Sam+F

It seems strange to me that the required reserve ratio -- the percentage of money that a bank has to keep in reserves when an amount is deposited -- is exactly 10%. It's easy to remember and easy to calculate, I'm sure, but it seems too easy and imprecise. It appears a little bit too square to actually maximize the well-being of the economy. It's almost like Ben Bernanke and others read a few too many pages of this goofy-looking book:
 * Unit V: Reserve Requirement**



Reserve requirements are necessary to keep the economy safe and stable. If reserve requirements were too low, bank runs would be more frequent and the economy would be more volatile. It's true that we now have the FDIC, which insures bank deposits up to $250,000, to prevent against the type of bank runs that plagued the American economy in the early 1930's, but we still don't want banks loaning out every last penny that hard-working people deposit. It makes the right to withdraw one's own money from a bank a bit more tenuous. That being said, we don't want reserve requirements too high either. That would hinder a bank's ability to increase the money supply, because the deposit expansion multiplier (which equals 1/rr) would go down.

Still, it seems odd that America likes to keep the reserve requirement at 10%. Isn't there some sort of mathematical model that could show the optimal reserve requirement? Something that better balances the two goals of stability and growth than the arbitrary figure we've settled on now?



It turns out that other countries already have these ideas in mind. The People's Bank of China (see photo above) has adjusted the reserve requirement no fewer than 19 times since 2007, mostly in an effort to combat inflation. Our inflation problem isn't as bad as the Chinese one, especially during this recession, but I suspect that, through smart reserve requirement planning, we could help our own economy along faster than it would on its own. Of course I think that most banks in China are owned by the govt so this makes it easy to do. Our Fed can't do this as our privately owned banks would go nuts at the rule changes. So, the Fed uses a variety of other tools as we've discussed. You're right though, 10% seems quite tidy. 10/10 -SW

As we know all too well, the American government's ratio of tax revenue to spending hasn't been too good. But it's not just a recent problem. America's debt grew tremendously during the New Deal and World War II, under FDR. His economic policy was firmly Keynesian in method: he believed that government should spend money on the poor and unemployed to shift out aggregate demand and lift the economy. Indeed, the New Deal did help the nation recover from the Great Depression, but the huge economic surge that accompanied WWII was probably even more influential. Since then, the national debt has continued to increase, especially in recent years. Here's the graph of real national debt over time:
 * Unit IV: Fiscal Policy**



Since 2005, too, it's gone up. It's now at roughly $15 trillion, which, even if deflated to 2000 dollars, would be well of the charts. Whether it's fair or not, we tend to blame Presidents for increases in the national debt. Here's a cartoon I found that emphasizes this point in a partisan way:



Of course, the President shouldn't be wholly responsible for surpluses and deficits. Congress and the nature of the economy as a whole have a large impact. Also, Obama, another so-called "tax and spend liberal," certainly hasn't presided over any fiscal surpluses like Clinton did in the late '90s, so this cartoon loses some of its impact. I think it's fairer to claim that both Republicans and Democrats tend to run huge deficits and increase the national debt. Still, though, this makes the moniker "fiscal conservative" a questionable one.

I found one last cartoon, this time mocking our huge debt itself:



It makes an important point: that it's easier to come up with money seemingly out of nowhere (through borrowing) than it is to raise taxes or cut spending. Sound fiscal policy, though, is very important to the economic health of the government and the nation. Great points Sam. Economists have tried to bring some sanity to all of this debate. The reality is no president has ever spent less the next year than the previous year. It's really perception and what you spend the money on. Reagan and Bush were "fiscal conservatives" as you point out but spent gobs of money on defense during the Cold War, even on threats like Star Wars. If politicians would fess up to this, we could have a much more sane and effective debate. Good comments and cartoons. 10/10

The Phillips Curve shows the inverse relationship between inflation and unemployment in an economy. This means that as unemployment goes up, inflation goes down, and vice versa. That's why, from a demand perspective, it's not possible for unemployment to go down and inflation to go down. Of course, if we start to adjust macroeconomic supply, then everything gets out of line. In that case, it's perfectly possible to have stagflation (in which both unemployment and inflation go up) if supply shifts in, or superinflation (in which both unemployment and inflation go down) if supply shifts out. The possibility of stagflation and superinflation might be part of the reason why supply hasn't been the focus of as much economic policy as demand is. It's kind of like demand's scary, mad partying neighbor. Mess with supply, and things might be super awesome: so "superinflation" doesn't sound like inflation going down though. hmmmm.
 * Unit III: Phillips Curve and Okun's Law**



Or they might get super, super ugly:



Okun's Law is very similar. It says that there is a tradeoff in the short run between unemployment and GDP. Specifically, for every 1% increase in unemployment, GDP as a proportion of potential GDP will go down by 2%. Interestingly, Okun's law shows a linear relationship, not the curved relationship that inflation and unemployment have in the Phillips curve.

So this is what I was thinking: what if you graphed GDP vs inflation? After all, the two curves we learned about graphed other combinations of inflation, unemployment, and GDP, but not that one. I got a curve that looked roughly like this:



but without the quantities on the axes (obviously), and with GDP on the y-axis and inflation on the x-axis. It's an interesting graph, really. Does the positive slope of the graph, though, mean that the government should encourage inflation to help the economy? Sadly, I don't think this is what the graph suggests. Inflation is a by-product of economic growth, so spurring on inflation would not necessarily create more growth. That would confuse the cause of a change with its effect.

The curved element of the graph means that GDP and inflation first increase at roughly the same rate, but eventually small increases in GDP correspond with huge increases in inflation. This, too, is interesting. As this begins to happen, I would assume that the economy is nearing full employment, so eking out a few extra dollars worth of goods and services produced takes a huge toll on the economy. This can be connected to the concept of sticky wages, since at the high x values on this new graph wages would have unstuck and workers would demand exorbititant wages. This might be the cause of the vast amount of inflation that would be the result of even a slight further increase in GDP. Yes, exactly. Refer back to the PPC. It gets harder and harder to get to Full Employment as you approach it since all the best resources are already being employed and compensated. Then, to get to FE, you have to pull in marginal resources which will have a higher MC thus prices go up. Nice application. 10/10

In 1987, Nobel Prize-winning economist Robert Lucas (classily pictured above) did some research about the impact of business cycles on social welfare. His research was based on the fact that lawmakers and some economists see business cycles in the macroeconomy like deadweight loss in the microeconomy. But Lucas, in his calculations, showed that business cycles aren't as big a source of inefficiency in the free market as people led you to believe. In fact, he determined that, since World War II, business boom/bust cycles have only cost people .1%, or one part out of a thousand, of their lifetime consumption. From a practical standpoint, this has two main implications, one in individual decision making and one in government policy, which I describe below:
 * Unit III: Cost of Business Cycles**

Individuals and individual firms shouldn't bemoan booms and busts to the degree they do. For instance, car manufacturers have struggled in the last few years because of the Great Recession, with sales down 5% or so, but that doesn't mean that those lost sales are permanently lost. They were made up for by consumer overspending in the years before the recession, and they will be made up for by consumer overspending in the years after the recession as well.

Governments shouldn't try to avoid business cycle volatility as much as they do either. Critics of Lucas' theory point out that perhaps these small losses were caused by the harmlessness of the business cycle swings between 1945 and 1987, when his research was published. If people (cough, cough financial experts since 1987) took his results too seriously and allowed the market to spiral upwards and then downwards out of control, then maybe the welfare costs of business cycles would be higher. In a few decades, I'll be interested to see if the most recent boom and downturn aligned with Lucas' trends or damaged sales more severely.

Of course, all controversial findings have their critics, and Lucas' is no different. Other estimates for the welfare cost of business cycles, published after Lucas', go all the way up to 12% of consumption, which would be a huge sum of money. These calculations use different models and different assumptions for various parts of our country's economy.

Well, that's about it. As a side note, an article I found said that a few economists, and I quote, did "a little algebra" and came out with a formula with no fewer than 17 different Greek and English letters in order to calculate all of this stuff. All I can say is that I'm duly impressed. Yes, economists are nothing if not diligent in their work, despite the fact that their work may be all wrong! But this guy has a good point. We over emphasize the downturns. But, previously, companies and people might have made a lot of money in good times. Where did it go? Maybe saving for the "rainy day" should be emphasized more. 10/10


 * Unit II: Outback Steakhouse and Flu Shot Subsidies**

Here's an excerpt from a blog I found, talking about Outback Steakhouse's subsidies for employees who get flu shots:


 * I currently work for Outback Steakhouse. I recently received notice that this year Outback has chosen to pay for over half of the cost of flu shots. All we must do is take our pay stub into Target and pay a small fee of ten dollars, total cost is twenty four, and we will receive this years shots. Surprisingly, there are still many of my fellow co-workers who have chosen to abstain from getting the shot, even when it is provided at such a cheap rate. Apparently, the subsidy alone does not provide enough incentive to go to Target and receive the vaccination.**

I thought this idea was interesting for several reasons. First, we usually think of subsidies as payments being given to the producer, not given to the consumer. Second, usually externalities are managed by government, not by a private company. Only the government, we tend to think, has the scale and capacity to act in the best interests of society as a whole. But this time, it's Outback Steakhouse, not the government, who is encouraging consumption of a good with a positive externality. I don't think that the owners of Outback Steakhouse are doing this just out of the goodness of their heart, either. After all, it costs Outback Steakhouse $14 per employee who takes them up on their offer! I'd say that, in this case, "society" isn't society as a whole, but the society of Outback employees and patrons, and that's why flu shots' positive externality has such a high marginal social benefit. It all boils down to the fact that Outback really doesn't want sick employees. If employees get the flu, they either have to take a few days off of work, harming the company's ability to turn profits, or they have to drag their flu-ridden bodies around the restaurant serving people steaks, which is unsanitary and just plain gross.

As the writer of the blog says, though, the subsidy isn't enough to convince many workers to get flu shots. Apparently, the marginal private cost of getting a flu shot, even after the subsidy, is higher than the marginal private benefit. And since individual workers, presumably, can't see the marginal social benefits the same way their employer can, the quantity of flu shots consumed in this Outback Steakhouse "society" still falls short of socially optimal levels, from what it seems like.

So maybe government is better than private industry at correcting for externalities after all. But I guess that neither government nor private business can correct for them absolutely, so we should give Outback Steakhouse kudos for the good effort. Actually, Outback is paying the producer of the shots here. It says that the subsidy has reduced the cost to the employee so Target must be getting something from Outback. About government, this is a good example of a Coase Theorem fix negotiated between "private" entities. I agree, for some the "cost" of a shot is too much no matter what. Ugh, I hate shots. 9/10 -SW


 * Unit I: U.S.-South Korea Trade Deal a Win-Win for Jobs, Economy**
 * Congress approved the deal this week in a rare bipartisan achievement after negotiators overcame U.S. auto industry complaints that previous efforts at a deal failed to do enough to lift South Korea's barriers to U.S.-made cars, the Associated Press reported.**
 * Both President Obama and South Korean President Lee Myung-bak hailed the trade agreement as a win-win for both nations, acknowledging the serious headwinds facing the global economy.**
 * Obama has said the newly-brokered deal with South Korea will create 70,000 new jobs and increase U.S. exports by $11 billion. The agreement will boost the economy more than the last nine trade agreements combined, he added, emphasizing the deal between the U.S. and Korea is a balanced one. "They buy as much stuff from us as they sell to us," he said, taking a swipe at some of America's less-balanced trade relationships. "That's how a free and fair trade is supposed to be. It's not a one-sided competition."**

This article is an example of comparative advantage. President Obama, apparently, is betting on an American comparative advantage in car production. That way, with a freer trade system, America could export cars to Korea, and American companies like Chrysler, GM, and Ford would be strengthened.

Obama seems to suggest that both the U.S. and Korea could trade cars with one another in future years. Although the article doesn’t say anything about it, maybe that’s possible because American companies would have a comparative advantage in certain car types and Korean companies would have a comparative advantage in others. America, for instance, might be able to produce SUVs at a lower opportunity cost than Korea could. In that case, the U.S.could export SUVs and import sedans.

From an economics perspective, one thing I don’t understand is Obama’s criticism of certain trade relationships as “one-sided competitions.” That’s not possible if you think about it. The U.S. wouldn’t export if we didn’t think that what we got in return was more valuable. But, that point aside, any economist would agree with this trade agreement. I bet it'll be good for both countries involved. Pareto Optimality Sam. The equilibrium where to move one way or the other would be to advantage one at the disadvantage of the other. Non-economic thinkers (most folks) simply get international trade wrong a lot. Your points are well taken. We don't trade with a gun to our head. Nice issue. 10/10