Some good articles on Euro crisis

For those interested in yet more good Euro articles, here are two of my recent favorites:

1. Economist special series (collection of articles):    

 Economist special edition on Euro crisis (11-12-2011)

This comes with an interactive guide to crisis:  Interactive guide


2. Good WSJ  article on how the crisis evolved that touches on many issues discussed in class.

WSJ (11-18-2011) Crisis Ensnares Central Bank in Desperate Bid to Save Euro by Brian Blackstone and Matthew Karanitschnig

UPDATED: What a Greek exit from the euro might look like ...

Time lapse animation of EU membership along with info on euro area (from European Central Bank)


The latest Economist article on the the crisis suggests that Greece's euro partners should focus more on linking bailout money to structural reforms (which will eventually lead to growth) rather than austerity.

Economist (November 5th-11th 2011) "Greece's Woes"





The ratio of debt to GDP can reveal when a country is in danger of not being able to meet obligation.  Greece's ratio of debt to GDP reached 147.8% in 2010 (see link to OECD at bottom of post), and so debt repayment is clearly a problem.  However, the ratio of debt to GDP does not reveal how the debt is structured or the interest rate a country has to pay.  To get a handle on a country's ability to meet debt obligations and undertake an austerity program, it may be more useful to look at the ratio of expenditure on servicing debt to total government expenditure.

After spending a few hours trolling the websites of the IMF, the OECD, the CIA World Factbook, the ECB, Eurostats and others, the only place I could find this information was the Greek Ministry of Finance's website (see link at bottom of post). If anyone finds another readily available source for this data let me know.

According to the latest data from the a presentation by the Greek Ministry of Finance,  interest payments on government debt amounted to 6.9% of GDP in 2010.   In that same year Greece's deficit was 10.4% of GDP (according to OECD). Even if Greece didn't pay one penny of its debt, it would still have had a primary deficit over 3% of GDP in 2010 (primary deficit = total deficit - portion of deficit due to interest payments). While the primary budget will improve as Greece's economy improves, austerity programs only make economic growth harder in the near term.

Reminder for students: A deficit over 3% is not considered sustainable in the long run.  EU members who have adopted the euro are supposed to maintain a deficit to GDP ratio of 3% or less. Then again, they are also supposed to maintain a debt to GDP ratio of 60% or less. So most of the countries in the euro area are in violation of the Stability and Growth Pact anyway.

If Greece defaults, it would no longer be able to borrow and should not expect any more bailouts.  It would have to balance its budget immediately. The resulting budget would be even more austere than the one in the bailout deal. Given these facts, leaving the euro currency union doesn't sound so desirable.

Playing bluff for a better debt reduction deal might work - but is very risky.  Under the current deal, Greek government debt would be reduced by 50% in exchange for an austerity program that reduces government expenditures and/or raises taxes. Greece could argue that a larger haircut is needed. If debt was cut by 66% or 75%,  Greece would have a much better chance of reaching a sustainable 3% total deficit to GDP ratio.

When Papandreau, the prime minister of Greece, proposed a referendum on the bailout deal, he was probably not focused on wrangling a larger haircut. Rather he was attempting to force his own party and the population at large to support the bailout deal. At the moment it looks like he may have succeeded in uniting the country behind the deal, although it may cost him his job someday. He narrowly survived a vote of confidence on Friday, November 4th.

The mere mention of the referendum on the deal put the markets in a tizzy.  The following two articles tackle some of the challenges.

WSJ (11-4-2011) "Banks Conduct Greek 'Fire Drills' " by Sara Schaffer Munoz and David Enrich


WSJ (11-4-2011) "Exit Would be Mess for Athens" by Stephen Fidler


Fidler argues the element of surprise is key. Announcing a currency switch in advance gives people time to hoard euros and get euros out of Greece, making the eventual conversion much more painful.  Munoz and Enrich report that this may already be happening. Citing an anonymous European bank executive, "corporate clients usually move their earnings out of Greece every two weeks. Now they move money out of the country as often as every day".

If Greece leaves the euro, sovereign default would be inevitable, i.e. the Greek government would stop paying some or all of its debt. However, Greek companies and individuals also have many loans in euros.  For loans made in euros inside of Greece, Munoz and Enrich argue that the Greek parliament is likely to legislate a predetermined conversion rate from euros to drachmas. This rate would likely end up favoring Greek borrowers at the expense of banks from Europe and elsewhere. Hence the banking systems 'fire drills'.

It is not clear the Greek legislature would be able to impose this conversion rate on loans made in euros outside of Greece. Greek borrowers obligated to pay back debt in euros (on loans made outside of Greece) but who earn their revenue in drachmas would likely face bankruptcy as the drachma devalues again the euro. The only certainty is lots of lawsuits.

For now it looks like Greece will stay in the euro area in 2011.  However, within the next few years the haircut may be renegotiated and/or Greece might yet still leave.

Questions for class:
1. What advantages for Greece, if any, do you see from Greece exiting the euro area?
2. If Greece leaves and defaults, lots of European banks would be in trouble.
      If they are not bailed out, interbank lending would grind to a halt and a deep
      European recession  would be likely. How would a deep recession in Europe
      affect your company?
3. Ten Zillion dollar question: If Greece leaves and European governments do bail out
      their banks, what do you think might happen?

More info:

 HELLENIC REPUBLIC MINISTRY OF FINANCE: Budget 2011 (Draft Law 18 November 2010)

OECD statistics

Bank of Greece Press Release (22/03/2010)

"In 2009, as the Bank of Greece had warned, the general government deficit reached 12.9% of GDP and public debt stood at 115% of GDP. These developments triggered a series of downgradings of Greece’s credit ratings and led to a large widening in the yield spread between Greek and German government bonds – resulting in increased borrowing and debt-servicing costs for the Greek government. The increase in debt-service expenditures, in turn, increased the country’s budget deficit, made fiscal consolidation more difficult to achieve, and had serious repercussions for the real economy and the banking system. The Greek economy is caught in a vicious circle, with only one way out: the drastic reduction of the fiscal deficit and debt so that there is an immediate reversal of the current trend."

Is High Inflation Good for Our Economy?

CNBC news clip on "Is High Inflation Good for Our Economy"


Krugman notes that  PR strategies are as helpful for Fed chairmen as for any other CEO. The recession in the early 1980's was induced by former Fed chairman Paul Volcker in order to fight inflation.  Volcker cleverly called his strategy "setting targets for monetary aggregates like M1 and M2" which borrowed credibility from the noted monetarist and Nobel laureate, Milton Friedman. This sounded better than calling the strategy "pushing the economy into a deep recession and keeping it there until inflation cried uncle" (quotes from Krugman's article).

NYT (10-30-2011) A Volcker Moment Indeed (Slightly Wonkish)

Krugman argues that if the Fed now wants to do the opposite, i.e. push the economy into inflation and keep it there until unemployment calls uncle, a good PR move would be to call the strategy "setting targets for nominal GDP" (again quote from Krugman's article).  Krugman then offers his support for some Bernanke induced inflation (above the usual 2% inflation rate target) to fight unemployment.

Many people disagree with Krugman. They argue that setting an inflation target higher than 2% is playing with fire.  The resulting inflation might be hard to control and the policy might undermine the credibility of  Fed as an inflation fighter.  People on this side of the argument often question whether pumping money into the economy would lower unemployment.  If the surge in the unemployment rate is structural (i.e. due to a mismatch between workers' skills and locations with companies' job openings),  and not cyclical (i.e. due to low general demand to buy stuff), then the Fed's actions would not accomplish much.

So what does the data say about how much of current unemployment is structural? It is still a work in progress. Nobel laureate Dale Mortenson recently gave a talk at Villanova University and provided new evidence suggesting that most of the spike in unemployment is cyclical rather than structural. See the ever informative Mankiw blog for more,

http://gregmankiw.blogspot.com/2011/01/how-much-unemployment-is-structural.html


The Fed has a twin mandate - essentially (1) keep inflation low, and (2) keep unemployment low. If the economy is experiencing inflation below 2%, these goals are aligned.  Pumping more money into the economy will both bring inflation back to the desired level and help lower unemployment.

However, if inflation is at 2% (as it is now) these goals are in conflict. Supporting more inflation now is in effect putting more importance on the Fed's mandate to reduce unemployment.  It would help those underwater homeowners with fixed rate mortgages - which might create a more mobile workforce.

What do you think? Should the Fed consider say a 4% inflation target for the next two years?






         

WSJ Report on Human Resources - Is it really so hard to find qualified employees?

WSJ (10-24) Human Resources 2011

This special report has a host of interesting articles with practical tips on increasing productivity like: (1) have a greeter at your door who smiles at employees on the way in to work, (2) handout lots of cookies, and (3) offer Zumba exercise classes.

The one most related to recent classroom discussion is

WSJ (10-24) "Why Companies aren't getting the employees they need" by Peter Cappelli

Cappelli argues that firms just need to set their sights lower and provide more on the job training. After reading his article do you agree? Would apprenticeship style programs solve your company's recruitment challenges?

Watch CNN (5-3-2010) report on apprenticeships:

Should trading partners get bailed out?

France and Belgium are in the process of bailing out the bank Dexia. Dexia made some bad bets, not just on debt from Greece, Portugal, Italy and Sain, but also on interest rate movements. If Dexia failed, it would not be able to meet obligations to its trading partners, many of whom are U.S. financial institutions.

When the U.S. bailed out AIG, it fully met AIG's obligations to European institutions. Many in the U.S.  were upset about the large tax-payer funded flows overseas. Can and should U.S. financial institutions expect the same treatment?

For more read:
NYT (10-23-2011) Bank's Collapse in Europe Points to Global Risks by Gretchen Morgenson and Louise Story


For a good short (<5 min) video news story about Dexia and the Euro Crises




Some thoughts for discussion:

1. Should trading partners be paid in full? Should trading partners take a haircut as a penalty for not being more careful with whom they traded?
2. Would increasing the risk of loss shrink international financial markets so much that real economies would grow slower in the long run?
3. Since the U.S. honored payments to AIG's European trading partners, should Europe honor payments to U.S. trading partners?

What are the protestors protesting?

For a funny take on the protestors, watch Stephen Colbert in action:
Colbert Nation (9-21-2011) Wall Street under Siege

The Colbert Report
Get More: Colbert Report Full Episodes,Political Humor & Satire Blog,Video Archive

For a serious take on the protestors, with LOTS of charts read:
Business Insider (10-11-2011) CHARTS: Here's What The Wall Street Protesters Are So Angry About...

This article provides the facts that the protestors have yet to clearly articulate.
Note: figure numbers below represent the order of figures in the article, and not the labels given in the article (many graphs are not labeled with a number).  If I were presenting the protestors' case, the graphs that I would focus on are:

1. Figure 10: CEO salary as percent of average workers
This has been increasing dramatically. Perhaps shareholders should be protesting too.

2. Figure 15: Chance of upward mobility (probability of rising to top 40% of income distribution)
This is now much lower than it was in the 1950's (though it hasn't changed much recently).

3. Figure 24: Bank lending
Bank lending after the bailout has been weak, lower than before the crisis, despite large profits. One of the major goals of the bailout was to increase bank lending.

4. Figure 30 (the last figure): Wages as share of the economy
This has been falling since 1970. The article calls this figure the "money shot".

Questions for students:
1. Did any of the graphs surprise you?
2. Did you find any of the graphs to be misleading?
3. Are there other related graphs you would like to see?

Dueling Nobel laureates on stimulus plans

Two leading conservative economists from over at the Hoover Institution,

WSJ (10-3-2011) Stimulus Has Been a Washington Job Killer by John F. Cogan and John B. Taylor

(22 minute interview with John Taylor)

Link to John Taylor interview (6-24-2011)

On the opposing side.

NYT (7-28-2010) How did we know the the stimulus was too small? Paul Krugman

(21 minute interview with Barton Biggs - calling for bigger stimulus)

Link to interview with Barton Biggs (7-1-2011)

To hear Krugman in his own words (11 minutes, starts at 7 min 30 second mark and finishes at 16 minutes, followed by question and answer session)
Paul Krugman lecture (12-21-2010)

Krugman talks about Japan's long period without growth, and implications for U.S. policy.

For my students:

1. Using the facts at hand, try to argue the case opposite to your initial beliefs.

2. Conclude with a discussion of the key concept that sways your final opinion.

The Lucas Critique implications for current policies

I can't resist sharing this article about Robert Lucas, one of the most influential economists of the last 50 years. In an interview, Lucas is asked how his findings relate to the current economic slowdown. Lucas suggests that while a stimulus might have been the right idea in 2008, its time has past. He now supports structural reforms that realign incentives towards growth. This dovetails nicely with his research on the importance of people's expectations and incentives.

See article:
(WSJ 9-24-11) Chicago Economics on Trial by Holman W. Jenkins Jr.


For a 4 min bio on Robert Lucas and an summary of his famous "Lucas Critique"
Short Youtube video clip on Robert Lucas, life and works

The Shrinking Middle Class and the Gini coefficient

(WSJ 9-12-2011) As Middle Class Shrinks, P&G Aims High and Low by Ellen Byron

In this WSJ article, Ellen Byron proves to sceptical economics students that businesses actually do use Gini coefficients. Gini coefficients are a handy measure of how evenly income is distributed in a country. A Gini coefficient of 0 would indicate everyone in the country has exactly the same income. A Gini coefficient of 1 would indicate one person collects all income. The U.S. is in the middle of the global rankings. Almost all countries in Central and South America and Sub-Saharan Africa have more income inequality. China also has more income inequality - primarily due to its rural/urban divide. European countries and Canada have had less income inequality than the U.S., but that may change as many governments are forced to cut back on spending.

The article points out that the U.S. Gini coefficient has been growing in the current recession, and suggests that it is likely to stay higher. This shrinking of the middle class is forcing many companies like Proctor and Gamble to change strategies. 

Questions for students: 

1.  Have you observed this phenomenon in your company's industry?

2.  If so, has your company changed its target consumer or altered its marketing/production strategies in response to these changes?

3. Do you think this a problem? Should policy makers address this shift? If so, how?

For the curious, here is a nice graph demonstrating the Gini coefficient (thanks to Wikimedia Commons). 

Taking stock of current conditions

Professor Tyler Cowen of George Mason University writes a blog (The Marginal Revolution) that ranked 21rst on WSJ's list of top economics blogs (see WSJ ranking of economics blogs 2009).


Video Interview with Tyler Cowen (13 minutes)

Cowen raises an interesting point;  this recession exposed structural problems that have been brewing in the U.S. for decades.  In particular he thinks the U.S needs to improve its education system in order to sustain growth and innovation.

Economics as a profession is also open for reform.  Cowen suggests that academic economists have become too specialized and don't have much to say - without devolving to partisan politics. This has created a niche for bloggers without pedigrees to weigh in with important ideas.

Despite a libertarian bent, Cowen supports more Fed action to help the U.S. economy recover.

For a good overview of the current state of the U.S. economy see:


(The Economist 8-27-2011) The Economy's Prospects

Here is a question for my students. What do you think about the relative merits of:

1. Further government spending in the short run (say on infrastructure),
    perhaps linked to long term budget agreements.
 
2. Fed activity to lower long term interest rates

3. Tax and regulation reform

Why target inflation at 2%, and what exactly should the Fed target?

Most central banks around the world target a 2% annual increase in prices, some more formally than others. The arguments for a 2% target include:


1. Deflation (falling prices) is so dangerous and hard to fix, that is better to leave a little cushion on the positive side.

2. Measuring inflation is hard. If statisticians don't fully account for how people change their purchases in response to relative price changes, then the reported inflation rate may overstate actual inflation. For example,  people drive less when gas prices go up and so use less gas. The reduction in quantity of gas consumed may not show up in inflation estimates (depending on which formula is used).  An inaccurately measured inflation rate of 2% might be consistent with an unchanged cost of living.

Note: The U.S. does produce an estimate of inflation that attempts to address changes in consumption patterns. This more accurate measure of inflation is not currently used in calculating COLA's (cost of living adjustments) for Social Security. If the current round of U.S. budget haggling is successful, that may change. The government would save a lot of money, but retirees would see smaller increases in annual income from Social Security.

3. A little inflation "greases the wheels" of commerce.

This argument in favor of a 2% inflation target requires further explanation.  For simplicity, let us focus solely on the major cost category of production, wages.

If ALL workers' nominal wages go up 2% but prices also go up 2%, then their real wage stays the same.  Recall: nominal wages = dollar amount printed on your pay stub, while real wages = nominal wages adjusted for inflation (a measure of how much stuff you can actually buy). Workers would only be happy in this scenario if they suffer from money illusion; they don't notice that they can only buy the same amount of stuff this year after their raise as they could buy last year before their raise.

However as discussed in Krugman's post, pay raises are NOT the same for all workers. See (7-9-2011) Why are wages still rising? by Paul Krugman.  Over time firms discover some workers are more productive than others.  At first glance, firms would like to give pay raises to some employees and pay cuts to others.  However, workers don't like pay cuts, and unions may make them near impossible. In addition pay cuts hurt morale and productivity, so firms don't like them either. Economists call this "downward nominal wage rigidity". Data shows that this phenomenon really does exist. See article mentioned in Krugman's post June 2010 NBER working paper) Some Evidence on the Importance of Sticky Wages by Barrattieri, Basu, and Gottschalk. 

Since firms find it difficult to lower nominal wages, firms respond by keeping some workers' nominal wages constant and raising the nominal wages of others.  If the inflation rate is positive, say 2%, unproductive workers save face by not getting a nominal pay cut - but the workers' real wages do go down (they can't buy as much of the now more expensive stuff).  By raising output prices 2%, firms can cover the cost of pay raises to their most productive employees without pay cuts to their less productive workers. In this way a little inflation "greases the wheels", and allows business to operate smoothly in spite of downward nominal wage rigidity.

Related research...
Some economists have proposed that central banks should target increases in nominal wages instead of increases in overall prices.  This might lead to a more stable economy, less prone to cyclical swings. From the discussion above, a nominal wage inflation target should also be set above zero, perhaps at 2%. For an excellent review of the long history of this idea, here are two other blogger's thoughts:

(July 2011) The Money Illusion

(5-2011) Why target the CPI? by Matt Rognlie

College Education & Opportunity Cost

In terms of rate of return, investing in a college education beats most alternatives, including the stock and bond markets. According to a recent Brookings research paper  (see Brookings paper), investing in a college education yields about a 15% annual internal rate of return.                              

This article provides a nice example of opportunity cost. Opportunity cost is a key concept in economics, but it is often poorly understood. Imagine you are at a decision point in life, a fork in the road. You can think of "opportunity cost" as the value of the road not taken. More formally, opportunity cost is the value of the next best alternative.  The opportunity cost from going to college is the foregone earnings you could have earned ($54,000).

Sometimes students have a hard time seeing foregone wages as a real cost. Suppose you decided not to go to college. You wouldn't fork over $48,000 for tuition and fees and you would pocket $54,000 from earnings. You would be $102,000 richer than your friends on the day they graduate from college.  Your friends would have forfeited their $102,000 to go to college.

Table based on Brookings paper, see NCES for tuition data

Note that the opportunity cost ($54,000) for a typical high school student is greater than the tuition cost at a 4 year college ($48,000). The tuition costs do NOT include room and board, since people must eat and sleep whether they work or go to school.  For most people, the gain in income from college ($570,000) far exceeds the combined costs of tuition and foregone earnings.

Admittedly some people, like Kobe Bryant, have a special talent that allows them to earn a huge salary without going to college. For these people, the opportunity cost of college is in the millions, and they are much less likely to go to college.  While some of the uber-talented still do go to college (think of starlets like the actress who played Hermione Granger), they presumably place a lot of value on the social, intellectual benefits of college and have a flexible earning schedule.  For the rest of us ordinary mortals, the 15% rate of return on a college education should be too good to pass up, especially when all the non-monetary benefits are considered.

For a note of caution on students loans and making sure you get something useful out of college, watch:

http://www.5min.com/Video/Evaluating-the-Costs-of-College-445269349

Evaluating the Costs of College

Returns for a full-time MBA also look good. Davies and Cline (2005) estimate that the internal rate of return on  a MBA was 18% and the average payoff time was about 9 years (time until extra earnings from MBA covered tuition and foregone earnings). The rate of return may actually be lower for top 10 MBA programs due to greater costs (see reference for Grady below for literature review).

BizEd (Jan 2005) The ROI on the MBA by Antony Davies and Thomas W. Cline

For EMBA students, you may already know that EMBA students' responses on surveys usually show more satisfaction with their MBA program than part-time or full-time MBA students. Since EMBA students do not forgo earnings, their payoff time is much quicker, closer to 4 years.

See:
 (1) Bruce, Grady (2010), Exploring the Value of MBA Degrees: Students’ Experiences in Full-Time, Part-Time, and Executive MBA Programs, The Journal of Education for Business, 85(1): 38-44. or 


(2) Executive MBA Council, Research on Return on Investment

The Bottom Billion

In this video clip Paul Collier talks about new breakthroughs since he published his book, The Bottom Billion, in 2007.  In addition to explaining why Africa is poor and what can be done about it, this book also explains in every day language: trade theory, exchange rates, and the history of key institutions like the World Bank. Collier says he wrote the book so it could be read at the beach. If a student could read only one book about economics, this might be it.

Paul Collier speaks in Brussels in 2010 (19 minutes)
http://www.youtube.com/watch?v=jht1JcFcNJg




For the lazy, cliff notes and perspective provided by the New York Times

NYT (7-1-2007) The Least Among Us by NIALL FERGUSON

For the curious, who want to buy the book:

http://www.amazon.com/Bottom-Billion-Poorest-Countries-Failing/dp/0195311450

Is the strong euro here to stay? The Cheeto-peanut parable

Krugman argues the euro will stay strong,  no matter what happens to Greece.   He suggests thinking of  "the euro-dollar exchange rate as if it were an exchange rate between the solid euro core — Germany, France, and a few others — and the United States."  NYT (6-1-2011) The Strength of a Failing Euro (Wonkish) by Paul Krugman

According to Krugman, investors expect the European Central Bank (ECB) to keep inflation in Europe lower than in the U.S.  This means that even if nominal interest rates are the same in the EU as in the U.S., investors expect higher real interest rates in the EU. 

Example: 

real interest rate = nominal interest rate - inflation rate (approximately)

Suppose nominal interest rate = 3.5% in both places, but inflation = 2% in EU and 3% in U.S., then the real interest rate in the EU = 1.5% and in the U.S. = .5%. 

European investments look better.

As long as the real rate of interest is higher in the EU, investors will want to park their money in Europe instead of the U.S.. This will require buying euros (and possibly selling dollars) which drives up the price of the euro (in terms of dollars).

Other experts caution that the euro could be set for a fall. Once the full extent of European banks' exposure to Greek debt is revealed,  the markets may conclude that Europe's core economies are not as solid as previously thought.  If so investors would pull their money out of Europe and into the U.S., especially into U.S. Treasuries. This would weaken the euro and strengthen the dollar. 

For the cautious argument watch the following CNBC clip: http://www.youtube.com/watch?v=J_SjxBAGk34

Let's look at the strength of the euro  in terms of  lunch room trades.  In this parable let Cheetos = euros and peanuts = dollars.  The European Cheeto Bank (ECB) sets the interest rates for Cheetos - if you save one Cheeto today you get two Cheetos next week. Initially a child can trade 5 peanuts for 1 Cheeto.

Suppose on Tuesday, a teen rock idol announces a love for Cheetos (or the ECB raises the Cheeto interest rate), then Cheetos become even more popular. Those unlucky kids whose moms' packed them peanuts will have to give up even more peanuts to get a Cheeto. They might have to give up 10 peanuts for 1 Cheeto. The cost of Cheetos in terms of peanuts  has increased from 5 to 10. The Cheeto (euro) is strong against the peanut (dollar).

However,  suppose on Thursday, a popular starlet announces that she thinks Cheetos are gross. She further exclaims that anyone who wants to be thin and cool should only eat natural foods, like peanuts (e.g. European banks' balance sheets are revealed to be gross). Peanut packers are suddenly looking good. The cost of Cheetos in terms of peanuts might fall to 4 as students flock to the safety of food without artificial colors. The Cheeto (euro) is weak against the peanut (dollar).

And yes, I did trade peanuts for Cheetos at school.  Fortunately,  I had a nice friend who gave me Cheetos even though there was no market for peanuts. While this does suggest that economists need to model altruism more carefully, we can probably safely ignore it in the foreign currency markets.

Institutions and growth (China vs. India)

While China is now wealthier than India and still growing faster, India's long run prospects may be greater. Institutions are the key. As discussed in the WSJ link below, China may hit a wall at about $15,000 per capita unless it reforms it institutions (private property, courts, press etc.). India's democracy will make it easier for it to reform its institutions. Today's election results in India suggest that voters are increasingly desirous of transparent, corruption free government.


WSJ (5-16-11) "Politics Plays Part in Achieving Rich-Nation Status" by Mark Whitehouse

WSJ (5-17-11) "Greater Expectations in India" by Ruchir Sharma

Here listen to one of the economists cited in the WSJ article,  Daron Acemoglu (MIT), talk about why countries differ in wealth:

Hyperinflation Zimbabwe Style

A recent article in the WSJ prompted me to make an eBay purchase - of 100 trillion dollar bills in Zimbabwe currency, the highest units of currency ever printed. Someone is making a fortune on these now defunct bills that are worthless in Zimbabwe. However, I think they will make a nice prop for class. (see WSJ 5-11-11, "Zimbabwe's 100-Trillion-Dollar Bill Is a Hot Collectible"). 

People in Zimbabwe now use the U.S. dollar or South African rand to conduct transactions. Zimbabwe is not alone in using the U.S. dollar as currency. Some countries use the U.S. dollar as their official currency (ex: Ecuador, El Salvador, and East Timor). Other countries set a fixed exchange rate between the local currency and the U.S. dollar, and accept dollars in transactions (ex: Panama, various Caribbean islands, and Lebanon). In yet more countries, the U.S. dollar is not the official currency or linked by a fixed rate, but is still accepted in transactions (ex: Peru and Uruguay).




To get an idea of what it was like to live through hyperinflation in Zimbabwe watch,


Uploaded onto YouTube by NTVKenya on Aug 19, 2008

Walmart in India

Raj Jain, President of Walmart India, talks about the potential outcome if India opens retail to foreign businesses. Currently, foreign companies like Walmart are limited to wholesale joint ventures (i.e. must partner with another Indian company and can only sell to stores, not directly to consumers).

- Now 30-40% of food output does not make it to consumers. Jain thinks a good cold chain could cut that in half. He points out that the spoiled food is not necessarily wasted - it is used to feed animals.

- Consumers would gain from the convenience of one-stop shopping, transparent prices without bargaining, and frozen foods. Jain notes that China opened up retail 15 years ago but 75% of retail sales are still conducted at Mom and Pop shops. Walmart would not mean the end of local retail.



Economist (4-14): Retailing in India Send for the supermarketers

Final Fed lecture

For the last post of the semester, I invite my students to watch and comment on two opposing views on quantitative easing. The term quantitative easing is used to describe the Fed's policy of buying  assets to pump money into the economy, thereby stimulating demand and reducing unemployment.

Opposed: over 4 million views, and lots of errors (jokes?) (7 minutes):



Pro: less than 6 thousand hits, but no errors (3 minutes):

The natural rate of unemployment

Christina Romer is currently on President Obama's Economic Recovery Advisory Board and was the former Chair of the Council of Economic Advisers. She is a full professor at the  University of California, Berkeley with an illustrious research and teaching record.

In this New York Times article she makes a good argument that the structural unemployment rate has not increased. If the unemployment rate stays high for a long time then the story changes - some people could lose their skills and become long-term, structurally unemployed. Some economists have argued that there already has been an increase in the number of long-term, structurally unemployed due to problems in the housing and financial sectors.

Romer points out that there were only 1.3 million people working in those sectors before the crisis. Even if none of them ever work again (but keep looking so they still count as unemployed), there are too few of them to have a big impact on the national unemployment rate. This ignores the possibility that other people who made stuff for new houses (like refrigerator manufacturers or landscapers) might also be permanently out of work.

For me, her most convincing point is that people who lost jobs in the housing and finance sectors are able to find new jobs at about the same rate as people who lost jobs in other sectors. In other words, people who worked in housing and finance are able to switch sectors - they are not much more likely to stay unemployed than anybody else. Once the recovery is fully underway they, and the rest of cyclically unemployed, should be able to get new jobs.

For more on this, and the effect of underwater homes see:

NYT (4-10-2011): Jobless Rate is Not the New Normal by Christina Romer

Jan Hatzius, Chief Economist for Goldman Sachs, agrees the natural rate (= structural + frictional) has not increased much and is probably now about  5.5%. (from 9-1-2010 interview on CNBC, 5 minutes)



Crash course on structural, cyclical and frictional unemployment (2 minutes)

Fun with Graphs

Graphical tools can help tremendously with information overload. A challenge for my students: this week look over these sites and report on a pattern you observe. Try to find a pattern other students haven't found yet.

I. McKinsey's interactive graph on cities
McKinsey Quarterly : Cities the next frontier for global growth (2011)

Below is my favorite graph of the hundreds you can generate yourself at this McKinsey site.  It shows which cities will have the most  middle class consumers (households with income greater than $20,000 per year) in the year 2025. The height of the bar represents the number of middle class households. Only the top cities (by number of middle class households) are shown. I counted 23 bars.

This graph sends a clear  message to business:  if you want to sell lots of product in 2025, then you need to be entering emerging markets now. By 2025, only 3 of the top 23 cities (ranked by number of prospective middle class customers) will be in the U.S..

II. Gapminder's interactive graphs on health and wealth
Gapminder World
If this doesn't load, go to http://www.gapminder.org/ and then click on tab for Gapminder World

Below is a screenshot of one of Gapminder's interactive graphs for 1950. There was a clear distinction between groups of countries. By 2009, things look very different - only Sub-Saharan Africa and Afghanistan fall in the Developing Countries square. This explains the rise of alternative labels - like low income countries (LIC).

Click on the following link to see the graph for yourself: Gapminder "developing country" graph . If you explore the site, you will find many other graphical demonstrations of the relationships between countries' health and wealth over time.

http://www.gapminder.org/GapminderMedia/wp-uploads/pdf_charts/GWM2010.pdf                    

Life Expectancy on vertical axis (y-axis) and GDP per person on horizontal axis (x-axis)

Key: Each country is a bubble. A bigger bubble indicates the country has more people.

The color of the bubble indicates where the country is located: 

             orange = Europe and former Soviet Union 

             yellow = North and South America

             red = Australia, China and Pacific Island Nations

             light blue = India, Pakistan, and Bangladesh

             dark blue =  sub-Saharan Africa

             green = North Africa

Touching the third rail

For the benefit of students who have not heard the expression "touching the third rail": Some trains are powered by an electrically charged third rail. It can kill  you to touch this rail.

In the U.S., entitlement spending has long been considered a third rail. Any politician who touches entitlements, would be run out of office. 

But finally, someone has been brave enough to propose actual legislation that addresses spending on entitlements. The big three entitlements are: Social Security (income for the elderly), Medicare (healthcare for the elderly), and Medicaid (healthcare for the poor and disabled - includes nursing home care for many elderly, approximately 25% of Medicaid spending goes towards the elderly - see Kaiser diagram).

By 2020, the Congressional Budget Office projects that these three entitlements will consume half of Federal spending. If  spending on entitlements is not cut and the U.S. wants a balanced budget by 2020,  then either: (1) military expenditures and discretionary spending will have to be cut sharply by 1/3, (2) taxes will  have to be increased, or (3) some combination of the first two options.

So far,  most polls of the public show they are opposed to cutting entitlements, but that has not stopped Congressman Paul Ryan from proposing a plan to tackle the U.S.'s long term budget deficit by cutting entitlements. He proposes changing the rules so that Medicare recipients receive a voucher towards their private health insurance (instead of the U.S. government footing the whole bill). Medicaid would be replaced with fixed block grants to the states. He didn't propose anything for Social Security, but frankly it is the least problematic of the three.

This proposal would limit the federal government's risk, but increase the exposure of states and future seniors to rising health care costs. Theoretically, it is possible that if plans are well designed, once consumers face more of the costs they will shop for bargains and the private sector will compete for them.

Ryan's plan would not affect anyone 55 years or older today. This would certainly increase its political chances of passing, but it may not be fair to today's younger generation. For more on this read,

NY Times (4-5-2011) Generational Divide Colors Debate Over Medicare’s Future

Now it is up to the Democrats to offer details of an alternative solution. Some solution is required.

Notes: According to the congressional Budget Office (http://www.cbo.gov/doc.cfm?index=12103), total projected federal spending in 2020 is $5,412 billion, and total projected federal revenue in 2020 is $4,703 billion. This results in a projected deficit of $710 billion. To close the $710 billion budget gap solely by reducing spending on defense and "other", spending on these programs would have to fall from $2,057billion (16% + 22% of $5,412 billion) to $1,356 billion ($2,057 - $710), which represents a 34% drop.  

ECONOMIC OUTLOOK AND FISCAL POLICY CHOICES, SEPTEMBER 28, 2010

Testimony before the Committee on the Budget, United States Senate (charts)

http://www.cbo.gov/publications/bysubject.cfm?cat=32

The Fed and AIG

Now that the economy has improved. AIG put in an offer (at 53 cents on the dollar) to buy back assets from the Fed. The Fed is instead selling them at auction to get a better deal for the taxpayer. Ironically, this could end up hurting the tax payer in May, when the Treasury tries to sell off its holdings of stock in AIG. For more read:  WSJ (3-31-2011) Fed to Sell Subprime-Mortgage Bonds From AIG Bailout )



For the curious, here is a good recap of the troubles at AIG (American International Group). Basically, AIG is a huge insurance company that in 2008 insured many supposedly safe assets for other financial institutions.  When these assets started looking risky (many were housing market related), it became clear that AIG would not be able to make good on all its insurance payouts. Had AIG failed, it would have taken much of our financial system with it. Hence, AIG was "too big to fail".

Falling Giant: A Case Study Of AIG by Gregory Gethard

Ode to Balance

WSJ (3-26-2011) 'Mommy Track' Without Shame by Virginia Postrel

In the most recent weekend edition of the WSJ, Virginia Postrel rights about 'MBA mothers' and the strategies younger women are pursuing to balance work and family. Since most college students will soon be making these decisions  themselves (with their spouses), I thought it worth a post.

Full disclosure, I find this article gratifying. I switched from a tenure track position (high status in academia world)  to an adjunct position in order to gain more time with my children. This was an unusual move at the time to say the least. I took a leap of faith that when I was ready I could get back on faster path.

I took inspiration from the example of the prominent mathematician Mary Ellen Rudin.  My father is a  mathematician in the same field as Mary Ellen Rudin, and he often talked about her unusual career path.
According to his version of the story, for years she worked in the background while raising her children. Eventually as her publications mounted, she was promoted from adjunct professor to full professor - and became universally recognized as one of the top mathematicians in the world in her field. I am not plotting my ascendance to world domination, but it is nice to know someone else has done it.

I suspect the next generation of men and women going through college now will be even more willing to reshape career paths to fit their needs.

JP Seiden, management consultant, takes a bleaker stance on work-life balance in this clip for college students and interns in 2009 (5 minutes).

Bernanke and challenges facing the Fed

 To read about the policy challenges facing the Fed, click on

WSJ (3-24-2011) Crises Scramble Fed's Inflation Calculus by David Wessel

or watch this interview with David Wessel (3 min)


David Wessels points out that if fears of oil price increases drive up prices (make AS shift left), the Fed will not be able to keep stimulating demand (make AD shift right) without further driving up prices.

Currently the Fed is keeping interest rates low and buying assets, and thereby pumping money into the economy. In the graph below, this policy results in a rightward shift in the aggregate demand curve from AD1 to AD2. This should move the U.S. economy from point 1 (now) to point 2 (by about 2012). If all goes as planned, the U.S. would enjoy higher output (and hence lower unemployment) with only a slight increase in prices.

Unfortunately for the Fed, oil prices increases and inflationary fears may shift the aggregate supply curve left from AS1 to AS2.  If the Fed sticks with its current policies, this decline in the AS curve would send the economy to point 3, with rising prices (i.e. inflation). To fight inflation, the Fed would be forced to stop stimulating demand; AD would stay at AD1 instead of shifting right to AD2.  The Fed would have to raise interest rates and/or stop buying assets. 

So instead of moving from point 1 to point 2, with more output (and less unemployment) and mild price increases, the U.S. could end up at point 4, with less output (and more unemployment) and price increases. The Fed's hands would be tied.  Due to higher inflation, it would not be able to maintain an expansionary monetary policy intended to increase output.

Note: I have simplified Wessel's analysis by  ignoring the possibility that AD could shift left from AD1 due to reduced consumer demand. This would reduce output even further.

Watch Ben Bernanke testify before House Budget Committee,  2-9-2011 (4.5 minutes)

http://www.youtube.com/embed/MXYgwZBIaWY

Bernanke points out that countries can run into trouble when the ratio of public debt to GDP reaches 100% - and that it would be ideal if the U.S. started addressing its long term problems now. He also cautions against drastic cuts right now as that will slow the recovery.

Bernanke also discusses: (1) continued expectations of low inflation for the next few years,  (2) while the Fed's primary objective is stimulating the economy, its efforts have brought in substantial revenue to the Treasury, 125 billion in last 2 years, (3) once the economy recovers, any losses at the Fed should be more than covered by extra tax revenue (due to booming economy) so the Fed will not become a drain on the Federal budget. 

When asked, Bernanke also gives an estimate of the number of jobs saved by the Fed's stimulus actions. He says a credible study by Federal Reserve economists found the Fed saved up to 3 million jobs. To watch more of Bernanke's testimony (1 hour 35 minutes) click on

http://www.youtube.com/watch?v=YibSWTEJ4rc&feature=related

Japan's disaster and the global economy

PBS Newshour interview with Greg Ip, journalist for The Economist on 3-15-2011 (7 min)


Greg Ip concludes that, barring a nuclear accident,

"The bank of Japan has the means to finance plenty of borrowing, the Japanese are very higher savers, .. and it is conceivable that if  done right a really, vigorously financed, executed reconstruction scheme could, in the end, prove to a big boost to Japanese growth."

As long as global supply chains are not disrupted for too long, the disaster should have little economic impact on the global economy.

To read The Economist article on this topic click on:

Economist (3-17-2011) The cost of calamity

For yet more video of reactions of experts
Bloomberg Video Clip (3 min)

Fix the budget or else ... the bond market will make you

Just like students get good grades from their teachers for good performance, countries get good grades from the bond market for living within their means (i.e. expenditures don't greatly exceed revenues).  Good grades from the bond market come in form of low borrowing costs, i.e. low interest rates, on government debt. The U.S. is currently able to obtain low borrowing costs from the bond market - but that will change if we don't tackle our long term spending problem.

To see how the bond market can "school" countries, just look at  Greece in 2010.  The international bond market decided that Greece's economic policies were unsustainable, and began charging Greece a  much higher interest rate when it issued new bonds (to payoff old ones). Greece was forced to make major cutbacks in pay and benefits for public employees, and government programs. There were riots in the streets.


Bloomberg 3-7-2011 Interview of JP Morgan's Chief Economists (5 min)

As a rule of thumb, a country starts getting in trouble with the international bond market once publicly held debt reaches 100% of GDP. The U.S. and many other countries will be there soon.  To read about the latest progress in addressing the U.S. budget problem now (before the bond market makes us) read:

WSJ (3-14-2011) Serious Debate on the Budget has Started

Three Wishes

The other day I played the three wishes game with my daughter.  At first she picked wishes that would help her immediate family. I told her as nice as that sounded, my first two wishes would have to be the eradication of  malaria, and a way to solve problems without war.  Hey, wishes don't have to be realistic. Improvements to education would certainly be a valid candidate for the third wish.

For some news on the malaria and education front - watch this great 20 min speech (2-2009) by Bill Gates. Some might disagree on the relative devastation caused by baldness.

http://www.youtube.com/watch?v=tsgvhP07BC8&tracker=False



In addition to vastly improving quality of life, all three of my wishes would certainly improve the world's economic condition.

As discussed in an earlier post (3-2-2011), the GDP of the U.S. in 2008 would have been at least 9% higher (1.3 billion loss due to low scores, estimate by McKenzie/14.4 billion 2008 GDP from BEA) if the U.S. had closed the achievement gap with the best performing nations. 

Likewise, malaria imposes a big cost on GDP in many African countries. Malaria may have been responsible for more deaths than any other disease in human history. Malaria used to be a problem everywhere, but is now limited to a band around the equator. From the World Health Organization (click on Fact number to go to the WHO site): 

Fact 10: "Malaria causes an average loss of 1.3% of annual economic growth in countries with intense transmission. It traps families and communities in a downward spiral of poverty, disproportionately affecting marginalized and poor people who cannot afford treatment or who have limited access to health care. Malaria has lifelong effects through increased poverty and impaired learning. It cuts attendance at schools and workplaces. However, it is preventable and curable."

Fact 3:  "One in five (20%) of all childhood deaths in Africa are due to malaria. It is estimated that an African child has on average between 1.6 and 5.4 episodes of malaria fever each year. Every 30 seconds a child dies from malaria in Africa."

For an interesting take on the war front as it pertains to the middle east - watch:

http://www.youtube.com/watch?v=yKQnL9Mmgng&tracker=False





What would your three wishes be?

Entrepreneurship and Growth

Great talk (3-2009) by noted Harvard Professor Tarun Khanna - 55 minutes long including Q&A.  Talk starts off with discussion of Slum Dog Millionaire, and touches on political freedom/elections and micro finance. Local money lenders may require over 1000% (on an annual basis) for loans, whereas NGOs (non-government organizations) or for-profit micro finance companies can offer 20%.


The Economist (see article link below) discusses the role of entrepreneurship in creating jobs - and offers it as a solution to the unemployment problems that sparked revolution in the Middle East. They relay the findings of the Kauffman Foundation, that "between 1980 and 2005 nearly all net job creation in America took place in firms that were less than five years old".
Economist (2-26-2011) Uncorking enterprise

Unfortunately, entrepreneurial activity in developing nations is hard to measure. Some is very productive, but some is just a desperate attempt to earn anything in the absence of other alternatives. A new index tries to measure entrepreneurship better.
Global Entrepreneurship and Development Index

A Union Expert Weighs In

Harvard Professor Richard Freeman is an expert on unions and finds that they increased productivity and wealth in the U.S. in the last 20  years.

Excerpt from an interview

For a fun (friendly) poke at Freeman, watch this Stephen Colbert clip:

Prof. Freeman does recommend one change that unions don't like: allowing firms to form committees with workers to improve conditions. Apparently forming such committees can get firms in trouble in the U.S. (violates National Labor Relations Act, see legal stuff). According to Freeman, these committees work well in Canada.

Freeman's critique of current labor union laws: http://economistsview.typepad.com/economistsview/2010/10/richard-freeman-labor-law-is-broken.html