Two Items of Interest

First, I'm a bit late with this, but for those of you who haven't sought it out already, PNC Bank has it's CPI (Christmas Price Index) up and running, showing the price changes in the gifts from the carol, The Twelve Days of Christmas.  As always, it's an interesting way to explore how an index works and how the various components fit together to provide a single measure. What's particularly interesting is how many of the components showed no change this year.

Second, today's edition of The Wall Street Journal had a great micro-parody of a macro-event (the recent financial crisis). It's well worth a look and good for a chuckle.

All of my classes are entering their last week of the semester. I suspect the same applies to many of you. So in case I don't get another chance to post before the new year, I wish you happy holidays and more good economic resources.

Dual Mandate

There is a very good short essay by Dan Altman over at Big Think.

It deals with the dual mandate faced by the Federal Reserve. For those of you who are unfamiliar with the term, the Federal Reserve is obliged by law to consider “maximum employment, stable prices, and moderate long-term interest rates.” The kicker is that first part. Many other central banks around the world are focused on stable prices only. This makes sense if you subscribe to the idea that money is neutral and understand the relationship in the equation of exchange M * V = P * Q  (or P * Y as many prefer).

But the author points out that it complicates monetary policy when fiscal policy is ineffective.  I even wonder if fiscal policy-makers are generally unwilling to face hard choices, hoping that monetary policy can solve the problem alone. If true, the tools in the monetary policy toolbox may not offer the solution that is being sought.  This is not the time to use the old adage, “when all you have is hammer, treat everything like a nail.”

I look forward to your comments.

Extreme Hyperinflation

Zimbabwe must hold the record.  See this story in today's edition of The Wall Street Journal.  (And it only has that value as a "collector's item.")

Supply, Demand, Interdependence, Inflation

Last week, we were discussing inflation. Later, outside of class, one of my students brought this article in Slate to my attention. It talks about rising food prices and some underlying factors. It gets into basics of supply and demand and provides opportunities to review whether you shift the curve or move along curve.

It also talks about the impact of government price policies and the interdependence that comes with a global marketplace. I think you’ll find it a useful addition to the discussion with your students on a number of levels. Let me know if you agree.

Inflation

For those of you dealing with inflation and the Consumer Price Index (CPI) in your classes, there are two great interactive graphics (HT to Chartporn) that you can use.

This one is from The Wall Street Journal and lets you compare the price behavior of any of the CPI components to the overall CPI and the core CPI.

Another excellent graphic is this one from The New York Times in 2008. It shows how all of the components are weighted within the various categories.

If for some reason you have trouble getting to either of these, go to the Chartporn post andclick directly on either the second or third chart. (You may have difficulty getting through toChartporn because of the school filters.)

 Let me know what you think.

PNC 12 Days of Christmas Price Index

If you have followed this blog for more than a year, you probably know about the PNC Wealth Management 12 Days of Christmas Price Index.  The index is based on the old Christmas carol wherein a true love showers the target of his or her affections with an assortment of presents – each corresponding to the 12 days of Christmas. I highlight it every year during the holiday season. I think it's a fun and interesting way to introduce economics and economic measurement.

As usual the folks at PNC have done a great job, providing explanations and teacher resources. My only concern this year is that those of you with slower systems or who lack certain computer capabilities in your classroom won't be able to enjoy it.

Nevertheless, I hope you enjoy it as much as I did.  I suspect you will be surprised by many aspects of the index this year. I know I was.

Deflation and Fisher Equation

Many of us use the Fisher Equation: Real interest rate = Nominal interest rate - Inflation rate. Many more of us don't know that Fisher was thinking about a specific market.

This article in the October issue of Monetary Trends by the Federal Reserve Bank of St. Louis provides some historical context. But more importantly, it puts the equation into current context by providing another view of the complex challenge the Fed faces as it deals with a slow economy coupled with the possibility of renewed inflationary pressure. I strongly recommend it for that section on monetary policy in your macro sections.

And share your thoughts. Is this usable with your classes? Or too "high-end"?

Some Fed Articles on Inflation

Here are three interesting and readable short pieces from the Federal Reserve System. They all deal, in one way or another, with inflation, and they all provide good background for teachers and students alike.

The first is from the Federal Reserve Bank of Cleveland's Economic Trends and is by far the timeliest. By that I mean it really is of the moment and probably needs to be used or read in the near term to have the most value.

The remaining two are courtesy of the Federal Reserve Bank of St. Louis. This one is from their Economic Synopses publication and deals with a practical definition of monetizing the debt. You know, it’s the answer you have to give when students ask "why doesn't the government just print more money and pay off the debt?" In this case, the definition depends upon intent. And the article provides some good historical context.

The next article is a brief essay from the recent issue of Monetary Trends. It asks "Why Do People Dislike Inflation?" And it provides a good answer. If your students sometimes speak like inflation might be a good thing (wages rise, debts are easier to pay off, etc.), this could be helpful.

I look forward to your thoughts on these articles.

Median CPI Drawing Board

The Federal Reserve Bank of Cleveland has posted the latest installment of The Drawing Board. This one deals with Median CPI.


(HT to CarpeDiem.)

Some Fed Publications of Interest

I've been waiting to post these and now seems to be as good a time as any. 

The first is a short piece from the Federal Reserve Bank of St. Louis's Economic Synopses. I find it a good, clear explanation of Okun's Law, the relationship between output and employment. This is particularly relevant as the economy begins to work its way out of the recession.

That brings us to the second publication, this time from the Federal Reserve Bank of San Francisco Economic Letter. It focuses on timing the beginning and end of recessions. It points out that the "two-quarter" rule that is commonly used in the media is inadequate, and suggests using indicators developed by the Federal Reserve Banks of Chicago and Philadelphia. While they don't coincide perfectly, both indicate the recession bottomed out in the summer of 2009 (Philadelphia calls June, Chicago calls August). The article may be of some value when discussing business cycles with your classes, especially for those of you involved in monetary policy competitions like The Fed Challenge.

And that provides a transition to the third article, also courtesy of the Federal Reserve Bank of San Francisco's Economic Letter. One thing many of us teach to our students is the Phillips Curve - a relationship between inflation and unemployment. Indeed, one of the items I frequently heard students in the Fed Challenge discuss was the Phillips Curve trade-off. And while many maintain the two are correlated, I still don't think there is evidence of a cause-effect relationship. This article doesn't change my mind, but provides more subtle explanation than many of us give it. Too subtle for our students? Perhaps for some. But not for all.

I welcome your comments on these articles.

Happy Birthday to Dr. Allan Meltzer

Today is the birthday of economist Allan Meltzer. Meltzer is a professor at Carnegie-Mellon University, and is one of the foremost scholars on the Federal Reserve System. His work, The History of the Federal Reserve is a must read for those who would understand the nation's central bank. The second volume is on my carousel at left (haven't read it yet), I am adding the first volume to my carousel. The first volume is one of most heavily bookmarked in my library, and I learned a great deal and understood a great deal more as a result of reading it.  I had a couple opportunities to hear Dr. Meltzer speak when I worked at the Federal Reserve Bank of Chicago. I was impressed not only by his knowledge, but his ability to connect with the audience.

You can learn a little about Dr. Meltzer here, you can read one of his papers on the Great Inflation here, and you can listen to an interview with him about inflation courtesy of EconTalk, here.

I welcome any comments.

Maybe He Missed "That 70s Show"

If you're old enough, you remember the one where a U.S. President imposed price controls to tame inflation and it didn't work. Anyway, Venezuelan President Chavez devalued the currency and then closed a large retailer because prices were raised.

Somebody doesn't understand one of the purposes of the price mechanism is to ration goods. Also doesn't seem to understand that prices send signals to producers and consumers. (HT to Dr. Mark for the lead.)

I see "Kelso" playing the role of the Venezuelan President. I welcome your thoughts.

Films and Prices

An old colleague of mine back in Illinois used to do an activity with his students where they converted movie box office gross to current dollars and then listed the most popular films by adjusted gross.  Needless to say there were some surprises. 

The new issue of The Economist has a chart that does the work for you. Have a pleasant weekend.  Don't forget to check back from time to time over the holiday.  I'll be here.

Some Classroom Resources

First is this item from National Public Radio's Planet Money blog. It's about a teacher in New York who is using Planet Money podcasts in the classroom. It includes some lesson ideas. I found some interesting, some not so. But I got some ideas out of it. You may get some as well.

Second, is an item from the Federal Reserve Bank of St. Louis's Liber8 newsletter. It's a three-page article on how modern macroeconomic schools of thought view the current financial crisis. With all the discussion about why the crisis wasn't foreseen, and what certain schools of thought lack, it is still interesting to look at the underlying assumptions when discussing policy responses. It's in .pdf format, but is full of interesting active links.

Finally, is this video from the Federal Reserve Bank of Cleveland. It is part of the Cleveland Fed's interesting and engaging Drawing Board series looks at how inflation is measured.



While it may spend more time than necessary on one specific (new) way to measure inflation, it does a good job of explaining why accurate measurement is important, as well as how the Consumer Price Index (CPI) is put together, and even a short discussion about "core" inflation. It is a little more than eight minutes long and could be used to set up the discussion about price stability and measurement.

I welcome your thoughts on any of these resources.

Some History of Monetary Policy...When Disco Was Dying

Here's something for those of us who are economic history nerds. (HT to Bill Polley.)

Those of us who were around in the late 1970s can remember a day in October, 1979 when the Fed changed its approach to monetary policy and took a hard stand against inflation. The idea was to focus on monetary aggregates via bank reserves, instead of targeting interest rates. It was, in effect, a return to one of the ideas of Irving Fisher. His equation M*V = P*Q (or P*T), is an important identity linking money growth to prices. (And, obviously, it is the title of this blog.)

There are a couple of Federal Reserve Bank publications that examine that important decision. This first one from the Federal Reserve Bank of San Francisco is, by far, the more concise - amounting to a handful of pages. This second, from the Federal Reserve Bank of St. Louis, is more comprehensive and, at over 80 pages, may be preferred by the wonkiest among us - the same group that has been waiting patiently for the second volume (now scheduled for two separate books) of Allan Meltzer's History of the Federal Reserve.

Fisher's idea is still a handy classroom tool for explaining the connection. The equation state that the money supply (M) multiplied by the velocity (V) or number of times the money supply turns over equals prices or the price level (P) times the level of goods and services transactions (Q or T, depending on your preference). By use of some simple algebra, it becomes (M*V)/Q = P. And we see that money multiplied by its velocity, divided by the output gives us prices. And if we examine the change in MV relative to the change in Q, the result is change in P (inflation). If the change in money is greater than the change in output, there is upward pressure on prices. Change in output greater than the change in money results in downward pressure on prices.

It is the relationship illustrated by Fisher's equation that is causing a lot of concern about the result of current monetary policy, and has many pundits speculating about the Fed's exit strategy from the current accommodative (easy money) stance.

Regardless, if you would like to know more about the mechanics of monetary policy at the time of the last major bout of inflation, these publications may make a good place to start.

I look forward to your comments.

Picking Up the Slack

One characteristic of a slowing economy is the increase in unused resources. From unemployment numbers that tell us of workers not being used, to capacity utilization numbers that speak of idle factories, to excess carrying capacity reflected in idled trucks, trains, and airplanes, there are things sitting idle that could be cranking out "stuff."

Today's issue of The Wall Street Journal has an excellent story (free content at this writing) about slack - the unused resources in the economy - putting it in the context of the Federal Reserve's next move. When will improvements in resource markets start signaling an upturn, and the possibility of renewed inflation? The article does have a link to some minimally interactive graphics. It's an opportunity to discuss productive resources and how they are priced (supply and demand). By focusing on the graphs provided, students can discuss how they reflect larger aggregate demand issues in the economy. They might even want to suggest how the first signs of inflation would manifest themselves in the various industries illustrated.

A Couple of Interesting Resources via Chicago

The first is not actually via Chicago, it's via The Council on Foreign Relations in New York. But the content is strictly from Chicago.

The CFR recently hosted the President of the Federal Reserve Bank of Chicago, Charlie Evans. I know Charlie from my days in Chicago, and I have immense respect for him. Naturally, I was excited to learn that he had given a speech at the CFR. I was more excited to learn that it's available as audio and video and transcript here.

Charlie's talk was titled "The Great Inflation Debate" and he thoroughly discussed the back and forth about the Fed's actions in the recent recession and whether those actions might lead to inflationary pressures. As always, Charlie was very thorough, and very thoughtful. His comments make excellent follow-up to the Krugman article highlighted in previous posts. At the very least, I would use this presentation with any students involved in any kind of policy competition (such as the Fed Challenge) or project. It provides a number of perspectives, and his answers to a wide range of questions provide further insight into current conditions.

The second resource is courtesy of the Center for International Studies at the University of Chicago. This past summer, the Center hosted a teacher institute, "Understanding the Global Economy: Bringing the World Market to Your Classroom." About six weeks ago, they had all the readings and PowerPoint presentations from the institute on their website. (Click on the "Resources" tab on the home page.)

I had a chance to look at most of them, and they were quite good. Mind you, I didn't agree with all of them. But the presentations balanced each other out quite well, in my opinion. (There were one or two that were more normative than positive, but we can leave that.) Since then, CIS has added videos of the presentations and some lesson plans.

The lesson plans are good, although they are old stand-bys that have been updated, for the most part. Nevertheless, they work. It is also important to note that there are lessons for all grade levels, which is not always the case with this topic. The videos are good quality, so they should be of help. I'm not sure I'll have the time to go through them all, but there are two or three that I will make a point to look at, because I've already borrowed from the assigned readings for those sessions.

I know you're all busy, but I hope you get a chance to look at these, and I hope you'll share your thoughts.

Random Thoughts from Reading

One of the things I do when I read is keep a journal of passages that I find interesting. The interest may be the words the author used to describe something; or a particularly vivid (to my mind) description of an event or place; a clear explanation of an idea; or just something that gets me thinking – along old lines or new doesn’t matter.

My objective for the journal has long been to react to each entry. The problem has been opportunity cost. To write reactions has meant not reading. That still hasn't changed but situation has changed over time. Originally the reaction was strictly meant for me. Now I can share these passages, share my thoughts, and solicit yours. Hopefully what started as personal reflection will now lead to discussion.

Given my recent review of Barry Eichengreen's Globalizing Capital, it is fitting to use a passage from another of his books as my first attempt to "share my journal."

“Why were European countries with depreciated currencies so hesitant to expand? To a remarkable extent, their actions were still conditioned by attitudes formed during the last episode when the gold standard had been in abeyance. The early 1920s had been marked by inflation, social turmoil, and political instability. Only when domestic interest groups had agreed to compromise over the distribution of incomes and the burden of taxation and had sealed their compact by reimposing the gold standard had this chaos subsided. Central bankers hesitated to capitalize on the suspension of the gold standard until they were convinced that the same would not happen again."
Barry Eichengreen
GOLDEN FETTERS:
THE GOLD STANDARD AND THE GREAT DEPRESSION, 1919 – 1939”

I found this passage interesting because it explains the lack of response by central banks in the early years of the Great Depression. Central bankers are averse to inflation, as are most bankers in general. Likewise they are concerned about political and social instability. These fears are logical. Inflation, political and social instability represent risk and risk makes long-term planning and growth difficult. But risk also makes long-term lending difficult. It increases the likelihood of default, and devalues the future stream of payments meant to repay the principal and compensate the lender (depositors as well as stockholders) for deferred consumption.

As Eichengreen points out in this book, after World War I the great commercial powers sought to restore economic and financial stability by reattaching their respective currencies to the gold standard. But this proved especially difficult because the powers sought to reattach their currencies to gold at the old values. This ignored the years of expansion in the monetary base that helped finance the war. It also ignored the fundamental change in the social and political structure.
Socially, there had been a major shift. Workers issues had become more important. Unions became a larger factor in economic and political life.

And with the expansion of the franchise, policy moved toward greater support of the working class - a welfare state. This restricted the flexibility in the economy to adjust to downturns by reducing wages and employment levels. This was accompanied by a corresponding lack of willingness by politicians to hold the currency value stable. Consequently a currency pegged to gold was contrary to the new social and political reality. A gold-based currency was fine, as long as it did not interfere with political needs.

When viewed in this light, the gold and currency connection to the economic unrest of the twenties that ultimately contributed to the Great Depression is understandable. There was a fundamental conflict between the central bankers and the policy-makers seeking to meet the desires of their newly important sector of the electorate.

To me, this speaks to one of the trade-offs of a democratic system. While greater opportunity and voice are among the benefits of a society with a wider franchise, it creates new incentives for the participants at all levels. And we know from economics that incentives are a motive to action (decision-making). By making the political system more responsive to the workers, the incentive to those representing the workers changed. And the opportunities for the workers changed as rules changed to accommodate them. These changes, in turn, act to limit the politically acceptable range of choices.

There is much more to Eichengreen's book. And there were more passages that intrigued me. When I'll get to them I don't know. But share your thoughts on the passage, and whether or not this type of entry is interesting and or useful. If it's an exercise in personal interest only, I'll discontinue it.
I look forward to your comments.

Measures and Measurement

In many economics courses, teachers will spend time explaining the various economic statistics that are released regularly. This is good because the information can provide some basic guidance about the past, current or possible future state and can be helpful in making economic decisions. But there is a problem.

One often gets the idea that the data contains more information than it actually does. And almost as often, one may think the data contains less. At which point, many of us and many of our students may wonder "what's the point?"

Ryan Streeter raises the same question in a recent issue of American Interest (hat tip to Arts & Letters Daily). In his article, he notes that the data we collect and depend was inadequate when came to forecasting the current downturn. That's debatable. There were many people who foresaw problems and said so. I suspect many of us actually were unable or unwilling to see what they saw.

Nevertheless, whether the information was or was not there, we are unraveling a financial and economic mess that was many years in the making and may take a while to unravel. In the interim, Streeter points out that politicians call for better regulation to avoid a relapse. But they miss the fact that better regulation presupposes better monitoring, which in my mind presupposes adequate (and improved) measurement. Streeter then discusses four basic economic measures we use to measure our collective health and finds them wanting. It is to this point that this blog is addressed. For while I agree with his call to action, I think that part of the problem is a basic misunderstanding of what the data does and does not say. That is where we need to focus when discussing economic measures with our students. And just for the record, I'm willing to stand corrected on my understanding, as well.

The four measures that are the focus of this piece are Gross Domestic Product (GDP), the Savings Rate, the Consumer Price Index (CPI), and the Poverty Rate. The author then suggests some possible remedies. While they are admirable, they also have the potential for problems.

Gross Domestic Product - Streeter makes an excellent early point. While consumerism is painted as a "bad thing" by most - consumption is the point for economics. By that I mean, and I read him to mean, that it is the satisfying our wants (consuming) that drives economic activity. We teach our students that our wants are unlimited. Indeed, I tell my students that they stop wanting only when they die.

He points out that goods and services are counted as consumption when purchased. He goes on to point out that this true even if "people cannot afford them and probably do not need them." Putting the normative aspects of that statement aside, the problem he cites can be countered by realizing that each individual has different time horizons for need - my mother always kept a well-stocked pantry that contained items she used rarely. But she did intend to use them and purchased them when the price was attractive.

Conversely he talks about goods that are produce but sit unsold - inventories. Granted they are produced with the intention of someone consuming them, but inventories can build. And while technically this falls under the heading of investment (I in the GDP equation), it still is a problem for consumption. The counter argument is that inventory problems are less now than they were because many producers have gone to lean manufacturing processes to reduce the problem. Still it exists and can be brought into classroom discussion.

Streeter then brings up an interesting point - citing Adam Smith he discusses productive and unproductive labor. What many feel are unproductive, others may feel is productive. The value of some of the services cited in the article, like beauty, is in the eye of the beholder. And probably are measured by opportunity cost and personal utility. If having someone do something for me (my taxes, my lawn, my will) frees me to do other things I am better at or enjoy more, I don't think that's "unproductive." And I think a case can be made that it's making me more productive.

Savings Rate - Here Streeter's explanation is likely to surprise many, and rightly so. He points out that much of what most of us consider saving is not counted as such. Money invested in 529s, 401(k) s and Roth IRAs are not counted as savings. This explains the headlines that, until recently, decried our falling (and sometimes negative) savings rate. This happened at the same time that more and more of us owned stocks, bonds, mutual funds and real estate. Conversely, without knowing this, many of us may have wondered why with a now rising savings rate the financial markets aren't doing better.

Consumer Price Index - This issue is batted around regularly. One need only look back a few days on this blog to see a post relating to it. The real issue may not be what consumption is missed by the CPI, but rather why we obsess about the measure. Granted it's easy to understand. But it's also easy to understand the shortcomings. That's why many agencies use other broader measures of inflation and consumption like the Personal Consumption Expenditures (PCE).

Poverty Rate - Streeter discusses many of the shortcomings of this measure, noting it was originally based on subsistence diet - a minimal measure of consumption, if you will. I would add one thing to his discussion, the fact that the measure should consider regional differences. Anyone who has moved around knows that it costs more or less to live in some parts of the country than others. Consequently, a measure of a subsistence diet - or a minimal level of consumption - should account for the differences.

In the end, the author discusses some ways to remedy the flaws of many of our economic measures. I found his call for a way to internalize risk in the measures interesting, but unworkable; if only because the future is unknowable. We can improve ways of measuring the potential for risk, but ultimately we can't eliminate it. There will be "black swans," the unexpected. And it is not illogical to base future expectations on past performance, because that's all we have to go on.

A dynamic economy is by its nature unpredictable. This does not mean Streeter's call for better measures should be ignored. But we go too far if we think improvement will provide us with perfect foresight. One of the things that this financial crisis will do, like all crises before it, is focus our attention on developing new and better understanding of how the economy works and how to measure new things. But I suspect we'll always be a little behind.

I welcome your thoughts.

Inflation & Deflation

Robert Samuelson had an interesting piece in The Washington Post on Sunday.

In it, he discusses price stability, approaching it as a discussion of whether we face a greater threat from inflation (a general rise in prices) or deflation (a general fall in prices). He cites two eminent economists: Alan Meltzer who believes inflation is the greater threat, and Paul Krugman who sees deflation as more likely. If we judge from recent actions of the Federal Reserve, they're lining up with Dr. Krugman. But we'll find out more on June 23 when the Federal Open Market Committee (FOMC) concludes its next meeting. The current Summary of Current Economic Conditions (Beige Book) certainly doesn't seem to presage an inflation problem.

But Samuelson's article has value beyond the discussion. In it, he refers fleetingly to the role of consumer expectations. This idea is important. Essentially, this means that whether the nation experiences inflation or deflation depends partly on what we expect as participants. For these expectations will likely influence our actions. If we expect inflation, we likely will start acting in ways that will help inflation along - spending rather than saving to avoid price increases for example. If we expect deflation, we will like go the other way - holding back on spending out of fear of a slower economy which would only slow things further.

But Samuelson goes on to make a more important point. And that point has to do with the structure of the Fed. Mr. Bernanke's term as Chairman of the Board of Governors ends in January. And Chairman Bernanke is on record that the Fed has pledged to preempt high inflation. That pledge is highly valued because it is based on the credibility of his predecessors, Paul Volcker and Alan Greenspan, as inflation fighters, and stretches back more than 25 years. Samuelson points out that nominating Bernanke for a second term as Chairman could do much to eliminate uncertainty and could offer some sense of commitment to price stability to all participants in the economy.

What are your thoughts? Do you discuss the role of expectations with your students? And do you think the Fed's leadership has any impact on expectations? I know the school year is about over, but hopefully we can continue discussions, and help you get some ideas for next fall. I look forward to your thoughts.

***UPDATE***
One of this blog's regular readers pointed out two additional items for consideration. The first is this opinion piece by Arthur Laffer from today's edition of The Wall Street Journal. Laffer falls squarely in the more inflation camp.

The second is this speech by Jeffrey Lacker, President of the Federal Reserve Bank of Richmond before the North Carolina Senate Appropriations Committee. President Lacker is an inflation hawk, and although that might cause you to place him in the same camp with Laffer and Meltzer, take a look at the final few paragraphs of his speech where he addresses inflation. He evidently doesn't fall into the inflation or deflation camp at the moment, expressing confidence that consumer expectations are firmly anchored at the moment.


This post references the following Keystone Economic Principles:
4. Economic systems influence choices.
5. Incentives produce "predictable" responses.
7. Economic thinking is marginal thinking.
and
9. Prices are determined by the market forces of supply and demand… and are constantly changing.