I told you the money supply doubled!

Remember, the monetary base is the amount of money in the economy that can be used for the exchange of goods and services. Look at the this graph...look at this graph!  This is like flying a helicopter and dropping thousands of dollar bills in every American town.

The Money Supply Has Doubled!

When our economy was on the gold standard, the amount of gold dictated the supply of money. The U.S. abandoned the gold standard in 1971, yet money is still valuable because there is a limited supply of money and it is accepted as a means of exchange.

In reality, the monetary base is our money. The Monetary Base is the amount of currency and reserves at the Federal Reserve Bank (FED). Only the FED can change this base, and just like the amount of gold determines the level of prices on a gold standard, the size of Monetary Base determines our prices level.

During a Cato Institute podcast on 12/9/08, economist Lawrence H. White noted that the Monetary Base has more than doubled in the last year!

More than doubled! In some settings, wouldn't this double prices (like in MV = PQ if V, and Q are unchanged)? Am I missing something?

Thoughts on Austrian Economics

Austrians tend to think of markets as an incredibly wise mechanism for allocating resources. Austrians also tend to think that increasing the money supply produces tough economic adjustments and perverse prices. Resources are not allocated well as a result, which is why they champion the gold standard.

But if markets are so wise, shouldn't markets be able to accomodate an increase in the money supply quickly and painlessly? If the money supply doubles, markets should quickly double all prices.

It often appears Austrian thinking is less about economic theory and more about political ideology.

Michael Pollan Stars in Atlas Shrugged

In the thought-provoking novel Atlas Shrugged, the mother of a politician dreams of converting the world to soybeans. Emma Chalmers, the mother's name, was a sociologist, whose judgment was held in high regard by politicians.

She considered the soybean a more nutritious and economical plant than more traditional food crops such as wheat. Her thoughts are best illustrating through her remark, "and if all of us were compelled to adopt soybeans as our staple diet, it would solve the national food crisis and make it possible to feed more people. The greatest good for the greatest number--that's my slogan."

Consequently, vast sums of money were directed by politicians into Project Soybean. Another consequence was that the soybeans were harvested prematurely due to inexperience with such large acres of soybeans in new areas. The politicians diverted railroad cars to receive the shipment of the inedible soybeans, causing wheat farmers in other areas to have no market for their product. That nutritious, edible wheat rotted in piles on the ground, awaiting rail cars that never came. Farmers rioted, and people starved.

Of course, Atlas Shrugged is fictional, and took place a long time ago, when many people mistakenly thought a socialist-type of economy might work. But it provides lessons for today. Consider the following.

Bill Moyers recently interviewed Michael Pollan, the author of books about food. While championing the local food movement, Pollan states, "And let's require that a certain percentage of that school lunch fund in every school district has to be spent within 100 miles to revive local agriculture." (transcript available here)

What hubris, and what insanity. Michael Pollan is a smart guy and makes some great insights. He is well-intentioned. It is true that people should eat more vegetables, and it is true that government should not subsidize foods such as corn syrup. But this suggested requirement is insane. It is okay to claim that we need to provide healthier school lunches, but it should not be Michael Pollan's job to determine how the healthier lunch is provided. Efforts to increase healthy vegetables and fruits in school lunches should give schools more money to do so and requirements regarding the nutritional content of the food, but let the schools and the food market determine where and how the food is produced.

Can you imagine the insanity of requiring a small, rural North Dakota school to provide 25% of its food from local sources?

Pollan is commended for his knowledge and efforts to education the public. But he is not so smart as to tell each individual school where their food should be grown. This hubris is not laughable, it is dangerous. This is why Ayn Rand wrote Atlas Shrugged.

Unintended Consequences

Economics professors love to make themselves look smart and policy makers look stupid. Hence, we love the Law of Unintended Consequences. This article provides a great overview of the law and examples. Below is a new example I found from the Journal of Public Economics.

U.S. counties which enacted smoking bans has experienced a 13% increase in fatal alcohol-related car accidents, as smokers drove further to find a bar that allows them to smoke. Which would you rather experience, second-hand smoke or a car accident?

Saving for Retirement

I would bet that very few individuals, even the most savy, know how much they "should" save to reach their retirment goals, or know what their expected retirement income is. The recent edition of The Economist provides a great rule of thumb we should relay to our students.

That approach will be hopelessly inadequate for those who want to build a decent pension, especially in defined-contribution, or money-purchase, schemes, where the employee bears all the investment risk. The average American scheme member contributes just 7.8% of salary to his pension scheme. His employer, on average, contributes only 4.4%. He has a pot worth only $68,000. A rule of thumb is that total contributions need to be around 20% of wages to match a traditional final-salary scheme.

The Economist, 12/6/08, page 13

Put your money under the mattress

From the 12/6/08 edition of The Economist

Any American who has diligently put $100 a month into a domestic equity mutual fund for the past ten years will find his pot worth less than he put into it; a European who did the same has lost a quarter of his money.

It is depressing that owners of capital cannot make money, even within a 10 year period.

The article also suggests a concept we should be teaching students. In times, such as these, we should buy, buy, buy! The Economist says,

If savers treated financial assets as they do other goods, they would sell them when they are expensive and buy them when they are cheap. Actually, they do the opposite.

Wealth of Nations: Part 1

While reading the first two chapters of Adam Smith's Wealth of Nations, I am struck by his frequent use of the word "opulence" when discussing the wealth generated by the division of labour. He could have just said wealth, or possessions, or living standard, but he chose what is a rather dramatic word. The use of "opulence" reveals just how large the benefits to the division of labour are, and how impressed he was.

I am also awestruck by his superb writing.

I read these chapters while watching my students take my final exam. They are a beautiful group of people, and quite diverse in their natures and talents. They will go into a variety of careers, and all do well. It is the division of labour, I learned, that results in these differing talents, and these differing talents that help make the division of labour so valuable -- produce such opulence! Consider these superb Smith quotes...

The difference between the most dissimilar characters, between a philosopher and a common street porter, for example, seems to arise not so much from nature, as from habit, custom, and education.

As it is this disposition which forms that difference of talents, so remarkable among men of different professions, so it is this same disposition which renders that difference useful.

Can Obama Create Jobs?

This nice Reason article talks about how Obama wanting to "create" 5 million green jobs really means 5 million jobs will be transferred from something else.  If green jobs are less productive than non-green jobs, it is akin to the Broken Window Fallacy.  Nice job, Reason, I haven't thought of it like that.

In the long-run, the supply of jobs is perfectly inelastic.  You cannot change the number of jobs, only the allocation of jobs across sectors.

Understanding Exchange Rates

Exchange rates can be difficult to understand.  The whole idea of exchanging currencies before one can exchange goods makes international trade more complicated than domestic trade.

I find it helpful to view a currency as consisting of two parts.  First, currency, as we are used to thinking about it, can be used to exchange goods and services.  If all countries used the same currency, trade would be simpler.  The second component of a currency can be viewed as a right to buy and sell in a particular country.  It is like an admission ticket into a country.  Let me explain.

The dollar is the currency of choice in the U.S.   For foreigners to obtain the "right" to buy and sell in the U.S., they must purchase dollars.  The dollar is then like an admission ticket into America. Once inside the U.S., the foreigners use those dollars the same way they use their currency as they proceed with buying and selling.  

Thus, when an American imports a good from another country, and when it pays in dollars, it is giving two things.  Those dollars given in payment give that country the right to trade in the states plus something of value to trade with.

So, suppose that we import tea from Sri Lanka.  Further, suppose that America comes out of its recession and once again becomes the preferred place of investment for people in other countries, including Sri Lanka.  Sri Lankans (is that what you call them) have a greater demand for American investments, and to purchase those investments, they need dollars.  They want more access to the U.S., and will pay a higher admission fee into the U.S.  When an American gives dollars for tea, it is now giving something of greater value, because the "right" to enter the U.S. is valued more.  Consequently, Americans can obtain the same amount of tea for less dollars.  The dollars are worth more.

I have learned that by viewing the dollars as a combination of these two parts -- a medium of exchange in the U.S. and an admission ticket into the U.S. -- in combination with the Indifference Principle, international trade and exchange rates become easier to think about.

Worst Intro Ever

Finally, after saying I was going to do it for years, I am reading Wealth of Nations front to back. Have you noticed that Adam Smith gave absolutely no introduction to this voluminous book?  He just went straight to talking about the division of labour without telling us anything about the purpose or outline of the book.

Best book ever, worse intro ever...

Best Economic Quote Ever

There is no grand narrative, only little stories. But the need for grand narrative is so firmly ingrained in human thinking that the fruitless search for it will never end. This book is dedicated to those for whom a partial understanding of complex reality is better than the reassurance of false universal explanations. 

--John Kay, last remark in Culture and Prosperity 

BTW, Culture and Prosperity is one of the best books about economic thought I have ever read.  If I live to an old age, I will read it at least seven times.

I have this friend, who...

Years of survey work has taught researchers that people misrepresent themselves on surveys. How do we accurately portrary people through research then?  My colleague Jayson Lusk and I have started accumulating evidence (references below) that instead of asking people, "what would you do...", we should ask them, "what would the average American do...".  When people answer this second question, they are really telling you more about themselves than they do in the first question.  

It is kinda like, when someone begins a question with, "I have this friend, who...", you know they are really asking for themselves.

I recently learned from Tyler Cowen's superb book Discover Your Inner Economist that people are sometimes more rational about choice when it concerns other people.  He states, "The more personal the choice, the more likely that fear drives out reason" (page 129).  For example, people make more rational choices about whether to take a vaccine when making the choice for others than themselves.

Lusk, Jayson L. and F. Bailey Norwood. “Bridging the Gap between Laboratory Experiments and Naturally Occurring Markets.” Journal of Environmental Economics and Management. Forthcoming

Lusk, J. L. and F. B. Norwood. “An Inferred Valuation Method.” Land Economics. Forthcoming.

New Era of Ag Econ

Last week I had the honour of being invited to the University of Nebraska to present my research on farm animal welfare.  At a party afterwards, I had a conversation with a researcher who received his PhD the year I was born.  He was, you could say, an economic behaviorist before his time; much of his research concerned violations of a standard rational utility function (what Diedre McCloskey calls the Max U framework).  In all those years, he was never able to get those studies published in an ag econ journal, because it violated Max U, but had to seek other journals.

Because my research on farm animal welfare assumed people may care for humans and animals other than themselves, he asked me if I had the same problem.  The answer is a definite no. Perhaps ag econ has drastically changed over the years, taking the Max U framework too seriously in the past when the economics profession never did.

Example: Jayson Lusk and I have a behavioral economics paper coming out in the American Journal of Agricultural Economics, where we show that contrary to the Max U framework, there can be a thing as too much choice (duh!).  The paper consists of four experiments, one of which shows that a significant portion of people are willing to voluntarily forgo choice and opt for a smaller choice set size, solely for the purposes of making the decision task easier.

The question is: are we behind the curve in the classroom as well?  Are we at least mentioning some of the results of behavioral economics?

Finance and the Macro

The internet is a specatular institution.  The financial chaos and employment woes are resulting in one of the most difficult economic times of my generation, and I am able to follow what the great minds are thinking through blogs.

For example, talking heads on the news keep stressing how important the financial sector is for the economy as a whole -- but why?  They never say. I doubt they really know.

But the gents at EconLog do.  See this posting for a superb economic story demonstrating the role of ordinary banks in creating economic wealth.

We are finally saving more money

Everyone is talking about nominal prices, money supply, blah blah blah. Everyone says all we need is more money, just hoping we can take our economy somewhat back to where it was.

What I like about the Austrian folks is that they tend to talk more about the real economy. They talk about real prices, not just nominal prices. They note that the economy is trying to get to a new equilibrium, and that causes some pain. We need to save more, and that is what people are doing now. See the graph below. This will hurt. But we are heading in the right direction.

Look again at the graph below. Shouldn't we be punished for a zero savings rate?

The Importance of California for Animal Rights Movement

Don't downplay the effect that Proposition 2 in California may have. When California committed to cut greenhouse gas emissions down to 1990 levels within 12 years, 17 other states followed. So did Congress and Britain.

One big difference: Schwarzenegger is against Prop 2.

Pilgrim Socialism

After arriving at Plymouth Rock in 1620, and after learning how to hunt and farm in current-day Massachusetts, the Pilgrims puruse a socialist economic plan for two years. Everything was owned by everyone. The pastures were held in no man's deed, so any person could place any cow on any plot of land at any given time. Yet who would want to make sure the cow eats, when its milk and meat will not be the product of one's labour, but instead shared with the colony. The colony's governor, William Bradford, wrote the following in his diary.

"community of property (so far as it went) was found to breed much confusion and discontent, and retard much employment which would have been to the general benefit and comfort. For the young men who were most able and fit for service objectived to being forced to spend their time and strength in working for other men's wives and children, without any recompense. The strong man or the resourceful man had no more share of food, clothes, etc. than the weak man who was not able to do a quarter the other could. This was thought injustic."

Bradford then turned to a more capitalistic form of economic order. How did it fair? Let's hear again from Governor William Bradford.

"every family was assigned a parcel of land"...[and each man was allowed to]..."plant corn for his own household." ..."This was very successful."..."It made all hands very industrious, so that much more corn was planted than otherwise would have been by any means the Governor or any other could devise, and saved him a great deal of trouble, and gave far better satisfaction."

Source: Dutcher, Brandon. "Give Thanks for Private Enterprise." Stillwater NewsPress. November 26, 2008. A4.

I Hate Aggregate Supply / Demand

Many economists are using aggregate supply and demand models to prescribe economic cures to our recent woes. At one time I knew AS / AD well, but never liked it or really felt comfortable with it. The AS / AD model using the concept of equilibrium to model disequilibrium, in a way. Thus, I was heartened recently to see these words from Gregory Mankiw, whose textbooks from which I learned AS / AD.

As a general matter, the state of aggregate demand depends on an amorphous variable called confidence. Anything that threatens to screw up AS in the long run most likely reduces confidence and AD in the short run. The textbook separation of AD and AS is useful for focusing discussion in the undergraduate classroom, but events in the real world are rarely so clean.

Entry Here

Blog Medley

Recent blog entries I like...

Teacher sells advertising space on his exams.

Thomas Sowell appropriately fires off at school administrators who seek to force students to perform community service.

Foreigners in Saudi Arabia get Farm Subsidies.

Great video explaining Collateralized Debt Obligations

Hank Williams Jr. plans to run for Senate in 2010.

What OK College Kids Listen To

Below is a list of what my Oklahoma agricultural college students are listening too. Artist on the left, album on the right.

If you're wondering, I'm listening to Panic at the Disco's spectacular new album Pretty.Odd, and as always, Wilco. I'm also trying the new Ryan Adam's album, but haven't made judgement yet.

Making Fun of Students

Here is a sentence from one of my student's papers. I added the underline.

Three quarters of them actually checked that they were more concerned after being presented the information, that's seventy-five percent.

Smoke'em if you got'em

For almost thirty years America has waged its war on drugs alongside South American governments. The result has only been the wasting of millions of dollars and a large prison population.

A number of politicians in South America are now proposing the legalization of drugs. If they do, we can finally see if it really works as expected.

Source: Cato Daily Podcast - Dec 1, 08

Blogs are awesome, and prestigious

I love blogs. They allow me to see what the great minds are thinking, and consequently, makes me a better economist. It appears blogs are becoming a legitimate and prestigious means of academic publishing. Tyler Cowen's book, Discover Your Inner Economist, like many books, tries to make the author appear to be one of the leading thinkers of the day. This is how they describe Tyler on the first page of the book.

TYLER COWEN is a professor of economics at George Mason University. His is a prominent blogger at marginalrevolution.com, the world's leading economics blog....

At no place do they mention Cowen's journal articles.

Unemployment During the Great Depression

Most economists know by heart the unemployment rate during the Great Depression: 25%. Today, I learned this number is a good number, but it is debatable whether it is the best number.

The government didn't take official statistics on unemployment back then, but one person, Stanley Lebergott, worked with the government to come up with some numbers. They are good numbers, but what I didn't know is that Stanley did not count temporary jobs in emergency programs. He only counted "regular work" like a government official or a full-time job in the private sector.

Other economists have argued these temporary jobs should count, and they address unemployment by including these jobs and also looking at the number of hours worked. Doing this, unemployment goes as high as 16% and as low as 9% during the Depression. Total hours worked during the Great Depression was down by 1/5, relative to 1929 levels.

More here.