Inflation vs. Deflation

The new issue of The Economist has an interesting article debating the issue of inflation and deflation. This is relevant to the current economy because one of the possible effects of a prolonged recession is that prices begin falling on a broad scale - deflation. Deflation is a problem in a number of ways. Long-term debts have to be repaid with dollars of increasing value. Falling prices act as an incentive to postpone purchases - furthering the incentive to reduce prices. And wages are prices.

We see the other relevant aspect if we borrow a quote from Milton Friedman, "inflation is always and everywhere a monetary phenomenon." Essentially, large and sustained increases in the money supply are ultimately reflected in higher prices. The actions the Fed has taken to provide stability in the financial sector have had the coincident effect of increasing the money supply. The concern is that once the economy turns around (and some say it may be doing so as we write) and begins to gain speed, the increases will have to be withdrawn.

The article in the economist mentions this video (HT to Greg Mankiw which is a satirical debate on the same question.


The chorus of the song asks whether we will become Zimbabwe - the poster child for hyperinflation (see this photo, HT to Mark Perry) - or Japan - which went through a prolonged recession/depression in the 1990s. It would provide an interesting kick-off to a discussion about current economic policy and the longer term effects.

The author of the piece in The Economist seems to think that inflation is a more manageable and less immediate threat. I'm not sure I agree. What are your thoughts?

This post relates to the following Keystone Economic Principles:
1. We all make choices.
2. There ain’t no such thing as a free lunch.
3. All choices have consequences.
4. Economic systems influence choices.
and
9. Prices are determined by the market forces of supply and demand…and are constantly changing.

Fishing with Fisher

I ran across an interesting item while perusing the comic strips today. And I love it when the comic strips get me thinking economically – even if I’m wrong. (Click on the strip to see the final panel.)



(The image wasn't functioning the last time I checked. Here's a link. - 2/15/10)

My response is, “if one accepts the assumption that clams are money and then applies that assumption to the situation, I'd have to say no inflation in the short run."

Irving Fisher developed the equation M x V = Q x P (money times velocity equals the transactions times the price level). I've always found it helpful when thinking about the economy (see title of this blog).

I think the equation indicates no threat of inflation. If clams are M and worms are Q, there would seem to be no reason for P to change, barring a shock to the worm supply.

Although one could make an argument that new clams from the river constitute an exogenous monetary increase similar to finding a new supply of gold or silver in a specie-backed monetary system. The long-term impact might be inflationary, as long as the clams hold out. But what if "peak-worm" has been already been reached? If that's the case, inflationary pressures could develop sooner.

I welcome your thoughts.

This post relates to the following Keystone Economic Principles:
8. Quantity and quality of available resources impact living standards.
and
9. Prices are determined by the market forces of supply and demand…and are constantly changing.

This Is What I Call Comprehensive

I realize it's getting down to the end of the year for those of you in the classroom. In fact, for those of you teaching AP Econ, the payoff is in less than ten days.

Nevertheless, I want to bring an excellent resource to your attention. (HT to Greg Mankiw.) Those of you who are regular readers of the on-line edition of The New York Times are probably already aware of it, but many of you may not be. Even if you don't use it this year, this will provide some excellent resources for next fall.

The site is a comprehensive overview of the credit crisis. There are links to well-written articles, video clips and a number of multi-media presentations on a variety of related topics. For those of you looking for deep background or even resources for student research projects, there are links to government reports, Federal Reserve publications, and coverage by other publications. This is comprehensive, and The New York Times is to be commended. I strongly recommend you spend some time mining this resource. I intend to.

Please share your thoughts both on the resource and how you might be using it.

This post relates to the following Keystone Economic Principles:
4. Economic systems influence choices.
5. Incentives produce “predictable” responses.
and
8. Quantity and quality of available resources impact living standards.

College Graduates and Their Skill Set

I don't know how many of you are familiar with the video 2 Million Minutes. It compares students from high schools in the U.S., China and India. And while I agree with the fundamental idea - that U.S. students need to be more aware of and better equipped to participate in the global economy - I thought the methodology could have been better.

To the methodology, I found the comparison of a very large U.S. suburban public high school, a middling (by our standards) Chinese high school, and a small private school in India to be unfortunate. I won't go so far as to say it was comparing apples to oranges, but limes, oranges and grapefruit may be appropriate.

The video does point out that, in many technical aspects, students from the Chinese and Indian high schools were more proficient than their U.S. counterparts. And given the frequent reminders of how U.S. students compare to other students in math and science, I will concede the point. My experience, while certainly not damning of the U.S. system in any way, would indicate that we could do better. Regardless, the inference is that the students in China and India are better prepared for college and career than are the U.S. students. I'm not sure that's a fair assumption because much can happen in four or five years of undergraduate education, both good and bad.

Now we can get to the spark for this post. This morning's issue of The Washington Post contained this article.

And while it spoke about university-level graduates, the story was still intriguing. The short version is that, at least in India, some students are graduating from some universities without some fundamental skills. These include basic communicating, problem-solving and, I presume, other "soft skills." It seems "skills" is seen as déclassé.

After finishing the article I was reminded of something a colleague in Chicago once said. He told me that if all that was sought was technical proficiency, there were a multitude of candidates that could be hired out of any major university's graduating class. What was tough was finding one who could write clearly and simply, work well with others on problems, and speak to a wide variety of audiences and still be understood.

I wish there was a comparison to U.S. and Chinese university graduates to draw a proper comparison. And while not totally negating the 2mm video and allowing for differences between high school and college, the Post article implies that "hard skills" are not the total package.

I know this post rambled over a wide area, but what do you think? Are you familiar with the video? What do you think is the "comparative advantage" for U.S. students? How do U.S. students (particularly university students) stack up in the "soft skills" area?

Someone's Missing Something...Maybe It's Me

Today's issue of The Wall Street Journal had an article with this headline, "P&G, Colgate Hit by Consumer Thrift" (content free as of this writing).

The story indicated that two of the big consumer product conglomerates Procter & Gamble and Colgate-Palmolive have moved to raise prices in the face of falling sales to keep quarterly profits from deteriorating. Both companies indicated higher total sales on declining sales volume.

It appears both are depending on the consumer's product loyalty to keep shareholder's happy. (Just to be clear, my mutual funds hold shares of these companies the last time I checked.) Either someone hasn't explained a demand curve and/or the idea of prospering by looking out for the consumer –what some might refer to as the "invisible hand."

It will be interesting to see how the firms prosper as the current cycle unwinds. Your thoughts are welcome.

This post relates to the following Keystone Economic Principles:
1. We all make choices.
3. All choices have consequences.
and
7. Economic thinking is marginal thinking.

Understanding Data

Many news sources are touting the performance of the stock market over the past two months. According to one article (not available in its entirety), the Dow-Jones World Index is up 12%, the best two month performance since its inception back in 1991. Other measures have strong results, as well.

But for many of our students, there's a tendency to assume that a percentage point gained in the recovery will negate a percentage point lost in the recent fall. That's not true. This is an excellent opportunity to review some basic math and statistics with your students.

A one percent fall from a level of 10,000 is 100 points. A one percent gain from a level of 10,000 is also 100 points. Unfortunately, we're not starting the climb at the same level we started the fall.

At its height, the Dow-Jones was above 14,000. At its recent nadir, it was below 7,000. That means a one percent drop was 140 points at the top and a one percent gain at the bottom was less than 70 points.

The market has gained back some lost ground, but we're not out of the woods yet. As always, your comments are welcome.

This post relates to the following Keystone Economic Principles:
7. Economic thinking is marginal thinking.

***UPDATE***
Back on April 21, in a post with a similar theme - understanding data - I posted on President Obama's directive to cut $100 million from the federal budget. Now, I've run across an excellent video that also does a very good job of clarifying the scale of the problem. (HT to Division of Labor.)




I'd say it probably doesn't provide a direct answer to the question asked here, but it's effective.

Uncertainty vs. Risk: How Policies (and Institutions) Affect Choice

Almost a month ago, I ran across this interesting post on the RealClearMarkets blog.

While the post was a plea for policy-makers to quit tinkering and let the market get on with the business of sorting winners and losers and start to repair itself; there was another important takeaway.

The author did a good job explaining the difference between risk and uncertainty, and the role both have in our decision-making psychology. While each of us has varying tolerances for risk - some are comfortable with and will accept more, others prefer relative sure things and will accept less. This manifests itself in many of our choices - whether in our financial life or other aspects of our day-to-day activities.

However, most of us have trouble with uncertainty - not knowing what will happen next. With risk, we can assess probability and decide on a course of action - from a coin flip to a decision to change careers. But uncertainty is akin to putting on a blindfold and earplugs and walking in a random direction. Not too many of us would make that choice.

As I thought more and more about the post, I ran across a couple of other posts that clarified things further - both from the Becker-Posner blog.

Gary Becker's post addressed whether banks that received funds under the Troubled Asset Relief Program (TARP) - or in some cases were forced to take those funds - should be allowed to repay the funds. This repayment would, allegedly, remove them from certain government oversight and presumably reduce the public spotlight that comes with accepting public funds.

In the course of this discussion, the government expressed some reluctance about accepting early repayment. While the reason is similar to those given when funds were first distributed - if some banks return the funds, the weaker ones will be identified - there was a sense that another concern was a concern that the government might lose some leverage. All of this followed close on the heels of a scandal about bonus payments by certain financial firms that had accepted funds. When that happened, policy-makers had responded with threats and rules designed to "encourage" bonus recipients to return their payments.

I read Becker's post to infer that by forcing healthy banks to accept funds, and by refusing to accept repayment from those same banks, one could argue their uncertainty might actually be increased. Like changing tax laws to recover income from a select group of employees, this would change the institutions or rules under which we make choices. If we see rules changed for industries on an ad hoc basis, driven by public opinion or even justifiable outrage, we may fear that the rules that form our decision-making framework are less predictable. That removes risk in our decision-making and replaces it with uncertainty. That can result in a more conservative approach to many economic and financial choices.

Richard Posner's response would seem to reinforce this idea. In his concluding paragraph, he sees numerous benefits to repayment. He points to the desire of financial institutions to remove the spotlight from their operations.

One may easily argue that if policy-makers could manage to stop changing the formal institutional structure of the economy, we might see some benefits from increased borrowing, lending and risk-taking characteristic of a recovering economy.

As always, I look forward to your comments.

This post relates to the following Keystone Economic Principles:
3. All choices have consequences.
and
4. Economic systems influence choices.