to all adjustable rate mortgages, even if they aren't "sub-prime." If that's so, the statement is a misdirection. If I'm correct on either of these points, the candidate's statement would appear to be reckless. If I'm wrong, the candidate's characterization may be correct and in the proper context.

Now, at this time I won't discuss the bad economics of a "rate freeze" and how it will act as a binding price ceiling and all that implies. Nor will I discuss the idea of "moral hazard" that arises every time government jumps to provide a bailout. We'll save that for another time.

**UPDATE** This might or might not be a good time to discuss positive vs. normative economic statements again - see my previous post. I'm not sure about the data in the second statement. Consequently I'm reluctant to categorize it as a positive or normative statement. But if it is not accurate, it's a good example of how normative statements can be made to sound positive by using suspect data.

I await your (or even your students') enlightenment.

Tuesday, December 4, 2007

It's the Economy....I'm Shocked, Shocked

It really should not come as a surprise, but a front page story in today's issue of The Wall Street Journal states "Economy Moves to Fore as Issue for 2008 Voters" Even before reading the article (it’s quite good) I find myself reduced to quoting Captain Renault in the movie Casablanca.

Actually, given the confluence of sub-prime, oil prices, and twin concerns about economic overheating and slowdown, one would actually be surprised if it wasn't the topic. And given the focus on things economic, teachers all across the nation will be using the economy and the elections to spice up their lessons in economics, political science, American history and current events, among other thing. This gives all of us an opportunity to discuss a very fundamental aspect of economic literacy and thinking.

Economics is parsed a number of ways, but one way is to distinguish between positive and normative economics. Positive economics is based on fact. It describes economic conditions as they are. Normative economics describes things as one thinks they should be. Politicians (of all stripes) generally are huge fans of normative economics, using normative economics to describe their future policies and the wonderful benefits that will derive from those policies.

Politicians generally shy away from positive economics; although they do like to use data to disguise normative statements in a way as to appear positive. By throwing in an occasional statistic, a politician can seem to base their proscription in economic reality. But the reality too often is that while they may start from a positive statement, they seem to rarely provide a full explanation of how and why their policies are expected to work, and the extent to which they will actually change behavior; and by extension, the expected impact on the economy.

There are reasons for this. First and foremost, they frequently don't know. Second, we the electorate frequently don't care about the positive because the normative sounds good. The normative also frequently doesn't address issues of cost - either monetary or opportunity cost. And we know that we like to hear what the benefits will be, but we don't want to hear about costs -- unless it's to be told that someone else will pay the costs.

But this is a good opportunity to use current events to reinforce economic learning. Have your students dissect the sound bites (or the entire presentations if you can) that come out of press conferences, stump appearances, and debates. Have them analyze what the candidates say and sort them in to positive and normative statements. I suspect you and your students will find few, if any positive statements. And what they do find will be dwarfed by the normative statements.

As a follow up, ask your students "why do the candidates do this?" And ask them if they think the statements actually enhance their opinions of the candidates' ability to solve economic problems, or whether the candidates are just acting in their own self-interest.

Finally, you may also want to consider reading Russ Roberts' essay, "Pigs Don't Fly: The Economic Way of Thinking about Politics". I would recommend you read it first, and then you can decide whether you need to distill it, or whether you can give it to your students straight. Either way, it could generate some good discussion.

I look forward to your comments.

Monday, December 3, 2007

The Value of the Dollar: Foreign Exchange and "Strength"

A recent topic in the course I teach was foreign exchange. After discussing some fundamentals, we briefly discussed some implications. I suspect we will discuss them further. Regardless, there have been a number of articles written on the topic by very good economists of late. I draw them to your attention because I know the topic is one that can cause confusion among students.

First, Don Boudreaux of Cafe Hayek had a good piece in the Pittsburgh Gazette last Friday. In it, he discusses the issue of a move to dump dollar, and why he feels it's unlikely. It's a good explanation, especially as it addresses the very fundamental observation that such a move would likely hurt the dumpers as much or more than the U.S. In fact, the only question I have regards his assumption that the dollar was "overvalued" when it was accumulated by other nations. Certainly it was valued more highly than now, but the value is what it is. If one believes in the power of the market, then the market should adequately represent the value as perceived by suppliers and demanders. This is especially true given the amount of time that the dollar was "strong" or "overvalued."

Second, Tyler Cowen at Marginal Revolution had a good piece in The New York Times on the advantages of a weaker dollar. While we often react to terms like "strong" and "weak" in a visceral way, it is important to remember that both terms are relative, and that foreign exchange, like any market, depends on both supply and demand to make the price. Relative preferences are revealed in the price, and we have to examine the motives of buyer and seller at that moment.

Third, Brad DeLong had a good piece in the Taipei Times that talks about where he feels the dollar may be at the moment. He discusses the implications for the U.S. economy depending on whether the dollar continues to fall, or whether it may have already hit (or be very near) the bottom. Either way, it's important to stress to students that the currency market, like the economy itself, is dynamic. And where either is now, is not likely to be where it is in the future.

Finally, Evan Davis who writes and blogs for the BBC has an interesting post in his blog on how we may be seeking to use trade isolationism and concerns about quality to counteract the weakening dollar.

If you're looking for a good, fundamental discussion, these might be good places to start.

I hope you have time to look at these. And please share your thoughts and observations once you do.