money

In Offense of Ben Bernanke, Part III: Bernanke, Blinder, and Underpants Gnomes

by Alex Schibuola on December 14, 2010

in Economy

Part I: The Fed is Competent?
Part II: The Natural Rate of Unemployment
Part III: Bernanke, Blinder, and Underpants Gnomes

Professor Blinder writes:

Here’s the first Economics 101 question: When central banks seek to stimulate their economies, how do they normally do it? If you answered, ‘by lowering short-term interest rates,’ you get half credit. For full credit, you must explain how: They create new bank reserves to purchase short-term government securities (in the U.S., that’s mostly Treasury bills). Yes, they print money. [Italics added]

But short-term rates are practically zero in the U.S. now, so the Fed wants to push down medium- and long-term interest rates instead. How? You guessed it: by creating new bank reserves to purchase medium- and long-term government securities.

I’m afraid that’s only partial credit, though. What the Federal Reserve has yet to elaborate on is why this “stimulates” the economy. You should know, Professor Blinder, that investment appears to be interest-rate inelastic. You wrote this in your journal article, “Is There a Core of Macroeconomics That We Should All Believe?”

The claim that QE2 is supposed to “stimulate the economy” bothers me. For those of you who watch the TV show, South Park, it reminds me of the underpants gnomes episode. The gnomes collect underpants and give the following explanation for why:

Underpants Gnomes:

Phase 1: Collect underpants.

Phase 2: ???

Phase 3: Profit!

Bernanke and Blinder:

Phase 1: QE2.

Phase 2: ???

Phase 3: Economic recovery!

I still want a better explanation for Phase 2… from the Fed. They say they want to be clear and explain their thinking, but I have yet to hear an explanation other than that.

If you want a more sane explanation for QE2: one could point out that many of the Fed’s current assets are maturing. This means that cash will be flowing back into the Fed and they want it out. Thus, the Fed is trying to keep its balance sheet steady rather than expand it per se.

I surmise that they intend to raise the opportunity cost of holding Treasuries, thus making private sector debt and equities relatively more enticing to hold. Then banks go back to private lending, commercial paper, corporate bonds, etc., and investment expands. So it looks like the people at the Fed have discovered a free lunch. But as ECON101 teaches us, Professor Blinder, There ain’t no such thing as a free lunch!

In Offense of Ben Bernanke, Part II: The Natural Rate of Unemployment

by Alex Schibuola on December 14, 2010 · 2 comments

in Economy

Part I: The Fed is Competent?
Part II: The Natural Rate of Unemployment
Part III: Bernanke, Blinder, and Underpants Gnomes

Professor Blinder writes: “All in all, it looks like the nation and the world need an Economics 101 refresher. So let’s start with the basics.”

All in all, it looks like Professor Blinder needs an Economics 101 refresher too. So let’s start with the basics.

There are three types of unemployment: (1) frictional, (2) structural, and (3) cyclical. I am frictionally unemployed if I leave my current job and take time off before starting my new one. I am structurally unemployed if I lose my job to globalization or minimum wage increases, etc. I am cyclically unemployed if the economy is in recession.

Keynes referred to cyclical unemployment in proposing his solutions. The Fed might be gravely mistaken to assume that today’s high, persistent unemployment rate is purely cyclical. The Fed can only impact cyclical unemployment, not structural or frictional. The sum of frictional and structural unemployment is the natural rate of unemployment. The Fed cannot alter this.

There are many reasons why structural unemployment rather than cyclical unemployment might be at play:

  1. Exchange rates are more volatile: unpredictable monetary policies and debt crises are the cause. If I am in an industry that relies heavily on exports, I am in danger of unemployment.
  2. Health care reform: the costs have yet to be determined and increase employment costs. Needless to say, employers care about the total costs of hiring employees, not just the money wage/salary they pay workers. This uncertainty overwhelms the tiny tax credits offered in the stimulus package.
  3. The housing market is still sick. If people can’t move easily, labor mobility is constrained. It’s more difficult for me to find work if I can’t move.
  4. Higher, extended unemployment benefits reduce the incentive to be employed, at the margin.
  5. The Dodd-Frank Act also imposes numerous uncertainties on the financial sector. This complicates the process of linking savers with investors. Consequently, investment is curtailed and higher unemployment results.
  6. The uncertainty about the capital gains tax rate didn’t help. Increasing taxes on capital decreases capital accumulation (investment). It does not help it. If productivity-increasing equipment costs me $200,000 and I’m willing to pay $250,000 for it, that’s great! If I have to pay a $60,000 tax on it, that’s bad: The equipment now costs me $260,000 and I was only willing to pay $250,000 before. Now I won’t buy it. I am worse off. The equipment supplier is worse off. The employees of the equipment supplier are worse off because they’ll need fewer workers for production.

If 10 percent is the new natural rate of unemployment, then fiscal policy simply crowds out private investment — private sector spending declines 1 for 1 with increases in government spending in that case. Monetary policy is completely impotent.

Fred L. Smith: Is Greed Good?

by Richard Morrison on July 2, 2010

in Video, Zeitgeist

[youtube:http://www.youtube.com/watch?v=rMRwqKYmjs8 285 234]

Money Is Not Wealth

by Ryan Young on August 13, 2009 · 1 comment

in Economy, Odds & Ends

Here’s a letter I sent recently to The New York Times:

To the Editor:

Eric Zencey’s article “G.D.P. R.I.P” (August 10) correctly points out that GDP has limited usefulness in measuring well-being. But his case is muddled by confusing money with wealth. Money is a unit of measure, like a mile or a ton. But it is not itself wealth.

He writes, “If you get into a fender-bender and have your car fixed, G.D.P. goes up.” It actually stays the same. If I don’t get into the accident, I’ll just spend the repair money on something else. While the accident may have no effect on GDP, it does have an effect on wealth; I am inarguably poorer. Instead of a working car plus a new tv, I can enjoy only the car.

Zencey’s confusion is itself an example of why GDP does a poor job of measuring well-being.

RYAN YOUNG
Fellow in Regulatory Studies
Competitive Enterprise Institute
Washington, Aug. 10, 2009

Appetite for Creative Destruction

by Iain Murray on February 2, 2009 · 2 comments

in Culture, Deregulate to Stimulate, Economy, Personal Liberty, Zeitgeist

Duff McKagan of Guns n’ Roses fame is going to be writing on financial matters at Playboy.com. What makes this more interesting than the simple fact it allowed me to type that last sentence is that Duff has outed himself as a free-marketer. He says:

I do find how money works rather fascinating. Adam Smith, the main person looked at to be the founder of capitalism, was a simple but brilliant economist who had particular ideas on how a free market would take care of itself. The theory of every little niche being filled in the marketplace seems too ‘free’ to actually work…but it has for the most part over the last 240 years. This is a statement made free of politics by the way.

Duff gets my vote for Mayor of Paradise City.