April 2011 Archives

Here's the review guide for Macroeconomics and International Economics. We'll take the quiz on that material next Thursday.

Last time it was trade. This time it's money. More specifically, we'll look at international currencies and the role they play in the world's economy. Here are some definitions that you will need to understand:

Exchange Rates: The value of currencies worldwide is provided by exchange rates, which tell you what each currency is worth in relation to other currencies. In simple terms, a currency is worth what people will pay for it. Exchange rates are constantly adjusted to reflect markets.

• Fixed exchange rates: After the 1930s, most countries abandoned the gold standard. Instead, each country's government "fixed" the value of their currency, deciding what it would be worth. (For example, the British decided to exchange their pound into US dollars at a rate of $2.40 per pound.)
  
  
• Floating exchange rates: After 1973, international agreements on fixed rates expired, and currencies began to have their value decided in the market. A currency's value will "float" up or down. (An estimated $3+ trillion dollars in currencies are traded every day in the world's foreign exchange markets.)
  

Purchasing Power refers to what money can actually buy in each country- calculating its purchasing "power". Purchasing Power Parity (PPP) would be when a currency can buy the same basket of whatever in any country.

Playing with "Purchasing Power Parity (PPP): I think you'll like this stuff...

To do the following, you need a copy of "cross currency" rates. You can get one from the Benchmark Currency Rates page at Bloomberg.com. (Yes, that's the same Bloomberg as in the Mayor of New York City.)

Economists refer to purchasing power parity to describe why, over time, the dollar price of a good in one country should equal its dollar price in all other countries. The notion that a particular type of cordless telephone should sell for the same dollar price in the United States as it does in, say, Japan and Great Britain, makes sense if you think about supply and demand in world markets. Suppose that the telephone sells for $29.99 in the United States, 2500 yen in Japan, and 20 pounds in Great Britain.

Let's figure out in which country the dollar price of the cordless phone is lowest?

1. What is the exchange rate between the Japanese yen and the United States dollar?

2. What is the exchange rate between the British pound and the United States dollar?

3. Calculate the dollar price of the cordless phone in Great Britain.

4. Calculate the dollar price of the cordless phone in Japan.

5. In which country is the dollar price of the cordless phone the lowest?

6. In which country is the dollar price of the cordless phone the highest?

So, what does "purchasing power parity" suggest that an entrepreneur could do to earn profits?

Of course, purchasing power parity theory suggests that price adjustment will continue until the dollar price of cordless phones is the same in each country. This price equalization is an example of purchasing power parity. Note that it works best for close substitutes that can be traded among countries over long periods of time.

Foreign Exchange map: This is a service from The Economist. Once you get to the page, you have to "Launch the Map". Give it a minute or so to load itself. After that, follow the directions from the first page. Try several comparisons between countries and over time periods. (Be sure I also show you the Big Mac Index.)

>>>>>>>>>

We'll start our shift to 21st Century topics early next week by looking at poverty and development economics. We'll at least get a start on this material today.

HOMEWORK for next session - Monday, May 2nd

Please have your copy of The World Is Flat ready to go by the end of next week.

Blog Entry #6 (Chapters 10 and 11) was posted and it will be due before class time on Monday.

I'm asking you to have Chapter 13 read for Monday. (I will post the final required blog for Naked Economics, but I'll have you read the Epilogue as well. There will be a bonus blog entry there you can do for extra credit if you want.)

Blog Entries #1 - #5 can still potentially receive full credit if posted before next Wednesday's class time. After that, you will only be able to receive a maximum of 4 out of 5 for any of those.

I'm looking at doing the Macroeconomics/International Economics Exam on Thursday, May 5th. There is a review page posted on the blog that you may find useful. You can again bring in a sheet of notes.

FYI -  NEXT Friday, May 6th (not tomorrow), you'll be able to head to College Counseling after checking in with me to celebrate College Choice Day. They'll have some refreshments and supplies for you to make a pennant with to hang next to your picture. (I'll treat it as sort of a catch-up day and be available to help anyone with that.)

At this time, you are supposed to have read Chapter 10, "The Federal Reserve," and Chapter 11, "International Economics." You should post a response of at least one good paragraph to one or more of these questions by the end of Monday. (You can also react to other posts.)

CHAPTER 10

1. Does the quote from Paul Krugman on page 219 fairly summarize the role of the Federal Reserve Chairman? Why or why not?

2. How did reading this chapter change or reinforce the impressions of monetary policy and/or the Federal Reserve you held after our Federal Reserve simulation?

3. The latter part of the chapter deals with inflation and deflation. Which do you think poses the more realistic threat to the American economy over the next decade? Why?


CHAPTER 11

1. After reading the George Soros story at the beginning of the chapter, do you think the ability to "speculate" in currency markets is a good or bad thing? Explain.

2. On page 251, Wheelan writes, "In general, a weak currency is good for exporters and punishing for importers." Assuming the US government has some influence over the value of its currency, would you advise them to weaken or strengthen it at this time?  Why? 

3.  You read about the decline of Iceland's economy in "three acts." Where do you think blame should be placed for what happened in Iceland?  Why?

4. Does reading more about the relationship between the US and Chinese economies make you more or less confident about our economic future?  Why"

Nice job with the simulation yesterday. Congratulations. You made the same two decisions that the "real" Fed announced. I've got a couple quick things we can look at to contextualize just what happened.

We'll wrap up our whirlwind tour of economics with a quick venture into international economics. Today, we'll look at trade.

An introductory discussion on trade
Very often, discussions of trade center on "winners" and "losers". Let's consider the case of NAFTA, the North American Free Trade Agreement. NAFTA went into effect on January 1, 1994. Its goal was to limit trade barriers among Canada, the United States, and Mexico. (We'll forget about Canada, since we have long had very free trade with them.)

Who do you believe have been/ are/ will be the "winners" and "losers" under NAFTA?

Brainstorm two lists, and have them ready to share. (I'm thinking of "classes" of people here - things like "American unions" or "Mexican entrepreneurs" or "consumers" or things like that...)

Introducing two key concepts in trade
We need to learn a bit of vocabulary that goes along with international trade. There are two fundamental terms that often cause confusion.

• absolute advantage: When two countries can each produce a different good (or service) more efficiently than the other country, each of the countries has an absolute advantage in the good or service they produce more efficiently.
  
  
• comparative advantage: When Country A can produce two different products more efficiently, but has a greater advantage in one product than the other, they have a comparative advantage in the product with the greater relative efficiency. Country B has a comparative advantage in the product in which the disadvantage is less large.

That seems like a mouthful, but let's try to make sense of it. Clearly, it is in both counties' best interest to trade in a situation of absolute advantage. What if we are talking comparative advantage?

Let's work through an example of a simple economy. Download this Comparative Advantage handout, and work through the scenario with a partner. 

Trade explained 

I have a short (2 page) reading that I want us to do. It may be the single most effectively worded defense of trade that I have ever read. Let me hand it out... This is from The Armchair Economist. Let's read it and talk about it.

Limits on trade

Next, let's think about the limits that are put on international trade. These barriers can take a number of forms.

• tariffs - taxes on imports (either for generating revenue or sheltering firms from competition)
• quotas - restrictions on the quantity of a good that may be imported or exported
• non-tariff barriers - regulations on labeling, packaging, and testing; customs restrictions
• embargo - This, of course, is a cutting off of trade with another country.
  

A couple questions to consider:

• What are the arguments in favor of restricting trade?
• What are the arguments against restricting trade?
• In your opinion, when are restrictions on trade justified?

There are a couple more definitions we need to make sense of this information when we look specifically at a particular country, such as the United States.

Balance of trade: Balance of trade data describe the exports of goods and services produced in the U.S. and sold abroad and the imports of goods and services produced abroad and sold to individuals, businesses, and governments in the U.S. To obtain the balance, imports are subtracted from exports and the result is described as a surplus if exports are greater than imports and a deficit if imports are greater than exports.

More commonly, you will hear of the trade deficit. This is exports minus imports.

• bilateral trade negotiations: These are trade negotiations between two countries only
• most-favored-nation clauses: These extend the benefits of lower trade barriers granted to one country to all nations what have most-favored-nation status. This term has been phased out in favor of the terms normal trade relations or permanent normal trade relations.

The Status of US Trade: Charts and graphs...

Here's current information from the US Government on our trade balance and situation. Here's more specific information on our trading partners.

World Trade Organization:

This is the largest international organization focused on issues of trade. Here are a couple resources for you to check out from their website.

• Understanding the WTO
• 10 Benefits of the WTO Trading System
• 10 Misunderstandings about the WTO

HOMEWORK for next session - Friday, April 29th

Blog Entry #6 (Chapters 10 and 11) was posted and it will be due before class time on Monday.

Try and get through Chapter 12 before class tomorrow, and we'll ask you to have Chapter 13 read for Monday. (That will be the final required blog for Naked Economics, but I'll have you read the Epilogue and there's a bonus blog entry there you can do for extra credit if you want.)

Blog Entries #1 - #5 can still potentially receive full credit if posted before next Wednesday's class time. After that, you will only be able to receive a maximum of 4 out of 5 for any of those.

I'm looking at doing the Macroeconomics/International Economics Exam on Thursday, May 5th. There will be a review list available on the blog by tomorrow.

FYI -  NEXT Friday, May 6th (not tomorrow), you'll be able to head to College Counseling after checking in with me to celebrate College Choice Day. They'll have some refreshments and supplies for you to make a pennant with to hang next to your picture. (I'll treat it as sort of a catch-up day and be available to help anyone with that.)

We'll get right to our simulation today...

Federal Reserve Board simulation: Even though the "real" one is taking place as we speak, we'll do our simulation of a Federal Reserve Board Federal Open Market Committee (FOMC) meeting. You'll each play a role as either a representative of one of the Federal Reserve districts, a member of the Board of Governors or as an economist.

This group normally meets eight times a year. The FOMC discusses current and near-term economic and financial conditions, prior to making a decision to raise, lower or keep short-term interest rates the same. We'll "deliberate" after hearing the statements from the member banks.

The federal funds rate (the one you will consider changing) is currently targeted at 0.25%. (Two years ago, it was at 1.00%. When I did this four years ago, it was at 5.25%.) Those of you wanting more historical data should look at changes in the federal funds rate over time.

Here's that article from Monday's Los Angeles Times that sets the stage for our simulation:  Fed Chief Ben Bernanke Faces Decision on Inflation.

Remember, in addition to "normal" open market operations, the Fed is also purchasing as much as $600 billion in Treasury securities between now and June as part of "QE2," its expansionary monetary policy of quantitative easing. While that wouldn't always be an "action item" at an FOMC meeting, we'll let you talk about it as well.

Here is the text of the press release issued on March 15th, at the end of the last FOMC meeting.

Release Date: March 15, 2011

For immediate release

Information received since the Federal Open Market Committee met in January suggests that the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually. Household spending and business investment in equipment and software continue to expand. However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Commodity prices have risen significantly since the summer, and concerns about global supplies of crude oil have contributed to a sharp run-up in oil prices in recent weeks. Nonetheless, longer-term inflation expectations have remained stable, and measures of underlying inflation have been subdued.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.

HERE ARE SOME RESOURCES TO HELP IN YOUR PREPARATION...

Preparing for the simulation: Many of you will represent one of the districts. Figure out who you "are" by consulting "your" district's home page. Browse around there for a while. In addition, go to the "Beige Book" below, and be sure to read both the overall summary and the page for "your" district.

Several of you will represent the Federal Reserve Board of Governors itself, and another of you will be Ben Bernanke. You might brief yourselves on the summary information, and you might browse the homepage of the Board of Governors of the Federal Reserve. By the way, only four Reserve Bank Presidents (plus the NY Fed President) at a time actually serve on the FOMC, but we'll let you all come to the meeting...

The Federal Reserve Districts and Banks - Clicking on the area of the map you represent will take you to that district's home page. There you can find information relating to your region.

The FRB "Beige Book" - This collection of information is compiled 8 times a year for use at the FOMC meetings. We'll use the April 13th data. This link will take you to the overall summary. In addition, the links on the left will take you to "your" district. There, you can find a one "page" overview of recent developments in your district.

Agenda for the Simulation:

• Chairman Bernanke calls the meeting to order. We can pretend that this is the April meting of the FOMC which is taking place concurrently in Washington DC.
  
  
• Federal Reserve District President presentations: (We'll go through the districts in "numerical" order. In your two minutes of fame, try to cover these...)
  
  
• provide an overview of current economic conditions in your district
  
• discuss the prospects for economic conditions for the near future
  
• identify any economic issues of special concern at the present time
  
• recommend whether short-term interest rates should be raised, lowered or kept the same.
  
  1st District - Based in Boston
  2nd District - Based in New York
  3rd District - Based in Philadelphia
  4th District - Based in Cleveland
  5th District - Based in Richmond
  6th District - Based in Atlanta
  7th District - Based in Chicago
  8th District - Based in St. Louis
  9th District - Based in Minneapolis
  10th District - Based in Kansas City
  11th District - Based in Dallas
  12th District - Based in San Francisco
  
• Chairman and Board of Governors offer their reports and/or recommendations regarding the direction for short-term interest rates (We'll let special guest US Treasury Secretary Timothy Geithner speak here as well.)
  
  
• Discussion of issues of controversy
  
  
• Each member of the Board of Governors and the Bank presidents cast a vote regarding the direction for interest rates, with the decision going to the majority.

HOMEWORK for tomorrow - Thursday, April 28th

Naked Economics Blog Entry #5 is due.

Getting Chapter #11 read for Thursday would be great. I'll post Blog Entry #6, and we'll shoot for having that done by Monday.

We'll be using The World Is Flat by the end of next week...

We'll start out today with any comments you wanted to make about the handout, "How Statistics Lie," that I gave you the other day. After that, let's see what you're interested in with the Naked Economics information on Chapters 8 -9.


Our new Economics material for today will center around organizing a preparing for a simulation of a Federal Reserve Board's Federal Open Market Committee meeting that will be held tomorrow.

Here's a reminder of key information from yesterday.

Open market operations: This is when the Fed buys or sells previously issued government (Treasury) securities.

• If the Fed wants to expand the money supply (boost the economy), they buy Treasury securities. That puts additional money into the banking system, and that should influence interest rates downward.
• If the Fed wants to tighten the money supply (slow the economy), they sell Treasury securities. That removes money from the system, and that should influence interest rates upward.
  

As of today, the discount rate is at 0.75% (down from 6.25% when I taught Econ in Spring 2007), and the prime rate is now at 3.25%. (It was 8.5% in 2007.) These drive a wide variety of interest rates for different types and durations of borrowing.

Here's Bankrate.com's tracking of a wide variety of interest rates.

Federal Reserve Board simulation: Tomorrow, we'll do a simulation of the Federal Reserve Board and a Federal Open Market Committee (FOMC) meeting. You'll each play a role as either a representative of one of the Federal Reserve districts or a member of the Board of Governors.

This group normally meets eight times a year. The FOMC discusses current and near-term economic and financial conditions, prior to making a decision to raise, lower or keep short-term interest rates the same. We'll "deliberate" after hearing the statements from the member banks.

The federal funds rate (the one you will consider changing) is currently targeted at 0.25%. (Two years ago, it was at 1.00%. When I did this four years ago, it was at 5.25%.) Those of you wanting more historical data should look at changes in the federal funds rate over time.

READ THIS: Here's an article from yesterday's Los Angeles Times that sets the stage for our simulation:  Fed Chief Ben Bernanke Faces Decision on Inflation.

Remember, in addition to "normal" open market operations, the Fed is also purchasing as much as $600 billion in Treasury securities between now and June as part of "QE2," its expansionary monetary policy of quantitative easing. While that wouldn't always be an "action item" at an FOMC meeting, we'll let you talk about it as well.

Here is the text of the press release issued on March 15th, at the end of the last FOMC meeting.

Release Date: March 15, 2011

For immediate release

Information received since the Federal Open Market Committee met in January suggests that the economic recovery is on a firmer footing, and overall conditions in the labor market appear to be improving gradually. Household spending and business investment in equipment and software continue to expand. However, investment in nonresidential structures is still weak, and the housing sector continues to be depressed. Commodity prices have risen significantly since the summer, and concerns about global supplies of crude oil have contributed to a sharp run-up in oil prices in recent weeks. Nonetheless, longer-term inflation expectations have remained stable, and measures of underlying inflation have been subdued.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. Currently, the unemployment rate remains elevated, and measures of underlying inflation continue to be somewhat low, relative to levels that the Committee judges to be consistent, over the longer run, with its dual mandate. The recent increases in the prices of energy and other commodities are currently putting upward pressure on inflation. The Committee expects these effects to be transitory, but it will pay close attention to the evolution of inflation and inflation expectations. The Committee continues to anticipate a gradual return to higher levels of resource utilization in a context of price stability.

To promote a stronger pace of economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate, the Committee decided today to continue expanding its holdings of securities as announced in November. In particular, the Committee is maintaining its existing policy of reinvesting principal payments from its securities holdings and intends to purchase $600 billion of longer-term Treasury securities by the end of the second quarter of 2011. The Committee will regularly review the pace of its securities purchases and the overall size of the asset-purchase program in light of incoming information and will adjust the program as needed to best foster maximum employment and price stability.

The Committee will maintain the target range for the federal funds rate at 0 to 1/4 percent and continues to anticipate that economic conditions, including low rates of resource utilization, subdued inflation trends, and stable inflation expectations, are likely to warrant exceptionally low levels for the federal funds rate for an extended period.

The Committee will continue to monitor the economic outlook and financial developments and will employ its policy tools as necessary to support the economic recovery and to help ensure that inflation, over time, is at levels consistent with its mandate.

Voting for the FOMC monetary policy action were: Ben S. Bernanke, Chairman; William C. Dudley, Vice Chairman; Elizabeth A. Duke; Charles L. Evans; Richard W. Fisher; Narayana Kocherlakota; Charles I. Plosser; Sarah Bloom Raskin; Daniel K. Tarullo; and Janet L. Yellen.

Agenda for the Simulation:

• Chairman Bernanke calls the meeting to order. We can pretend that it is the next scheduled meeting of the FOMC, which is a two-day meeting that begins TODAY in Washington DC.
  
  
• Federal Reserve District President presentations: (We'll go through the districts in "numerical" order. In your two minutes of fame, try to cover these...)
  
  
• provide an overview of current economic conditions in your district
  
• discuss the prospects for economic conditions for the near future
  
• identify any economic issues of special concern at the present time
  
• recommend whether short-term interest rates should be raised, lowered or kept the same.
• Chairman and Board of Governors offer recommendations regarding the direction for short-term interest rates
  
  
• Discussion of issues of controversy
  
  
• Each member of the Board of Governors and the Bank presidents cast a vote regarding the direction for interest rates, with the decision going to the majority.

HERE ARE SOME RESOURCES TO HELP IN YOUR PREPARATION...

Preparing for the simulation: Many of you will represent one of the districts. Figure out who you "are" by consulting "your" district's home page. Browse around there for a while. In addition, go to the "Beige Book" below, and be sure to read both the overall summary and the page for "your" district.

Several of you will represent the Federal Reserve Board of Governors itself, and another of you will be Ben Bernanke. You might brief yourselves on the summary information, and you might browse the homepage of the Board of Governors of the Federal Reserve. By the way, only four Reserve Bank Presidents (plus the NY Fed President) at a time actually serve on the FOMC, but we'll let you all come to the meeting...

The Federal Reserve Districts and Banks - Clicking on the area of the map you represent will take you to that district's home page. There you can find information relating to your region.

The FRB "Beige Book" - This collection of information is compiled 8 times a year for use at the FOMC meetings. We'll use the April 13th data. This link will take you to the overall summary. In addition, the links on the left will take you to "your" district. There, you can find a one "page" overview of recent developments in your district.

SITE OF THE DAY: FederalReserveEducation.org is great. Check it out. We'll take a closer look at their "The Economy - Crisis & Response" feature yet this week.

HOMEWORK for tomorrow - Wednesday, April 27th

Naked Economics Blog Entry #5 is due today.

You were asked to be through Chapter 10 in Naked Economics by today's class time. Getting Chapter #11 read for Thursday would be great.

We'll be using The World Is Flat by the end of next week...

At this time, you are supposed to have read Chapter 8, "The Power of Organized Interests," and Chapter 9, "Keeping Score." You should post a response of at least one good paragraph to one or more of these questions by the end of Tuesday. (You can also react to other posts.)

CHAPTER 8

1. "When it comes to interest group politics, it pays to be small." (page 179) Imagine that your world is limited to the MPA community. Give an example that you think supports this claim made by Wheelan. (You should avoid mentioning names if it might be controversial or hurtful in any way.)

2. What SHOULD we do when it comes to ethanol?

3. How do we keep interest groups from using/abusing the political process to "generate regulation that either helps them or hobbles their competition?" (page 181) Should we even try to control this? Why or why not?

4. Is giving a president "fast-track authority" desirable? (page 186) Why or why not?

5. "Creative destruction" is a term coined by Joseph Schumpeter. (page 183) Using examples from today's world, comment on the desirability and/or drawbacks of such a process from your perspective.

CHAPTER 9

1. After you finishing reading the joke on pages 191-192 you tell yourself, "I can be funnier than that." Here's your chance. Write an anecdote, story, joke that makes a commentary about our current economy. Keep it clean, and no stealing someone else's material.

2. After reading about the Gross Domestic Product, assess its usefulness as a measure of economic progress. Is there another measure you think we should use?

3. During the Great Depression, FDR once said that we have "nothing to fear but fear itself." (page 202) Is that good economic advice for today? Explain why or why not using a specific example or examples.

4. We've spent time talking about both monetary and fiscal policy. (pp. 206-209) Assume that an economic recession is on the horizon. (OK, this year you can assume it is already here...) Which of these tools, or what combination, would you want government to use?

Just a reminder that you were asked to read Chapter 9 in Naked Economics over the weekend. Please read Chapter 10 tonight.

We'll start the week out with a good video clip. Here's another, earlier, Hans Rosling clip that I think you'll like from those TED conferences - "Hans Rosling shows the best stats you've ever seen." It's a good segue into the types of international issues we will soon be considering. (As a reminder, here's the Gapminder webpage.) I promise you that you'll also see the first 95% of that sword-swallowing clip when we get closer to development economics.


What is money? I know, dumb question. However, the reality is a bit more complicated.

Money is something that we can use to make purchases with. Generally speaking, there is a continuum of ways to make purchases, but some are clearly easier than others. Liquidity refers to the ease with which an instrument can be used to buy things.

What is considered "money"? Certainly, the currency and coins in your pocket are money. What about checks? Credit cards? Savings accounts? Bonds? Well, the answer depends on just who you are asking.

The Federal Reserve holds that money has three functions:

• serves as a medium of exchange - People will accept money in exchange for goods and services.
• serves as a standard of value - Money is a unit of measurement that can be used to specify the value of other things.
• serves as a means of saving or storing purchasing power - Money is a form in which wealth can be held.
  

Various definitions of "Money Supply": These are the most common classifications. They get "bigger" as you go down the list.

• M1: currency (in circulation), demand and checkable deposits (banks and thrifts)
• M2: M1 and savings accounts, additional (small time) deposits, and retail money-market funds
• M3: M2 and additional (longer time) deposits, and eurodollars, and institutional money-market funds

"Money Supply for Dummies" - If you can get past the demeaning title, this is a really informative article.

If you want to look at changes in the money supply (M1) over recent years, you can manipulate this data from "Economagic" to produce graphs.

Banking and the Federal Reserve System: To fully understand banking, you need to get beyond seeing banks as simply places where people keep money. Only a small percentage of deposits are actually on hand at a bank at any given time. Instead, we operate on the fractional reserve system. Banks keep a percentage of deposits on hand, but they are able to loan out the remaining funds in order to generate profits. Think about how that fits into our macroeconomic model of the economy.

The Federal Reserve System was created in 1913 to strengthen the nation's banking systems. You can learn more about how it works by consulting "The Federal Reserve System."

The nation is divided into twelve districts, and most banks within each district are members of the system. Each district has a Federal Reserve Bank. These twelve banks are governed by the seven members of the Federal Reserve Board in Washington DC. These members are appointed by the President to serve fourteen year terms, so they are designed to be the "independent" authority for monetary policy. The Chairman of the Federal Reserve system is also a Presidential appointment, and that is currently Ben Bernanke. (Alan Greenspan finished finished his fifth 4-year term as Chairman several years back. Reagan, Bush, Clinton and Bush all named him to that post.)

The "Tools of Monetary Policy" - The Fed has three main tools at their disposal.

Reserve requirements: These are the percentages of deposits that banks need to keep on hand in their vaults or on deposit at a Fed bank. (The Fed last changed this rate in April of 1992, and it is a rarely used tool of monetary policy.)

• If the reserve requirement were raised, banks would have less money available to lend.
• If the reserve requirement was lowered, banks would be able to increase lending.

Discount rate: This is the interest rate that the Fed charges banks for loans. Member banks can borrow from the "discount window" at this lower rate. This is now rather symbolic, as the Fed considers itself to be the "lender of last resort." Banks are encouraged to borrow from other banks.

• When the discount rate rises, it would typically slow economic activity.
• When the discount rate is lowered, it would typically stimulate economic activity.

Open market operations: This is when the Fed buys or sells previously issued government (Treasury) securities.

• If the Fed wants to expand the money supply (boost the economy), they buy Treasury securities. That puts additional money into the banking system, and that should influence interest rates downward.
• If the Fed wants to tighten the money supply (slow the economy), they sell Treasury securities. That removes money from the system, and that should influence interest rates upward.
  

As of today, the discount rate is at 0.75% (down from 6.25% when I taught Econ in Spring 2007), and the prime rate is now at 3.25%. (It was 8.5% in 2007.) Both of those rates are unchanged from last year. These drive a wide variety of interest rates for different types and durations of borrowing.

SITE OF THE DAY: The FED's own education site is pretty good. Check it out. We'll be setting up a simulation of a FED meeting tomorrow.

Assuming we have time, I was planning to close with another video clip. (We'll do it another day if need be.) Maybe some of you have heard of Khan Academy. (It'll come up in a couple weeks when we talk 21st century education.) Here's a clip of Sal Khan's talk at TED 2011 when he explains what he has set out to do. (I was originally planning to show a clip with him talking about the economic crisis in CNN a while back, but I thought this might help lay the groundwork for both our upcoming look at education and his own program.)

HOMEWORK for tomorrow - Tuesday, April 26th

Naked Economics Blog Entry #5 is posted, and it will be due on Tuesday.

I'll ask you to be through chapter 10 by Tuesday's class time.

Initially, we'll look at taxes today, and then we'll take two cracks at figuring out the "big picture" of the economy.

From yesterday - The topic of the "debt ceiling" was raised. Here's an article from earlier this week that gives you the scoop on that... Debt Ceiling FAQs:  What You Need to Know. "Raising the Ceiling" is an interesting Washington Post graphic on this as well. Here's a much more extensive set of debt (and other) clocks than the one I showed you yesterday.

Taxes: There's an old saying that, "there's nothing certain but death and taxes." Today, we'll spend some time looking at the less depressing half of that adage... Hopefully, you've been convinced by now of the economic necessity of some form of taxation. (If not, contemplate life without roads, schools, police, and national defense for a while...)

So, if we work from the common assumption that taxes are a necessity, there remain several questions:

• Who should be taxed?
• What should be taxed?
• How (at what rate) should the tax be levied?
• What should happen to the money collected from the tax?

Let's start our look at some internet resources with this... Taxpolicy.com invites you to "Build Your Own Tax Policy." It asks you a series of questions and then sketches out your broad views on taxes as derived from those answers.

The history of taxation: Of course, the history of taxation is long. If you want more information than you can ever use, consult "The History of Taxation" at the "Taxworld" website.

Types of taxes: There are several broad categories of taxes. Economists generally classify taxes as progressive, regressive, or proportional. (Another type of tax is called a "head" tax. Everyone pays the same amount.) Let's make sure we understand the differences.

Discuss: Which type of tax do you think is most fair? Are there any that you strongly oppose? Is the sales tax regressive?

The Federal Income Tax: This, of course, is the "big one". It has been in place since 1913, and it is the single largest source of governmental revenue.

One of the legacies of the Reagan years was a period of tax reform. Now, there are six federal income tax rates: 10 percent, 15 percent, 25 percent, 28 percent, 33 percent, and 35 percent.

For married couples, the 15 percent rate currently applies to taxable income up to $69,000, whereas the 25 percent rate applies to taxable income between $69,000 and $139,500. Here is the Internal Revenue Service website. 

Discuss: Do you think it is fair to tax higher levels of income at a higher rate? Would you like to see a more or less progressive income tax?

Of course, Minnesota gets its share of income as well. You can learn more about that at the "Minnesota Department of Revenue Home Page." You can also browse around here to find a copy of the tax forms you would need to file as well.

For comparisons, here's some data on State Income Taxes for the rest of the nation.

Looks like we missed it. For the purposes of federal income taxes, "Tax Freedom Day" came on April 12th. However, if you were living in Great Britain, it would be May 29th.

>>>>>>>>>>>>>>>>>>>>>

Next, it's time to see how this all fits together. We'll look at two versions of "how the economy works." For us, it is convenient that one focuses on "demand," while the other focuses on supply.

Demand, demand, demand: Let's look at flows in the economy, particularly as they originate on the demand side. We'll largely be looking at work pioneered by John Maynard Keynes. (I think this material is as potentially confusing as any that we will use this quarter.) We'll look at a visual representation of this.  I have a handout for you.

Supply, supply, supply: We'll look at the competing theory to the previous "grand explanation" of the economy.

By the early 1970s, serious questions emerged about relying solely on Keynes' explanation:

• Supply "shocks", such as the OPEC oil embargo of 1973, hit the economy, but the Keynsian model alone could not offer advice for dealing with these crises.
• For the first time, America was facing rising unemployment and rising inflation. The Keynsian approach alone couldn't explain these type of departures from the "business cycle" model.
• This approach tended to be short-term in its focus, and that diverted attention from longer term issues like economic growth and standard of living.

It was out of these concerns that a new approach, supply-side economics, emerged. It had its strongest impact during the Reagan years. (Many called it "Reaganomics".) Although the overall approach doesn't find as many supporters among economists today, looking at its approach still helps fully understand macroeconomic theory.

Here it is; a brief tour of the "supply side"...

The first key idea was found in the early 1800s when a French economist named J.B. Say got a law named after him... Say's Law: "Supply creates its own demand..." This idea held that overproduction and underproduction would never be problems since production itself generated enough income to purchase what is produced. "Gluts" or shortages would lead to price adjustments until the glut or shortage disappeared.

The experience of the Great Depression, and its sustained, high unemployment, led to an acceptance of the ideas of Keynes and discredited "Say's Law".

Modern "supply-siders":

The key to understanding this approach is the idea of incentives. Keynes assumed that an increase in demand automatically meant an increase in supply unless the economy was at "full capacity". Supply-siders disagree, saying that the production won't happen if the costs are too high.

What could make the costs too high? Things like taxes and interest rates.

The "solution"? Incentives- particularly in the form of lower taxes.

• They argued that reducing costs will lead to more production by business.
• Also, lower taxes would encourage household savings, creating more funds for investment.
• Further, some claimed that decreasing tax rates would lead laborers to work more, furthering the cycle.

The second key difference is the effect of government deficits, or the theory of crowding-out.

Here's the argument: When spending exceeds taxes, the government borrows money in financial markets. (States and locals also sell revenue bonds to finance projects.) The federal government also sells treasury bonds.

Supply-siders say these actions pull money (capital) out of the private markets and raise interest rates. These actions "crowd out" private investment, lowering output and employment.

You may have noted a potential contradiction here. How can you hope to both cut taxes to stimulate the economy and avoid budget deficits that might crowd out investment? What do you think?

Remember, although relatively few economists still hold these ideas, the concepts of "supply-side" economics still influence public policy decisions today.

HOMEWORK for next session - Monday, April 26th

Naked Economics Blog Entry #4 is posted (Chapters 6 and 7). You should be caught up through the four of those ASAP.

You were asked to read Chapter 9 in Naked Economics over the weekend. (Blog #5 will be on chapters 8 and 9, and I'll post it this weekend.) I'll ask you to be through chapter 10 by Tuesday's class time.

At this time, you are supposed to have read Chapter 6, "Productivity and Human Capital," and Chapter 7, "Financial Markets." You should post a response of at least one good paragraph to one or more of these questions by class time on Friday. (You can also react to other posts.)

CHAPTER 6

1. (pp. 126-127) "Meanwhile, one in five American children - and a staggering 40 percent of black children - live in poverty." Should our federal government be doing more to change these numbers? If so, what? If not, why not?

2. "Human capital is an economic passport." (p. 128) Provide an additional example/examples of where this is/has been the case. It can be someone specific or a more general case that illustrates what you believe Wheelan means by this.

3. Given the recent controversy over outsourcing and the on-going process of globalization, what do you make of the "lump of labor fallacy" that Wheelan introduces? (p. 132) Do we need to rethink this? Why or why not?

4."There is a striking correlation between a country's level of human capital and its economic well-being." (p. 135) Assuming this is true, give at least three specific nations around the world where you think this will prove very positive or very harmful in the near future. Give a reason why for each nation.

5. Is rising inequality a price worth paying if it is accompanied by rising productivity? You can answer as an economist, a moralist, a patriot, or whatever... (This is most directly addressed beginning on page 141.)

6. "Take" Cornell economist Robert Frank's survey on page 144. What would you select? What do you think that says about you? Ask three people not in the class and report on which they picked.

CHAPTER 7

1. Wheelan explains that there are four functions for all "financial instruments": raising capital; storing, protecting, and making profitable use of excess capital; insuring against risk, and speculation. Project yourself two decades into the future, and assume that you are in a good, but not great, financial situation, maybe with a family. Prioritize these functions in terms of how you would anticipate using "financial instruments" at that point in your life. Explain why you ordered them that way.

2. Are you more "risk adverse" or "risk tolerant" when it comes to financial issues? React to one or more of the insurance anecdotes (or another with which you are familiar) in this chapter.

3. Later in the chapter, Wheelan shares some "lessons" about the markets. Comment on anything you "learned" in the anecdote about the "brownstone" or anything else.

4. On pages 164 and 165, Wheelan talks of a monkey picking stocks. (OK, a fictional monkey, maybe Curious George?) What do you make of this story? Does it change your level of "confidence" in financial markets?

5. In the section entitled "Diversify" (page 171), Wheelan urges his students to flip coins. Do you think this is a valuable activity here? Can you think of another that you would recommend for students learning about financial markets?

Today, we'll take a look at how the government gets its money and how it spends it. The budget, the budget deficit and the national debt will be the big topics for the day.

To set the mood, here's an interesting visual. What does one TRILLION dollars look like?

The Government and Its Role: Today, we'll focus on the numbers. These numbers, of course, will vary from year to year...

Where does the federal government get its revenue from?

44% from individual income taxes
36% from Social Security payroll taxes
11% from corporate income taxes
4% from excise taxes
2% from customs duties

The Budget and the Budget Deficit -

Here's the history of the US budget deficits and surpluses since 1940.

Here's a look at the CBO budget deficit projections for the near future.
Here's what the future looks like for Medicare and Social Security.

Let's check out Budget Explorer: The Complete U.S. Federal Budget. You'll get your chance to balance this whole thing...

2011 Federal Budget Explained in Plain English - Here's a description of the FY 2011 budget proposal. DO THIS: Browse through this write-up looking for two decisions that you like and two decisions that you question. We'll talk about what you find.

Obama's 2012 Budget Proposal: How It's Spent - Here's an interesting graphical look at the budget proposal for FY 2012 done by The New York Times.

Where does the federal government spend its money?

22% is spent on Social Security
20% is spent on defense
9% is for other "direct" spending
10% on Medicare
6% on Medicaid
15% on interest on the national debt
other areas are smaller
about 2% is spent on welfare
less than 1% is spent on foreign aid

The largest single source of revenue for state governments is the sales tax. Local governments depend most heavily upon property taxes.

What are the risks associated with budget deficits? (Be sure you understand the theory of "crowd out" by the time we're done.)

We'll give you a few minutes to read "The Mythology of Deficits" and see what you think about that.

The National Debt: This is simply the sum of all outstanding government deficits.

Here's an example of a Debt Clock that we mentioned earlier. See what your share is today... I also have a series of charts from the report cited below to show you.

Grandfather Economic Report: Michael Hodges had put together this large site concerned with presenting information on the national debt. (To make it clear, I'm NOT agreeing with all of this guys recommendations or conclusions. I just think it is interesting what an "average" citizen is doing here.)

DO THIS: Browse through this report. The pictures and graphs are very user-friendly. Find five things (statistics, graphs, comparisons) that are of interest to you, and make note of them to share in class. Then, make at least two "policy recommendations" for the US government based on what you have learned. We'll share those in a while.

HOMEWORK for next session - Friday, April 22nd

The Naked Economics Blog Entry #4 is posted (Chapters 6 and 7). I'm asking you to have that posted before tomorrow's class if possible, but please make sure it is taken care of that no later than this weekend.

Please try to read Chapter 8 in Naked Economics tonight and get through Chapter 9 over the weekend.

Checking in with Naked Economics: Even if you are behind in the reading, you can contribute to these conversations. I'll ask you to form groups of four and consider these questions for about ten minutes:

• Taxes were due Monday. (The 15th was a holiday in DC.) What does your group see as the two biggest benefits of a system of taxation like that of the United States? What are the two biggest drawbacks?
  
  
• When it comes to the economy, does our government try to do too much or too little?
  
  
• Should government due more to redistribute income?  Why or why not?
  
  
• What experiences have you had with the type of issues raised in "Economics of Information?" (Some of the issues included adverse selection, racial profiling, incomplete information, asymmetry of information, and branding/signaling.)

Let's finish up the GDP information from yesterday that we didn't really get to in class. (Go back to yesterday's blog entry.)

Fiscal v. Monetary Policy - Let's make sure you understand the basics of these two concepts, since we'll come back to them again and again.

Today we have two more big "economic indicators to consider: Inflation and Unemployment

Inflation: We'll be looking at inflation today, since it might be the economic issue of most concern to policymakers and consumers. (I suppose that would be more true when the economy isn't emerging from its most serious challenges since the Great Depression...) This topic will come up several times, but we'll get some of the basics out of the way.

Defining "inflation": Inflation is a sustained increase in the overall level of prices. The most widely reported measurement of inflation is the consumer price index (CPI).

The Consumer Price Index measures prices of goods and services in a market basket of goods and services that is intended to be representative of a typical consumer's purchases. The percentages currently used to describe the categories of goods and services that market basket are as follows.

• Food and beverages 15 %
• Recreation 6 %
• Housing 42 %
• Education 3 %
• Clothing 4 %
• Communication 3 %
• Transportation 17 %
• Medical care 6 %
• Other goods and services 4 %

Inflation and the CPI, March 17, 2011 - This is the text of the most recent inflation report from the National Council on Economic Education. We can take a look at some of the graphs and charts for a minute. This little application is pretty cool...

You probably looked at hyperinflation with Germany after WWI last year. Here and here are signs that your economy is undergoing hyperinflation.

Much of the following information is simply copied from the EconEd website for our convenience in class today...

Causes of Inflation: Over short periods of time, inflation can be caused by a decrease in production or an increase in spending. We get the names for the two major types from this: demand-pull and cost-push.

Inflation resulting from an increase in aggregate demand or total spending is called demand-pull inflation.

Inflation can also be caused by increases in costs of major inputs used throughout the economy. This type of inflation is often described as cost-push inflation. Increases in costs push prices up.

A relatively minor, third cause - Over longer periods of time, that is, over periods of many months or years, inflation is caused by growth in the supply of money that is above and beyond the growth in the demand for money.

Costs of Inflation: Here's one short summary of some of the costs of inflation.

• High rates of inflation mean that people and business have to take steps to protect their financial assets from inflation.
  

• High rates of inflation discourage businesses planning and investment as inflation makes the forecasting of prices and costs more difficult.
  

• Inflation does reduce the purchasing power of money.

• Inflation does redistribute income. People on fixed incomes such as pensions or whose salaries are slow to adjust are negatively affected by unexpected inflation.

(I HAVE NO IDEA WHY THE FONT CHANGES SIZE...)

Unemployment: This, in many ways, is sort of the flip side of what we did with inflation.

Defining "unemployment:  The unemployment rate is the percentage of the U.S. labor force that is unemployed. It is calculated by dividing the number of unemployed individuals by the sum of the number of people unemployed and the number of people employed. An individual is counted as unemployed if the individual is over the age of 16 and is actively looking for a job, but cannot find one. Students, those individuals who choose to not work, and retirees are therefore not counted in the unemployment rate.

The Current State of Unemployment: The most recent figures we have take us through December.  This is a lot of numbers, but just browse it for a couple minutes. Here are the newest charts from the Bureau of Labor Statistics.

Questions to consider and discuss:

• What surprises you (if anything) about the statistics and graphs above? What explanations do you have for the discrepancies?

• In January 2002, a falling unemployment rate was accompanied by a significant fall in employment. How can the number of individuals employed fall and the unemployment rate fall at the same time?
  
  

Unemployment in your backyard (or anyone else's) ... You can go to the Bureau of Labor Statistics website and check the Local Area Unemployment Statistics for your city and/or state.

Answer these questions:

1. Is unemployment in our area higher, lower, or roughly the same as the national average? What about your favorite vacation spot? Your grandma's hometown?

2. What factors contribute to our area's unemployment rate? (Think about recent news...)

• Which industries have expanded?
• Which industries have contracted?

3. Will the recent changes affect you?

4. If avoiding inflation were your highest concern, where should you move? If you like the idea of unemployment, what cities would you recommend for your next move?

Here's the lesson on Employment and Unemployment that parallels the above one on inflation. There are some interesting things in there.

Unemployment Insurance:  Go to the website for the Minnesota WorkForce Center. Browse through the links and see what kinds of benefits are available in this state.

• Do you think unemployment benefits are appropriate in Minnesota?
• What changes, if any, would you make?
• Do you think these benefits are a disincentive to work?
  
  

The Relationship between Inflation and Unemployment: The Phillips Curve - Economists have long claimed an inverse relationship exists between unemployment and inflation. This "Phillips Curve" quickly gets very technical, but you can see the basics at this link. Browse around for a bit.

HOMEWORK for tomorrow - Thursday, April 21st

Please continue in your reading of Naked Economics. You should have Chapter 7 ("Financial Markets") read for Thursday. Blog Entry #4 (Chapters 6 and 7) will be posted yet today and it will be due on Friday.