Slides for 1/31/08

These slides are for our class on the U.S. trade deficit, and consist mainly of different graphs. We'll be going over them in class in detail.

More Trade Deficit Analysis

This text is from testimony given before Congress, and suggests the trade deficit is relatively benign. Is there anything that the author is not considering regarding the role of trade deficits?

Is the Trade Deficit Unsustainable?

Here's a review of an academic paper that suggests the U.S. could face severe consequences from running such large trade deficits. If you write a short article review of this, make sure you try and identify what the cost of these deficits are. Why would they be bad for the U.S.? Does our model in class allow for these kinds of costs?

Problem Set #1

Here is the link to the first problem set. There will also be a link to it in the right hand column of this web site. The homework is due February 5th, and covers material in Chapters 2, 3, and 5.

Chapters Assigned

People had questions on exactly what they should be reading in the book. Here is the breakdown according to the course outline in the syllabus.

1. Introduction, data and basic facts: Chapter 2
2. Income, Money and Open Economies: Chapter 3 (sections 1,3,4), Chapter 5, Chapter 4, Chapter 18
3. Short run fluctuations, building the IS/LM model: Chapter 10, 11
4. Open Economy IS/LM: Chapter 12
5. The Philips Curve: Chapter 13
6. Other aspects of the macroeconomy: Chapter 15, Chapter 6
7. Growth and development: Chapter 7, Chapter 8

Free Money

Here is an article describing the basics of the just-announced agreement on fiscal stimulus in the U.S. One thing you'll notice is that in addition to the rebate checks to individuals, there will likely be several provisions meant to lower taxes on businesses. An interesting question regarding this is: do businesses and individuals have different marginal propensities to consume? And if they do, how does this affect the power of this stimulus bill?

CPI Basket

We talked about the CPI in class. The CPI, you'll recall, measures the cost of a specific basket of goods (i.e. 4 apples and 3 oranges) over time. Issues with the CPI are that the basket doesn't necessarily represent what you or I actually consume. Attached here is the actual breakdown of the CPI basket by category in excruciating detail. The broad categories, and their percentage weight in the basket is:

Food and Beverages 14.99%
Housing 42.69%
Apparel 3.73%
Transport 17.25%
Medical 6.28%
Recreation 5.55%
Education and Communication 6.03%
Other 3.48%

You'll see that housing is the biggest category, followed by transportation and food. Does it makes sense? Depends on who you are.

Exciting Times

It may not be the best news for the macroeconomy, but financial panic and impending recession at least make things more interesting. Here's the article today from the Washington Post on the drop in global stock markets, the Fed's emergency rate cut, and the possibility that we'll head into recession.

The link between stock markets, the Fed, and recessions is something we'll address as we go through class. For now, you can think of it this way. If the economy is going along normally, then the financial markets are taking your savings and pushing them out to different firms who invest these funds (either by lending the firms money or by investing in the firms stocks). The firms who get your savings use them to hire more people, buy more machines, or buy their CEO a new gold bathtub.

When financial markets get panicked, though, they are wary of giving your savings to firms, because they think the money will disappear. So they essentially hide your savings under the mattress as cash, and firms don't have access to new funds to hire new people or buy new machines. So economic activity slows down.

The Fed is trying to induce the financial markets to keep lending. How? We'll get to that in the next couple of days.

Cool Maps

This map, from here, replaces every state with the name of the country that has a GDP of the same size. That is, Texas and Canada have the same total GDP. California and France have the same GDP. Illinois and Mexico have the same GDP. It is a nice indication of how big the U.S. economy is relative to the rest of the world.

And incidentally, if you were worried about Iran or Pakistan hoping to engage in some war of conquest, consider that this would be equivalent to either Alabama or Arkansas doing the same.

Here's the graph of CPI and the GDP Deflator over time. As you can see, they tend to move quite closely together. (Source: Mankiw's 6th Edition)

Stimulating What?

This is an interesting post about the goals of fiscal stimulus (i.e. tax cuts or more government spending). People generally feel that this kind of stimulus needs to take place soon, so that it can counteract the probably decline in GDP that is occurring right now. However, as the authors of the post point out, do we really care about GDP, or do we care about people losing jobs? If the stimulus package takes a long time to enact, maybe that is okay, because it will result in a stronger job market - which ultimately matters more directly to people.

Rising Inflation

We'll be talking in more detail about the kind of numbers quoted here. The article is pretty clear on the trade-off that the Fed faces in its decisions. Higher inflation vs higher growth of GDP.

Fiscal Stimulus

We'll get around to talking about this eventually, but here is an article regarding the role of the government in mediating recessions. The authors point out that fiscal stimulus (i.e. government spending or lower taxes) should fulfill three requirements:

1. Fiscal stimulus should be timely. (That is, the extra spending or lower taxes have to be put in place while the economy is actually heading into a recession, not afterwards. This is a problem because the Federal government tends to move very slowly.)

2. Fiscal stimulus should be well targeted. (That is, it should go to those people who need it the most - unemployed or under-employed people.)

3. Fiscal stimulus should be temporary. (Recessions are short-run events, so the stimulus does not need to stay in effect forever - just until the economy gets back to full employment.)

It matters how you count things

This article is a nice example of why we spend so much time learning how to count GDP. The upshot is that due to a different way of counting, we think China and India are about 40% smaller, in GDP terms, than before.

Slides from 1/15/08

Link here to get slides from first lecture, including graphs of GDP, inflation, and unemployment.

The Fed Chair Speaks

As reported here, Ben Bernanke is indicating that the Fed will likely drop interest rates at their meeting in January. A few quotes of interest, along with questions that you should be able to answer by the time we finish this course.

The Fed chairman said “we stand ready to take substantive additional action as needed to support growth and to provide additional insurance against downside risks”.

(How can the Fed support growth?)

He warned that the strains in financial markets “continue to pose a downside risk to the outlook for growth” with investors still uncertain about the true value of complex financial assets and about the extent of additional losses that may be disclosed in the future. The financial situation “remains fragile and many funding markets remain impaired” he said.

(To what extent can the Fed affect the attitude of the financial market?)

The Fed chairman did not discard the US central bank’s inflation concerns, warning that the renewed strength in oil prices was “lifting overall consumer prices and probably putting some upward pressure on core inflation measures as well”. He hinted that provided inflation expectations remained steady this would not get in the way of Fed easing, but said “we will be closely monitoring the inflation situation, in particular as regards inflation expectations”.

(Why is the Fed worried about inflation? And what do they have to do with it?)

The 4 Boneheaded Biases of Stupid Voters

The economic biases that we talked (or will talk) about in class are from an article by Bryan Caplan that you can read in full here. Feel free to use this article as the source of one of your short article summaries. (If you do so, go ahead and just focus on one of the 4 biases, you don't have to summarize the entire thing.)

To remind you what the biases were (are), here's a quick summary:
1. Anti-market bias - the feeling that any act that results in a profit for one person must be anti-social by definition. (If you think GM is ripping you off, then take the bus. Otherwise, be quiet).

2. Anti-foreign bias - the feeling that economic exchanges are "different" if they occur with foreign countries as opposed to with locals. (You run a trade deficit with GM when you buy a car. Should we put tariffs up between you and GM?)

3. Make-work bias - the feeling that there are a fixed number of jobs, in specific categories, to be filled. (In 1900, 40% of the people in the U.S. worked on farms. Now, its 3%. Are 37% of American's now unemployed?)

4. Pessimistic bias - the feeling that things are getting worse in general. (Since 1950 we've had 9 recessions. Since 1950 there have been exactly 6 years out of 57 in which GDP actually shrank. GDP per capita in the U.S. is 3.4 times higher today than in 1950.)