Econ 100B: Links Roundup
2:21 PM, July 22, 2008Over the last few classes, I’ve talked about several things in the blogosphere and/or other media. I’m going to link to them in this post. Hopefully, I’ll cover everything - if not, let me know in the comments.
The pros and cons of a weakening dollar were discussed in the following (July 3rd) Marketplace podcast:
U.S. exports are up and imports are down as a result of the dollar losing so much of its value against the euro. Who comes out ahead and who falls behind? Jeremy Hobson reports. [link]
Professor Robert Reich talked about a long-term stimulus package, as opposed to the current one in this (July 2nd) Marketplace podcast:
The economic stimulus was just a drop in the bucket. If Congress really wants to get the economy back on its feet, commentator Robert Reich has some summer homework for them. [link]
The Wall Street Journal has some numbers on monthly consumption, and consumer confidence, showing a slight increase in consumption (presumably from the stimulus package), but a sharp drop in consumer confidence:
Those charts, as well as several other economic indicators can be found on the Wall Street Journal’s Economic Indicators page.
In class today, we talked about some of the non-mathematical problems with the Consumer Price Index - having more to do with the actual construction of the basket itself, rather than with the appropriate weights. Professor Menzie Chinn on the Econbrowser blog:
This post focuses on issue separate from the mathematics of the index forumulation, and has to do with what the typical weights at any given instant in time should pertain to. Should one use the expenditure weights that pertain to all the households aggregated in the economy? Or should one use the expenditure weights that pertain to the “typical” household? [link]
And finally, we discussed a new post by Stefan Tangermann on the Vox blog, that attributes rises in food prices to policies directed towards biofuels, and not coming from speculation and increased demand:
New research shows that India, China, and speculators are not the culprits in the food price explosion. Biofuels were a significant element in the 2005-2007 food price surge as they accounted for 60% of the growth in global consumption of cereals and vegetable oils. …new research also shows that biofuel support policies are disappointingly ineffective on environmental grounds, [and] governments should reconsider them. [link]
Speculate On This
12:14 PM, July 11, 2008Why is it, that when something goes wrong a scapegoat must be found? Oil prices rising cannot be because of increased demand from other developing countries, nor can they be because of the increased usage of oil in the United States without a matched increase in supply. Didn’t you know? They’re because of the speculators! Those nasty, greasy people who soil the market with their grubby little paws and make it impossible for normal, clean-cut people to go about their business. But hey, it seems Western civilization has always had this problem:
Speculation has been a favorite target of politicians looking to mollify anxious voters since the time of ancient Greece, when the orator Lysias protested that wheat traders had reduced Athens to a “state of siege.” Even in market-friendly America, there is a long tradition of
denouncing speculators as dishonest, unproductive parasites; the
nineteenth-century preacher Henry Ward Beecher decried their “cool,
calculating, essential spirit of concentrated avaricious selfishness.” [link]
Far be it from me to defend speculators, but they definitely have their place to keep markets free-flowing. When a commodity’s expected to see an increase in demand, who but the speculators predict the increased demand and hasten the process of reflecting that in the price? They provide necessary liquidity, and do so in a reasonable way.
Speculators do play an important role in setting the price of oil and
other raw materials. But they do so based on their expectations of
future trends in supply and demand, not on whims. If they had somehow
managed to push prices to unjustified heights, then demand would
contract, leaving unsold pools of oil. [link]
And, ok, once in a while things get a little out of hand, when speculators invest a little too much in futures contracts for a particular commodity (in this case, oil), but they don’t actually buy the oil (or sell it, for that matter). In fact, there are no drastic changes in oil inventories to reflect that.
Speculators, by contrast, mostly use futures contracts to gamble on oil
prices, and have no interest in buying or selling real barrels of oil.
These gambles can be tremendously lucrative, but they don’t directly
determine the real (or “spot”) price of oil. That’s set by the people
who are buying and selling actual barrels of petroleum. Although
speculators could directly distort oil prices by turning their futures
contracts into oil and then taking it off the market to drive up
prices, a look at oil inventories shows no sign that this is happening. [link]
At the end of the day, it’s easy to blame the speculators, but instead of doing that why don’t politicians call for real change and risk making life difficult for their constituents? Stop driving the SUV, start doing some real research into alternative energy, etc. etc.
This is not new, but it’s worth reminding one’s self about who the top seven oil-consuming countries are and how varied their usage is:
Deficit Difficulty
6:19 PM, July 3, 2008An old student emailed asking for clarification on an Economist article he read that is about the trade deficit. Here’s what the article is saying, in essence:
- The PPP predicts that the dollar should rise now, in terms of the Euro ($1.16/Euro by PPP, $1.55/Euro in nominal terms) - eventually, arbitrageurs should drive that difference away. That is, more French and German tourists buying dollars should drive the price of the dollar up (i.e., appreciation).
- Dollar speculators also feel that things have bottomed out (the dollar bears - people who bet against the dollar’s fall, not Cal students! - are despondent).
- The FEER model, on the other hand, is saying exchange rates should actually *increase* (devaluation of the dollar) given full-employment, sustainable deficit values of 3% of GDP (a flexible-price model-type analysis). According to the FEER, a rule-of-thumb is for each percent increase in the deficit more than 3%, the dollar should devalue by 10%.
- Yet another study by Richard Cooper shows that the deficit is actually going to *increase* (imports will increase) when compared with the share of assets owned by foreigners in other “rich” countries. That is, the share of assets owned by foreigners in the US is less than those owned by foreigners in other comparable economies (because of secure property rights, speedy dispute settlement, etc.).
So is the deficit going to increase or decrease? Well, that is the million-dollar question. But I digress. Beau was asking, specifically,
I understand that a cheaper dollar makes exports cheaper, which in turn reduces the current account deficit. I also understand that in terms of a relatively low PPP, it may be a good time to invest in the dollar, as the dollar may strengthen to increase PPP. Finally, I know that foreign savings is negative net exports. But if net exports are increasing, then foreign savings are decreasing, not increasing. What do the foreign and domestic financial markets have to do with a persistent and large trade deficit?
I suspect Beau’s confusion stems from #4. But he answered his own question: Foreign savings equal negative net exports, so an increase in foreign savings coming in should increase the deficit by decreasing NX. Or at least, that’s what Cooper thinks.
There are two main ways in which the financial markets affect the trade balance. Firstly, there are instances where a US company will exchange shares of stock in return for goods from a foreign country, thus decreasing the trade deficit. Secondly, capital inflows put upward pressure on the dollar - when foreigners buy assets in the US outright, they need to buy dollars first, and this results in appreciation, which, in turn, raises the dollar value of exports. And this, once again, raises the trade deficit.
What I found interesting was the percent of the deficit that oil constitutes. It looks like it’s over 50% now. Is anyone panicking yet? Anyone? Anyone?
Econ 100B: Handouts on the Solow Growth Model
4:52 PM, July 2, 2008Professor Brad DeLong (the co-author of your text book) has some interesting lecture notes on the Solow Growth Model for his Econ 101B class. While not all of them will be interesting to all of you, #1 is a good introduction to the subject and is accessible to everyone.
Those of you who were skeptical of my explanation on how we reached the steady-state and why the definition of equilibrium in the Solow Growth Model is what it is, might find #2 and #3 interesting. They are both a more calculus-intensive explanation of things, and use the rigor of math rather than the somewhat more vague explanations that we discussed.
Note that none of these are going to be on the exam - these are additional readings.
- Introduction to the Theory of Economic Growth
- How Fast Does the Economy Head Toward Its Balanced-Growth Path (Math-Intensive)
- Two Additional Notes (Math-Intensive)
The Risk Premium
1:25 PM, June 26, 2008To say that the risk premium is the difference between the return on stocks and the return on bonds is assuming that markets are constantly in equilibrium. This is not always true. In fact (to rehash an old handout) in the NYT from 2006, there’s an article by Daniel Altman which says,
For decades, the returns on stocks have usually been much higher, relative to bonds, than risk alone would seem to justify — perhaps as much as six or seven percentage points higher. If risk were the only explanation, the difference would suggest that investors were extremely risk-averse, to the point that they would never leave the house for fear of having to cross the street. [link]
Nevertheless, despite short-term blips (both, up and down) in the risk premium, long-term studies have shown that it is mean-reverting or constantly tending towards a steady average. Later, in that same article,
According to research by William N. Goetzmann and Robert G. Ibbotson, two finance professors at Yale, that premium has stayed fairly constant over long periods through virtually all of American history. For lack of a better reason, there may just be something special about American capital markets, so that a high equity premium would tend to revert to some sort of long-run average. In other words, the equity premium may be a partial predictor of future stock returns and even the future growth of the economy. [link]
[I've uploaded the paper to my server, if you're interested in venturing into the realms of technical econ reading]
I blogged about this earlier, but interestingly enough, because the current (narrowly averted?) financial crisis had so much to do with debt and debt-related instruments (like bonds), it put a whole new spin on the risk premium - these instruments became riskier and less liquid than stocks. So what do you think happens to the risk premium when the return on bonds falls below the return on stocks? When bonds become riskier than stocks? Read more.
Econ 100B: The Inverted Yield Curve
2:53 PM, June 24, 2008While talking about the inverted yield curve, I over-simplified the explanation (thanks, Gabe) of what causes it. While it does have to do with supply and demand, the yields are not related exactly in the way you might think. We will get back to where I over-simplified, and why, when we get to talking about the IS-LM curves.
In the meantime, I’ve posted the first handout for the semester. It’s a post by Barry Ritholtz on the blog Seeking Alpha. It illustrates the arguments for and against the yield curve as a predictor for recession. Remember that it is not a technical article (which is why I thought you might like it) and some of the issues have more complexities than meet the eye. But on the whole, it is an enjoyable read and illustrates how economists can never agree on anything and still be right about everything (!).
Here’s an excerpt:
So is the Yield Curve still relevant? There is a dispute amongst economists to that effect. In addition to the aforementioned Mr. Laffer, several other notables have raised questions:
“Two researchers who focus on recession forecasting, Lakshman Achuthan and Anirvan Banerji of the Economic Cycle Research Institute, argue that the yield curve is overrated as a recession harbinger. They note that the yield curve failed to invert before recessions in the 1950s and early 1960s. They also point to the misleading signal sent in 1966-67, when a lengthy inversion didn’t precede a recession.”
We know that there were recessions that were not preceded by an inverted yield curve. But were there inverted yield curves that didn’t produce a recession?
“Those who think highly of the yield curve’s predictive power have history on their side. Seven times between 1965 and 2005, yields on the 10-year note have dropped below those on the three-month Treasury bill for an extended span. In six of those instances, the U.S. economy went into recession soon after.
Here’s a direct link to the article.
Who Said Macroeconomists Can’t Run Experiments?
2:27 PM, June 24, 2008Last week’s Economist talks about the virtues of using randomized trials to answer macroeconomic policy questions. Randomized trials are similar to drug trials, where you select a random group of people to test an idea along with a control group on which you test something else. They talk about an experiment done in western Kenya, in the distribution of bednets going towards malaria eradication:
…researchers looked at what happened in 20 antenatal clinics in western Kenya when some gave away insecticide-treated bednets, an anti-malaria therapy, and others sold them for different prices. Their conclusion was that free distribution is far more effective in getting people to use bednets than charging even a nominal sum would be. [link]
That argument for charging people for this is simply that if people pay for something they will value it more. Of course, nothing is as it seems, and it turns out that in the part of the country that they were given away people already owned millions of bednets, so the value was already known. Furthermore, most of the recipients were pregnant women - which is good - but if you want to eradicate malaria then you want them to be universally distributed. So we are back to Square One. The experiment worked in this part of the country, but is it worthwhile to distribute bednets across the nation? Unknown.
This is of course a problem of random selection. Listening to Terry Gross’ Fresh Air on NPR the other day, I heard an interview with Elizabeth Pisani, an epidemiologist who is battling AIDS across the world. She was telling the story of a survey done by her group in Southeast Asia, to find out the average number of clients that prostitutes got per week. They were surprised by how low the numbers were - something like three per day (if I remember correctly).
Speaking later with another prostitute, she found out that the women she interviewed were so-called “dogs”. The very fact that they were available to be interviewed by her team showed that they were not in high demand. This skewed the numbers downwards. When they randomized it a little more, by asking different women at different times and so forth, they got much higher numbers. Here’s the show, if you want to listen to more.
Perhaps if there is enough research done into a particular culture/country/region to ensure that the trials will be truly randomized then one might be able to claim that macroeconomists can also run experiments, just like microeconomists. Then again, who was it that said that all macro is micro, anyway?
An Announcement for Econ 100B Students (Updated)
11:14 AM, June 23, 2008Students from Econ 100B - welcome to this blog. I am working on writing up the syllabus for this course, but I have already posted for you:
- the first lecture slides;
- a (very) rough course schedule, so you have an idea of what we will be doing and when, and;
- a link to the text book website.
Note: All posts for Econ 100B will be in the sidebar to the right - below where it says “Econ 100B”.
The text book for this class is Macroeconomics by Brad DeLong and Martha Olney, 2nd Edition. ISBN: 0072877588. The publisher is McGraw-Hill/Irwin. If you wish to use the first edition, you do so at your own risk. I strongly suggest you buy the second edition.
I have kept some links to old handouts from the macro course I taught last semester - feel free to browse through those. I will use at least two of them (maybe some more) again during this course.
If you have any questions or comments, please feel free to send me an email. My address is on the right.
Update (4pm): The syllabus is now online.
Housing Crisis 101
1:09 PM, June 2, 2008
Picture by Kristy Jamison
Ira Glass of the Chicago Public Radio show This American Life has devoted an episode of the show to the current mortgage crisis and its build-up. It’s certainly one of the easiest-to-understand explanations of the crisis that I’ve heard. He includes interviews with mortgage brokers and financial service employees, but omits the nitty-gritties of the crisis itself. I wouldn’t say it’s inaccurate, but it’s definitely not for finance geeks.
Read more about the episode (access to the entire episode from that link). Listen to a 30-second promo (mp3).
Portfolio Magazine has a (geekier) multimedia study aid to accompany the above show, if you’re interested.