Friday, October 31, 2008

Economics, U.S. History and the Current Economy

I suspect those of you who are teaching U.S. History use the current economy as an illustration in class. Most people are busy drawing parallels to the Great Depression, but if you want to dig deeper, I've provided links below to some interesting articles that you can use to draw parallels to various events in the 19th century, rather than restrict yourself to the 20th.

And while I'm sure you can find issues to debate in each article (I did); they give the students a sense of the value of studying history - and how economic understanding can offer another view.

Have a good weekend.

Does This Happen Often? by John Steele Gordon

Panics and Politics also by John Steele Gordon

A Short Banking History of the United States also by John Steele Gordon

The Real Great Depression by Scott Reynolds Nelson

Thursday, October 30, 2008

Factors Affecting Demand

When we discuss markets with students, we like to talk about the factors that affect the components - essentially, what can move the curve to the right or to the left. We do this because our students tend to see price as the main factor. But we often have to remind them that changes in price move us up or down an existing curve. The question we then repeat is "what shifts the curve?"

When we explore further, we often get to the main determinants. Income, prices of related goods (substitutes & complements), tastes, expectations, and changes in the size of the market (number of buyers).

The current state of the economy is having an impact on prices in a number of areas. But one of the more relevant to your students may be college. Changing incomes and the continuing high price of education is changing the choices people make from where to go to school to what to study. This article from today's issue of The Wall Street Journal provides excellent examples of how price affects choices, and how income and expectations can affect the demand component of price. I think it would provide an excellent place to start a discussion reviewing demand and shifting demand.

What do you think? Can you think of or recommend other pieces to go along with this one?

Tuesday, October 28, 2008

Aphorisms for the Current Situation

Irwin Kellner, one of the economists and columnists on Marketwatch, revived a column from last year. It's one I actually remember reading, and it uses some old saws to explain why there's plenty of blame to go around when it comes to analyzing the current financial situation.

How do you use it in class? I'd do what Dr. Kellner did. List the aphorisms. But instead of providing the analysis, ask the students how each one might apply to the current situation. It will provide some interesting opportunities:

First: have they even heard some of these? I am tempted to place folk wisdom and aphorisms under the category of institutions - the rules that help shape our decision-making. If the students are not familiar with the sayings, the idea behind the saying may not be playing any significant part in their decision-making.

Second: (and more important) can they make they see the connection? Can they apply the folk wisdom to the current issue?

Third: Are there any consistent gaps in their view/analysis? Are any of the players seen as not culpable or participating in the formation of the mess? That provides you with a teachable moment.

Please share how your students do with Dr. Kellner's list.

Friday, October 24, 2008

A Couple Thoughts on "Buy Local"

First, there's an interesting interview with Russ Roberts, host of Econtalk and a presenter at the forthcoming AP Economics Conference co hosted by the Powell Center for Economic Literacy and the Federal Reserve Bank of Richmond.

Russ is going to debate with Bill McKibben, author of Deep Economy, next week on the topic of "Buy Local"

The reason I point you to Russ's interview is his comment about choices about buying local need to be individual. I agree that we all need to understand the issue and choose according to our own levels of "satisfaction" and our ability to make use of our own scarce resources. This brings me to my second recommendation.

This cartoon does an excellent job of showing the opportunity cost of choosing to buy local. One way is that the purchaser is gaining satisfaction by doing his part to "buy local." That should be worth something. At the same time, someone on a limited income may choose differently. By my calculations for every four gallons purchased "locally," one could afford almost five gallons purchased from a conglomerate. It depends on how one chooses to use scarce resources. Like Russ, I think the individual should be allowed to make the choice.

Do these resources offer any possibilities for your classroom?

Of Monetary Policy and the Fed

Here are two resources worth your attention, particularly if you do the Fed Challenge. (HT to Greg Mankiw on both of these, by the way.)

The first is a post on Dr. Mankiw's blog showing charts from the St. Louis Fed. I expect (and fervently hope) that these spikes disappear in the not too distant future. But they are representative of what the Fed does in a financial crisis. You might want to have students also look at reserve positions at banks and fed funds lending activity.

The second is for when you and the team have been working hard and need a break and a laugh. (This should be particularly meaningful to those who were in the Seventh District Fed Challenge when I was still in Chicago.)

Are there negatives to using the video? I look forward to your thoughts.

Wednesday, October 22, 2008

It's A Wonderful Life...Or Is It?

For the past 10 days, I've been reading and rereading this piece that appeared in the October 12 edition of The Washington Post. It caught my eye because it featured a large image from the Capra film It's a Wonderful Life. The photo had Jimmy Stewart's George Bailey lecturing Lionel Barrymore's Mr. Potter.

As economic and financial educators, we know and often use a different scene from that movie that features a run on Bailey's savings & loan, and his subsequent explanation of how a bank works. It's a sound, basic description of the process of changing short-term liabilities (deposits) into long-term assets (loans), and the potential problem with the mismatch.

The article in The Post attempts to lay the current financial problem
at the door of George Bailey's establishment. Easy credit for less deserving borrowers trying to grab hold of the American dream. Put that way, you may be tempted to cede the point. I've made it myself. However, one thing is missing in this analogy - a bit of institutional history.

The rule book now is different than the rule book facing Mr. Bailey and Mr. Potter. At the time Capra's film was made, both types of financial institution were tightly regulated as to rates they could pay depositors, types of loans they could make, and who held the loans. And as has been pointed out in numerous places, the establishment of agencies to subsidize and/or guarantee mortgages established different incentives for numerous parties up and down the financial line. But the tightly regulated market of the 1940s is different than the market of today. A post on this blog from last week listed a number of laws that helped change the rulebook for financial institutions. And those laws further changed the incentives and changed the market.

I agree with Ross Douthat that providing incentives for loans to riskier borrowers was a contributing factor to the current situation. But there are other parties who played a role. In each case, we need to remember a basic axiom in conomics: "People respond predictably to incentives." If a system is established that rewards risk-taking, either by borrower, lender, investor, regulator or politician; we shouldn't be surprised when the risk is taken. But we also need to remember that risk has an upside and a downside. And to that end, we may need to let things fail as well as succeed.

In conclusion, let me get back to the idea of using It's a Wonderful
in the classroom. While many of us use the "run" scene in class, it may be worth our time to use the clip of George Bailey confronting Mr. Potter and some other businessmen about home ownership, "Doesn't it make them better citizens? Doesn't it make them better customers?" I think there are still people out there; trying to meet their obligations on loans they took out just before the top. The fact that they are trying to make those loans work and keep their homes would seem to answer "yes."

I look forward to your comments.

Monday, October 20, 2008

Economics in the Musical "Big River"

Last fall when the students of the Upper School at Collegiate (home to the Powell Center for Economic Literacy) did The Music Man for their fall musical, I spent some time on the economics in that play, and managed to pull one economics lesson per day for a week. This year, the students are presenting "Big River", the musical based on Mark Twain's Adventures of Huckleberry Finn. This time, I thought I would try to focus on one concept or idea and try to point different examples of it in the play. This didn't prove to be less challenging or less entertaining. And despite the fact that a warning appears in the opening scene, "Persons attempting to find a motive in this narrative will be prosecuted; persons attempting to find a moral in it will be banished; persons attempting to find a plot in it will be shot. By order of the author. Mark Twain." I pressed on.

The concept that seemed to offer the most interesting opportunity was "productive resources." We know from Powell's Keystone Principles that productive resources are important. There are four types of productive resources: "natural resources" that occur in nature and include things like animals, plants and minerals; "human resources" which include all human effort, whether physical or mental and include all of the skills that humans possess; "capital resources" which includes money, tools or other products held back from consumption for purposes of producing later; and entrepreneurship" which includes the ability to mix and the other resources in new and innovative ways, and taking the risk on providing a good or service.

There are a number of instances where the concept of productive resources is well-illustrated in this musical. Here's how I see them. Please feel free to disagree or add to.

There are a couple hints at productive resources in the number, "Do You Want to Go to Heaven?" The first is the general encouragement to learn to read. Reading is presented as a skill (human resource) that yields benefits - not the least of which is being able to help one get to heaven. But there's also a mention of Judge Thatcher investing money for Huck and Tom Sawyer that yields them "a dollar a day." That’s a good example of capital resources in a productive enterprise.

Huck prepares dinner while his father is railing against the Guv'ment. He rolls fish (natural resources) in cornmeal (natural or capital resources) to cook them.

This scene is opened with the song, "Hand for the Hog". And by the end of the song, we're convinced that the hog is one of the grandest of natural resources regardless of your undertaking. From providing food to being a good pet, you have to give a "hand for the hog." As it turns out, the hog is an important resource to Huck as he tries to fake his own murder so he can run away from his father. Later in Scene V, Huck and Jim pull an old catfish out of the river for dinner. And the catfish (a natural resource) proves to be the source of capital resources (a gold coin), that gets put to use as they provision a raft and set out down the river.

Jim talks about his dream to get his wife and children out of slavery. He envisions trading his labor (human resources) for cash (capital resources) until he has enough to buy their freedom.

This scene sees Huck and Jim have been joined by a couple of other fellows, who go by the names of Duke and King. They're conmen and actors and proceed to develop a plan (entrepreneurship) to get some money from people in a small town by putting on a show. They use their talents (broadly speaking) and cunning to develop a way to trick some of the inhabitants into paying for the show, but then to bring others with money into the show to see the NONESUCH.

Here we find our small quartet heading past Arkansas and developing another plan to take advantage of their human resources to trick a grieving family out of their inheritance. Through a combination of acting and solid listening, King and Duke pick up enough information to perpetrate the fraud, only to be caught by the untimely arrival of one of the people they are impersonating.

We're almost near the end, and this brings Tom Sawyer into the story. Huck has been passing himself off as Tom for a while since getting rid of King and Duke. However, he's stuck at Tom's uncle's home (who evidently hasn't seen Tom in a while), and he needs to get Jim free. Jim was captured as a runaway and is stuck in the uncle's shed. As it turns out, the real Tom shows up. Tom Sawyer has a penchant for elaborate and risky plans (entrepreneurship) for getting what he wants. His intellect is a human resource. However, it seems that all of his plans are more elaborate than they need to be, calling for all kinds of capital resources (spoons and pie) and even some natural resources (spiders).

The show ends shortly thereafter, with Huck planning to head out to the Western Territories. There may be other examples of productive resources in the play, but just this handful shows how an "economic way of thinking" can provide a new view of a classic and fun piece of theater, and provide a new level of appreciation.

I look forward to your comments.

Do the Right Thing...?

There was an interesting piece in the Weekend Edition of The Wall Street Journal on Saturday. It was an interview with Anna Schwartz of the National Bureau of Economic Research (NBER). If the name is unfamiliar to you, she was the co-author with Milton Friedman of A Monetary History of the United States, published in 1963. She is 92 years old and is considered one of the preeminent monetary economists.

The most interesting part of the interview was near the end. She believes that Mr. Bernanke is fighting the last war, i.e. treating the current situation as if it were the same as The Great Depression. According to Dr. Schwartz, the issue back then was one of liquidity. In the period immediately following the Stock Market Crash, liquidity dried up. The Fed compounded the problem back then by tightening up on liquidity – starving the financial system of what was needed to keep running.

But Dr. Schwartz feels that this is not a liquidity crisis, rather a crisis of confidence. If that is true, the Fed can pump as much liquidity into the system as it wants, but until lenders feel confident that they’ll be repaid, little is going to happen. She also feels that Secretary Paulson’s original proposal to purchase the bad debt may have been more effective than the current Fed attempts.

This can make for an interesting discussion in classes discussing current events and monetary policy. It may also be the basis for some lively debates, either in class or on-line if you have a class chat room, blog or wiki. I would submit that another of her comments may also provide some fodder for discussion. About half-way through the piece, Schwartz says “Everything works much better when wrong decisions are punished and good decisions make you rich.” She continues, “It’s very easy when you’re a market participant to claim that you shouldn’t shut down a firm that’s in really bad straits because everybody else who has lent to it will be injured. Well, if they lent to a firm that they knew as pretty rocky, that’s their responsibility. And if they have to be denied repayment of their loans, well they wished it on themselves.”

This brings me to my question on this blog. How many of you use classroom blogs/wikis/chats to extend classroom discussion? If you don’t, is it a decision you made or one that is imposed by your school or district? I’m curious as it might help us at the Powell Center decide what we can do further take advantage of this medium.

I look forward to your comments.

Thursday, October 16, 2008

I Had to Chuckle....

I read this headline and thought to myself, "anyone who read Schumpeter."

But then I realized, "Who read Schumpeter?"

Conspicuous Consumption, Economics and Personal Finance

"Keeping up with the Joneses." It's a phrase most of us have run across at one time or another. Generally, we know what it means: if the neighbors get x, we need to get x (or if possible x-plus). We'd like to convince ourselves that "we were thinking about getting one anyway," or "once I saw the actual item, that was the last bit of information I needed." But the concept actually goes a bit deeper and has roots in economics and sociology.

In economics, the idea is called conspicuous consumption. And it is usually attributed to a 19th century economist named Thorsten Veblen. Veblen wrote about the upper classes of his time, and their desire for displays of wealth. He attributed this activity to the desire for status-seeking. Purchasing larger homes, "better" food and clothes, etc. was a way of displaying a real or imagined socio-economic pecking order. It was status-seeking.

This concept started moving around in my mind recently when one of my students asked a question about "name brands." We were discussing the idea of utility and I had mentioned that consumers seek utility in the goods and services they purchase. I mentioned the three types of utility: form, place, and time - and the student asked what form of utility was present in "branded" clothing. My response was that the brand differentiated a product - say a pair of jeans or shoes - from other like products, even if only by label. In my opinion, that was an example of form utility.

But the aspect of status-seeking and conspicuous consumption was also brought into the discussion. I asked whether status was actually improved by such things. It may be a matter of perception (ours) as opposed to reality (other people may not actually care). Conversely, do we receive psychic income if we feel better and if so, what is that worth? That was a couple weeks ago, but then the topic surfaced again as I read Greg Easterbrook's book, The Progress Paradox: How Life Gets Better While People Feel Worse.

First, let me say I enjoyed the book. His examples of broad economic progress were convincing. And the idea that wealth is not synonymous with happiness is not new. To that point, I think many of us need to examine the big picture before bemoaning our station in life. To make things seem worse than they are may be, as Easterbrook supposes, partially genetic. But it is also played up for self-serving reasons by individuals and groups that have a stake in our feeling bad.

That being said, Easterbrook uses a term in his book that, in my mind, clarifies what Veblen was writing about. Easterbrook uses a different term to describe the "having and exhibiting of that which is not needed." That description would easily explain conspicuous consumption. And while Easterbrook points out that the idea has always existed among the rich, he maintains that it has trickled down toward the middle class. He gives a few examples of items that fit his definition. You or I may disagree with some of them. But one of the beauties of the market is my wants/needs don't have to coincide with yours. However, I think the question which determines whether something falls into Easterbrook’s and Veblen’s concepts may be "what is it used for?" If the purpose is to impress or signal status, perhaps their terms aren't that far off.

As a classroom application, Veblen’s (or Easterbrook's) idea has value. It provides another way of examining the concepts of value, consumption, and utility. And in the personal finance setting, these topics can come into play when we ask students to prioritize their wants in setting goals or making budgets. Everyone needs to continually ask, "Am I buying this because it meets basic utility, or am I buying to signal?" Either way, we need to be aware of what we expect our purchase to do for us in order to make smart choices. After all, if you're willing to accept the opportunity cost...

What are your thoughts?

Wednesday, October 15, 2008

A Brief Institutional History

There are a lot of things I hope to post on in the next few days, but this one begged to be first

In today's (10/15/08) issue of The Wall Street Journal, Peter Wallison of the American Enterprise makes what I consider to be a significant misstatement in his opinion piece. Early in the essay, he states that "While there has been significant deregulation in the U.S. economy during the last 30 years, none of it has occurred in the financial sector."

I would contest that claim, whatever it's based on. To go back 30 years is to start the clock in 1978. By my count, there have been at least five acts. (In fairness, Wallison does cite two of them later in his essay, but to dismiss any of these as "not significant" to the financial sector is, in my opinion, questionable.

The first act I would count as significant is the Depository Institution Deregulation and Monetary Control Act (DIDMCA) of 1980. The short explanation is that this act is allowed banks and savings and loans into each other's "businesses". In turn, this allowed S&Ls to hold assets other than mortgages; and gave access to the Fed's discount window to depository institutions that were not banks, while extending the Fed's reserve requirement to those same institutions.

The second piece of legislation that I think should be viewed as significant is the Financial Institutions Reform, Recovery and Enforcement Act (FIRREA) of 1989. It consolidated two federal S&L regulators into one and placed the combined entity within the Department of Treasury. It also established the Resolution Trust Corporation to clean up hundreds of insolvent thrifts, and expanded Fannie's and Freddie's responsibility to support mortgages for low- and moderate- income families.

The third law and the first piece of legislation mentioned by Mr. Wallison is the Federal Deposit Insurance Corporation Improvement Act (FDICIA) of 1991. It strengthened the FDIC by allowing it to borrow directly from the U.S. Treasury, and to resolve failed banks by using the least-costly method available, while authorizing the FDIC to assess deposit insurance premiums according to risk undertaken by banks. (I suspect this may have provided some, if not a lot of incentive for banks to securitize risky loans. But I'm just speculating on that.)

The Riegle-Neal Interstate Banking Act (RNIBA) of 1994 is the fourth piece of legislation. It allowed banks to begin branching across state lines. If I'm not mistaken, it also allowed bank-holding companies to consolidate charters from different states into national charters. This provided impetus for some consolidation of banking in the U.S.

The final piece in my list, and the second piece of legislation cited by Mr. Wallison, is the Gramm-Leach-Bliley Financial Services Modernization (GLBA) Act of 1999. It repealed part of the Glass-Steagall Act of 1933 and allowed competition between banks, securities firms and insurance companies by allowing them to combine into single entities.

While it seems that Mr. Wallison backtracks by allowing that FDICIA and GLBA may have been significant, I would contend that the other pieces of legislation also had significant impact on the financial sector in the past 30 years. All of these changed the rules and the structure of that sector in significant ways. And by changing the rules and structure, the incentives were changed. And the new incentives rippled through the financial system, causing changes in behavior - by firms, by consumers, and by government entities.

I welcome your thoughts.

Monday, October 13, 2008

Globalization, Interdpendence and the Financial Crisis

The current situation has managed to focus our attention on domestic economics and financial markets. There have even been occasional references to developments outside the U.S., although many of the people I talk to, including students don't seem to understand the connection between U.S. and financial markets. It's almost as if the idea of interdependence, particularly interdependence in a global economy, was foreign (excuse the pun).

There are a couple of resources that you can use with your students to help them understand the global import as well as the global impact of current events.

The first resource is from last Friday's (10/10/08) edition of The Washington Post. The article is about the impact the U.S. financial crisis is having on some of India's poor. Many American corporations and not-for-profits have been active in India. Grants to organization like Habitat for Humanity have helped provide better homes for many people around the world who previously lived in poor conditions.

The second resource is from today's (10/13/o8) of The Wall Street Journal. This piece is short, but the interactive feature has the most potential. It allows students to roll their cursor over a world map and learn about the impact of the financial crisis on various countries.

If you're trying to integrate economics into geography or geography into economics or to connect current events to either or both of these areas, the articles are worth your time.

Please feel free to share how you're using the information in your class, and how your students react to it.

Tuesday, October 7, 2008

Supply Meets Demand: Market Clears

For those of us still interested in microeconomics, there's an interesting story in today's issue of The Wall Street Journal.

The story is about the challenge facing Home Depot CEO Frank Blake shortly after he took the reins in 2007. While visiting a store in Arizona, he found they had a surplus of lawnmowers. And while visiting another store on the west coast, he noticed they were short on popular power tools. The problem was all stores carried the same inventory, almost regardless of what sold in the specific location.

The solution for Home Depot, as it has been for other large retailers mentioned in the story, has been to localize the selection of merchandise while still taking advantage of the volume-based pricing available to large chains. Essentially, HD used data to determine which items in a large centralized inventory, will do best at each store. Match supply to demand.

With fewer unsold items, overall costs drop and prices can be lowered while still maintaining profitability. It's a good story and a good example.

I look forward to your comments.

Friday, October 3, 2008

A Couple Resources and One Hypothetical

I'll point you to the resources, first. In today's issue of The Wall Street Journal, George Mason University economics professor, Russell Roberts, has an excellent opinion piece on the role of government in providing the foundation for the current situation. If we take as a given that "people respond predictably to incentives", then the rules (institutions) of the market that collapsed were written some time ago by political leaders who were, themselves, responding to incentives - reelection being the most obvious. If you're into economic history with an institutional bent, this is a good piece to use to start a discussion.

Another interesting resource, particularly for those of you teaching American History, is in the forthcoming issue of The Chronicle of Higher Education. Scott Reynolds Nelson, a history professor at the College of William and Mary, writes that a good analogy for current times is not the Great Depression. Rather, he suggests the Panic of 1873. I especially enjoyed all the global parallels he sees.

Finally, here is an unrelated question for you. I've been thinking about the "buy local" movement and trying to imagine a debate between that idea and an old quote about the market. The quote states that through the miracle of the market, "every morning New York gets fed." (I think the original quote is by Frederick Bastiat and refers to Paris – but I may well be wrong on that.)

As I think about New York, I wonder how one could promote "buy local" and still feed the city. One would have to cast a wide net to do so – and by the time the net was cast widely enough – we’re still talking about traditional trade. How would you argue either side or both sides of this discussion with your classes?

I look forward to your comments. Have a good weekend.

Thursday, October 2, 2008

What Is Money?

This blog has been dealing with some weighty issues for the past few weeks, and that's understandable given events. But I was thinking it was time we reverted to some fundamentals and something on the lighter side. And I found it in today's edition of The Wall Street Journal. The front page story deals with Mackerel Economics. It's not about the world-wide mackerel market (although I did find out there is a shortage). Nor is it about the peculiarities of the mackerel industry. It's about mackerel being the currency of choice in the Federal Prison System in the U.S.

Now many of us probably thought "cigarettes" were the medium of exchange, but that was phased out some time ago because of health concerns. Consequently, rather than convert to strict barter, the economic system of the prison needed a substitute currency.

Mackerel actually seems to serve well, given the institutional (pardon the pun) restrictions. It fulfills the three functions of money - medium of exchange, measure of value and store of value fairly well. How it serves as medium of exchange is evident in the article. But, you may ask second and third functions. The measure of value is achieved because the cost is fairly uniform ($1 a package). The third function is met because the fish comes in sealed, foil pouches and few people actually eat the product. Many commodity based money systems have problems on this count because the underlying asset has more than one use. It even holds for gold.

If you want to approach the topic of money using the basic characteristics of money, mackerel seem to have some of the characteristics: durability, uniformity, acceptability. Others such as portability, divisibility, storability, are more limiting: prison authorities can impose limits on "substitute currencies" because of barter restrictions; and the foil pouches are not divisible. Also, since mackerel have more limited use "outside." Prisoners due for release often end up giving it away (bequest?) or “spending" it all before leaving.

Regardless, this is an interesting way to introduce the idea of money to your students and to help them understand that money is defined by function. (Now, I wonder if they have a monetary authority. Maybe the Flounder Reserve?)

I look forward to your comments.