Dr. Sherry Jarrell

A Lesson from former East Germans and more

Have you ever noticed how the most ardent supporters of capitalism and free markets are those who've experienced a world without them?  How those who speak out most poignantly against health care reform in the U.S. are those who've experienced nationalized health care?  No?  If you can, then, take a moment and think back to the coverage, the news, the sound bites.  Take a look, perhaps a second look, behind the headlines and I venture that you will find endless examples of this phenomenon.    It is those who have done without freedom of choice, free markets, and self-determination who treasure it most, who most understand its value, who've lived with the consequences of its absence.   

We need look no further than Chancellor Angela Merkel and her recent victory in Germany's national election. http://online.wsj.com/article/SB125403307571043923.html   Chancellor Merkel grew up in communist East Germany and is now leading Germany out of recession with tax cuts and reduced government spending. 

   We should be listening to what the world is telling us.  Very hard, and very quickly.  We don't want to have to lose it before we appreciate what we have.  

 

Comment on WSJ: Fed and inflationary expectations

Fed Acknowledges Inflation Hawk Concerns

By Jon Hilsenrath

Today’s Federal Open Market Committee statement included a nuanced tip of the hat to hawks on the central bank’s policy making committee who think the Fed is putting too much weight on the argument that the economy’s substantial slack will drive down inflation.

Fed Chairman Ben Bernanke. (Reuters)

Slack is the economy’s productive capacity that doesn’t get utilized — unemployed workers, empty hotel rooms, unsold homes, idle factory floors, etc. When there’s a lot of slack, it puts downward pressure on prices in the short-run. It’s one very important reason why the Fed has felt comfortable assuring markets that it is likely to keep interest rates exceptionally low for a long time. Because slack is likely to keep inflation low, the Fed will keep rates low.

But Fed officials have been engaged in an intense debate in recent months about how much slack matters. Some hawks believe other factors are more important ingredients in near-term inflation. One of those other factors is inflation expectations — if investors, businessmen and consumers expect more inflation, they could cause it by demanding higher prices and wages in anticipation. The Fed indirectly acknowledged this argument in the September statement: “With substantial resource slack likely to continue to dampen cost pressures and with longer-term inflation expectations stable, the Committee expects that inflation will remain subdued for some time.”

In previous recent statements, it hasn’t mentioned inflation expectations. It focused mostly on slack. Here’s how the Fed put it in August: “Substantial resource slack is likely to dampen cost pressures, and the Committee expects that inflation will remain subdued for some time.”

The practical implication of this little wording change? Keep an eye on measures of inflation expectations, such as inflation-protected Treasury bonds and University of Michigan surveys of consumers. They have been stable. But if they start rising, the Fed’s inflation view could change and tilt it toward a more hawkish stance.http://blogs.wsj.com/economics/2009/09/23/fed-acknowledges-inflation-hawk-concerns/

My comment:  Price levels result from the intersection of demand and supply. Aggregate demand in the U.S. increases with an increase in purchases by consumers, businesses, or government, and with an increase in the money supply (yes, money SUPPLY). The aggregate supply curve is basically the marginal cost curve of the economy, or the sum of the cost curves of all firms in the economy. It is driven by productivity and wage rates; more productivity, lower costs, and a downward shift in supply, pushing GDP up and the price index down. Lower efficiency and/or higher wage rates result in higher costs, a shift up in the supply curve, and a higher price level. Slack refers to "unused capacity," generally unused plant or physical capacity. But slack also results from "unused labor capacity," i.e., unemployment. There is no question that the U.S. economy currently has significant slack in both areas. This basically means that the short run supply curve is relatively flat; that a given increase in demand can be met by an increase in quantity supplied with minimal increase in prices. But that is not the end of the story. There are two additional factors that must be considered. One, the fed reserve is in unchartered territory right now, underwriting record increases in the money supply, which translate into unknown but potentially monstrous increases in aggregate demand. Unless the long run supply curve is flat, which it certainly is not, this is inflationary. Two, there is some evidence, though not entirely convincing, that expectations of inflation lead to increases in wages, but this is generally only after the economy experiences repeated bouts of unanticipated inflation. So, the bottom line is that supply and demand drive equilibrium output and price, as always, and that inflation will in fact result if the increase in demand continues to outstrip the increase in supply in the economy.

The smallest hint of oil surplus leads to a real fall in oil prices!

Today, the mere hint of a fairly insignificant surplus in U,S. oil reserves pushed down current oil prices and energy-related futures and other speculative plays.   Can you imagine the reaction to an announcement of a new source of U.S. oil reserves?  Of renewed off-shore drilling capacity?  Relaxed EPA standards? Additional refinery capacityA?  Our energy prices would be cut in half and we'd be so much less likely to war with oil-rich nations on whom we now depend for the functioning of our economy and who, indirectly or not, limit our economic and personal freedoms. 

How much is "too much" Unemployment?

How much unemployment "should" our economy have?  How much unemployment is too much, and how much is just right?  How high does the unemployment rate have to go before significant changes are made in government policy and approaches?

The question of the optimal level of unemployment has generally been answered by reference to the so-called "natural rate" of unemployment.  The natural rate of unemployment is measured as the long-run average rate of actual unemployment in an economy over time; it is a "trend line," as seen in this graph below:

This graph is from the Congressional Budget Office and taken from a paper, "The Effect of Changes in Labor Markets on the Natural Rate of Unemployment." [See Figure 2]. 

So, generally, when you hear policymakers say that the unemployment rate is "too high," they are generally comparing the current rate to the natural rate of unemployment.  

I have two very big issues with using the natural rate of unemployment to inform or critque policy.  One, the natural rate of unemployment is based on the long-run average of "where we have been," and should not limit where we think we can go.  Why not set a policy goal of halving the natural rate of unemployment?  Why should the experiences of the past limit what we as an economy aspire to do?

My second issue with using the natural rate of unemployment to inform policy is its inability to distinguish between long-term structural sources of unemployment, which are costly and detrimental to our economy and should be the focus of government policy, and unemployment that results from the search activities of employees and employers alike, which tends to short-term in nature and often leads to better matches between labor and business.  By focusing our national resources on retraining our labor force to fill the needs of emerging industries, we could eradicate much of the most harmful type of unemployment:  structural, long-term, chronic unemployment that leads workers to simply give up and leave the labor force, which actually reduces the reported unemployment rate, yet masks a significant cost to our economy in terms of wasted human resources.

The Unemployment Rate hides Dramatic Labor Market Activity

In an earlier post, I explained how the reported U.S. unemployment rate, which was 9.6% in August of 2009, is measured. This post will explore the reported unemployment rate in more depth, distinguishing between the short-term, temporary sources of unemployment and the long-term, more structural, and troubling aspects of the unemployment rate.  

The 9.6% U.S. unemployment rate remains the same next month if no one changes their employment status.  But the rate also remains unchanged if the same number of people hired get fired.  In truth, the U.S. unemployment rate nets out enormous flows of people into and out of the labor force and, for those in the labor force, between being employed and unemployed.   

A representative month in the unemployment statistic tells the story.  In May of 1993, there was no change in the reported U.S. unemployment rate.  And yet, fully 5 million people got jobs that month; 3 million were just entering the labor force; the other 2 million were in the labor force but had been unemployed.  In the same month, 5 million other people left employment:  3.2 million left the labor force, some for good reasons and some for bad, and 1.8 became unemployed.  

The net reported U.S. unemployment rate also hides another very important phenomenon, and that is that there are two distinct types of unemployment:  short-term and long-term unemployment.   The fact is that some short-run unemployment is desirable.  In general, it is better for people to take some time in finding the ideal job, one in which they are productive, happy, and satisfied.  If individuals always take the first job offer that comes along, rather than searching for a good fit, the odds of a bad match and future job separation increase. 

Chronic unemployment is a bad thing, however.  The economic, social, and psychological costs of the chronically unemployed are enormous.  

Policymakers must carefully weigh the costs and benefits to society of the type of unemployment insurance they support:  a little unemployment insurance for a short period helps people to find the right job, which is a good thing.  Too much unemployment insurance over too long a period encourages slack and enables more structural, long-term unemployment, which is a very bad thing for our economy.      

The Unemployment Rate: how it's measured, what it means

The unemployment rate is often used as a signal of how well an economy uses its resources. The social costs of involuntary unemployment are evidence of a poorly functioning economy. The unemployment rate in the U.S. currently stands at about 9.7%, causing deep concern about the overall health and viability of our economy.

Let's first make sure we know how this reported unemployment statistic is measured. An economy’s population is divided into two mutually exclusive and exhaustive groups:

            Population = Those in Labor Force (L) + Those Not in the Labor Force (NL)

            The Labor Force, L, is composed of the Employed (E) and the Unemployed (U) 

    The Unemployment Rate, u, is the Number Unemployed, U, over the Labor Force, L.

You are generally considered unemployed only if you self-report that you are looking for work but have not yet found any.   If you are employable, currently unemployed, but have stopped looking for work, you move from the Labor force into "those not in the Labor Force." As people move out of the labor force, the measured Unemployment rate actually falls. For example, if the Labor Force is 100,  and 4 of the 100 are unemployed, the unemployment rate u = 4/100 = 4%. If one person leaves the labor force, u now falls to 3/99 = 3%.  

Is this fall in the unemployment rate good news or bad news?  It depends on why the individual left the labor force.  If they simply gave up trying to become gainfully employed, the drop in the Unemployment rate is not a good thing.  If the person left because they met the love of their life who could support them in comfort, and they now devote their time volunteering in the community, the fall in the unemployment rate is a positive development.

In the next installments, I will talk about the "natural rate of unemployment," and what it means and how it is calculated.   I will discuss why it is optimal to have some positive level of unemployment in an economy, and why our government policies should focus on.ly on the structurally unemployed.  Finally, I will lay out the remarkable amount of movement into and out of the labor force in any given period that is masked by the unemployment rate that is reported on the national and local news, and how the unemployment rates vary between regions, states, even counties across the country.  

Government Policy encourages next round of foreclosures!

Call me crazy but I thought that the sudden rise in single-family home mortgage foreclosures that began a year or so back was one of the main causes of the current financial crisis.  And that many of these foreclosures resulted from families over-extending themselves, taking on too much debt given their income and other financial obligations, in part because of incentive programs designed to reduce the upfront cost of the home and the monthly mortgage payments during the first several years of home ownership.

So why is Washington pushing to expand and extend the first-time home buyer tax credit?

 

According to the National Association of Realtors (NAR), <see link> as discussed in Calculated Risk: Finance & Econ,  http://www.calculatedriskblog.com/2009/09/first-time-home-buyer-nar-numbers.html approximately 2 million first-time home buyers will take advantage of the credit by the end of 2009. How many of these individuals would have waited to buy their first home until they were more financially secure, had more of a down payment saved, and were better able to weather the inevitable financial challenges that will come their way, without the incentive program?  Basic economics tells us one thing, if nothing else:  when the price of a good is reduced, demand goes up.  These incentive programs reduce the price of home ownership to qualifying individuals, and demand goes up.  Demand that would not have arisen at the higher price. We know this because this is exactly what the incentive programs are designed to do; encourage demand that would have otherwise not occurred.

Have we learned nothing from the latest failed experiment at social engineering?  

Obama cornering our children on September 8th???

Have you heard the news?  Obama is going to address our children in their classrooms on September 8, 2009.  What I want to know is why was I not informed?  Oh....yes....I know why parents weren't informed! Because we'd say no, or we'd at least want to know the school's plan for presenting our children with the "other side of the story," an opposing point of view.  Talk about a captive audience! 

http://www.docstoc.com/docs/10582301/President-Obama’s-Address-to-Students-Across-America-September-8-2009