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    QE2: Pros and Cons

    Nov 8 • Demand, Supply, and Markets, Economic Debates, Households, International Trade and Finance, Macroeconomic Measurement, Money and Monetary Policy • 525 Views

    Reminding us that there is no such thing as a free lunch, The Washington Post has an excellent interactive summary of the pros and cons of a QE2 impact.

    But first…what is QE2? Through a second round of quantitative easing, the Federal Reserve will purchase government securities. By purchasing securities, the Federal Reserve injects money into the U.S. economy. Very simply, (but not quite exactly the way it happens) the Fed can call you and say, it wants your Treasury bonds. You say “Yes,” and sell them to the Fed for $100. You deposit that $100 in your bank account. Because the bank now has more to loan to people, it can lower its interest rates. Also, you have more to spend.

    Who will be helped by these purchases? Anyone who wants to buy a house and can get a mortgage will pay a lower interest rate. Similarly, businesses could find it more attractive to borrow money and expand. Furthermore, stock prices could rise because of the expansion that lower interest rates stimulate. Internationally, lower rates usually lead to a cheaper dollar. Consequently, U.S. exporters benefit because their goods and services are relatively cheaper.

    Who will be harmed by these purchases? People with savings (typically retirees) will get lower interest rates for their money. Some believe that injecting large amounts of money can cause too much expansion, inflation, and bubbles. Internationally, if the dollar is cheaper, then imports such as oil become more expensive.

    You can see where all of this is going. With valid arguments on both sides of QE2, there is a big split in the economic community. This NY Times economix blog lists equally eminent people on both sides.

    The Economic Lesson

    Government can guide the direction of economic activity through fiscal and monetary policy. Fiscal policy takes us to spending, taxes, and borrowing. Monetary policy involves the supply of money and credit.

    As the source of monetary policy, the Federal Reserve has used three basic tools: the interest rate they charge banks, the size of reserves that banks are required to have on deposits, and buying and selling government securities.  QE1 and QE2 reflect far more extensive buying activity than the Federal Reserve has ever done. Some have even said it equals dropping money out of a helicopter down to the economy.

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    Creatively Destroying Pontiac

    Nov 7 • Businesses, Economic History, Economic Thinkers, Innovation • 272 Views

    At some point, sooner or later, people get tired of black. During the 1920s, Henry Ford realized that the Model T, so very practical and affordable because it only came in black, needed some vitality.

    What forced him to recognize that the Model T was becoming obsolete? The Pontiac (and Chevrolet, Oldsmobile, Buick, and Cadillac). Competing against Ford’s Model T, General Motors created a car for every pocketbook in different colors. Pontiac was second in line, as the consumer moved up the price ladder of G.M. cars.

    Fast forward to 2010. 84 years old, the Pontiac has died. According to the NY Times, the cause was indifference. Pontiac will join its sibling, the Oldsmobile, which left us 6 years ago.

    The Economic Lesson

    Pontiac’s demise reminds us of Joseph Schumpeter. The word to associate with Schumpeter is entrepreneur. For Schumpeter, the entrepreneur is the innovator whom we find in small and large businesses. Increasingly, though, bureaucracy takes over and kills creativity. Perhaps, the Pontiac died because G.M. no longer sparked entrepreneurial passion.

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    Where is QE2 Going?

    Nov 6 • Demand, Supply, and Markets, Financial Markets, Money and Monetary Policy • 265 Views

    Did you ever wonder how things really happen? We read about quantitative easing and hear some gigantic number but then…what? Who does it and how?

    In a Planet Money podcast, journalists visit the Fed and observe how one person implements Fed policy. It all began during 2008 with frozen financial markets, mortgage related securities that no one want to buy or sell, and a $1.25 trillion assignment. One way to rescue wounded financial institutions was to buy securities from them. They get the money. The Fed gets the securities. And then, with more to lend and spend, the banks can lower interest rates and start money moving.

    For QE1, at the Fed, several people, daily, sat in front of a computer, selecting securities and then buying them. Keeping track of totals, when they were done, they had spent $1,249,999,999,999.39, 61 cents less than their goal. In this interactive graphic, the Washington Post explains the pros and cons.

    Now, QE2 is about to begin.

    The Economic Lesson

    Discussing the Great Depression, during 2002, Ben Bernanke told economist Milton Friedman, “You’re right, we did it. We’re very sorry. But thanks to you, we won’t do it again.” (from In Fed We Trust) Dr. Bernanke was referring to the inadequacy of the Federal Reserve’s response during the 1930s. Now, as the Chair of the Fed, through QE1 and QE2, the Federal Reserve has been flooding the economy with money through its purchases of securities so that, as he said, “…we won’t do it again.”

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    Trash and Trade

    Nov 5 • Economic Thinkers, International Trade and Finance • 252 Views

    A WSJ article tells us “Memo to All Staff: Dump Your Trash.” But should they?
    According to the article, Texas state workers, Phoenix city workers, and Dartmouth college professors have all been told to take out the trash. Texas, as a result, is saving close to $825,000 on janitorial expenses. Dartmouth says its goal is to increase recycling but also it is saving money.

    As economists, we can ask the cost of taking out the trash. With cost defined as sacrifice, we have to consider how trash time would have been used. Would college professors use their time more productively on an alternative endeavor? Correspondingly will society pay because unskilled labor has less work?

    The Economic Lesson

    For every decision, there is an alternative that we decided not to do. That alternative is called the opportunity cost of the decision. Sometimes, seemingly wise decisions are less optimal when we realize we could have used our time more wisely.

    19th century economic thinker David Ricardo based his support of free trade on opportunity cost. He said that everyone will benefit when nations trade because then, by specializing, each nation can use its time and resources optimally. 

     

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    Outsourcing and Immigration

    Nov 4 • Businesses, Demand, Supply, and Markets, Developing Economies, International Trade and Finance, Labor • 210 Views

    A recent economics paper provides a surprising solution to those who believe outsourcing is a problem.

    The story, as explained by George Mason economist Tyler Cowen, involves the connection between offshore jobs and immigration. Traditionally, economists say that offshore jobs are great for efficiency because of lower costs. This new study implies that not only can we achieve lower costs here, but also we benefit because of the higher skilled jobs that new domestic facilities create.

    For example, assume a factory that assembles widgets cheaply in a developing nation can bring its work back to the U.S. because of less expensive immigrant labor. In addition, it will need management and technical support to run the plant. The result? We can enjoy lower unemployment for different types of labor while unskilled immigrants fill a gap in domestic labor markets.

    The Economic Lesson

    Combating a 9.6% unemployment rate is complicated. We need to be aware of the mismatching and delays explained by this year’s economics Nobel prize winners, of the connection between immigration and outsourcing, and of the importance of innovation. How can a fiscal stimulus target these objectives? 

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