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    Too Big To Fail

    May 25 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic Debates, Economic History, Financial Markets, Households, International Trade and Finance, Money and Monetary Policy, Regulation • 376 Views

    The HBO documentary, “Too Big To Fail” was excellent. But what to come away with?

    TBTF (Too Big To Fail) solves problems and it creates them.

    TBTF can reverse a confidence crisis. When the world is worried that the failure of a large bank will catastrophically ripple from one institution to the next until all financial markets are frozen, TBTF can solve the problem.

    However, TBTF distorts financial behavior. Without TBTF, for chancy loans and risky projects, creditors provide less funding and ask for higher returns. With TBTF, by diminishing risk, the creditors’ incentives change. Consequently, it is much easier to fund speculative ventures that might endanger the institution. 

    In other words, TBIF creates the very problem that it solves!

    Here, during an Econtalk interview, economists discuss TBTF. Also, the book, Too Big To Fail, by a former Federal Reserve president and vice president provides considerable insight. A third resource is the book on which the HBO documentary was based, Andrew Ross Sorkin’s Too Big To Fail: The Inside Story of How Wall Street and Washington Fought to Save the Financial System–and Themselves.

    The Economic Lesson

    In 1781, Alexander Hamilton said that, “Banks…have proved to be the happiest engines that ever were invented for advancing trade.” In 1791, primarily because of Alexander Hamilton, the first Secretary of the Treasury, the First Bank of the United States was established by the U.S. Congress.

    With only 3 banks in the entire country, Hamilton believed more could be done to expedite U.S. economic development. His goal was to have more money circulating that businesses, consumers, and government could use. As a powerful and large financial intermediary, the bank achieved his objectives.

    An Economic Question: Looking at 1791 and 2011, explain why borrowing is important for economic activity.

     

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    Animal Spirits and Gas Prices

    May 24 • Behavioral Economics, Businesses, Demand, Supply, and Markets, Economic Thinkers, Government, Households, Labor, Macroeconomic Measurement • 460 Views

    Is a 9-cent drop enough to ignite our “animal spirits?” The 9-cent decrease refers to the average national price of a gallon of regular gasoline. And “animal spirits” is the optimism that leads to more buying and investing.

    During the 1930s Great Depression, British economist John Maynard Keynes (1883-1946) said that statistics such as lower interest rates could theoretically stimulate economic activity. However, to generate growth, we also need “animal spirits.”

    Fast forward to 2011. Analysts cite gas prices and unemployment as the two key variables behind rising and falling consumer sentiment. Plunging from a high of 112 during 2000, the University of Michigan measure of consumer sentiment is now 72.4.

    Why care about consumers’ sentiments (aka their animal spirits)? Consumer spending is the largest component of our GDP.

    The Economic Lesson

    Initiated by economist Arthur Okun (1928-1980), the “misery index” is the total of the inflation rate and unemployment. Currently, our misery index is 12.16.

    An Economic Question: Specfically referring to its inflation and unemployment components, how does the misery index relate to consumer sentiment and animal spirits?

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    The Real Cost of a Car

    May 23 • Demand, Supply, and Markets, Environment, Government, Households, Regulation, Thinking Economically • 367 Views

    To see how much a car costs, just add up the purchase price, insurance, gas and a yearly service. Yes? According to one group of researchers, a car that is driven 100,000 miles costs $19,000 more than you might think.

    The $19,000 relates to external costs. Pollution from autos creates health spending. Congestion generates delays, alternative plans, noise. Accidents means fatalities, days lost at work, medical expenses, property damage. In addition, more gas takes us to oil dependency and carbon emissions. Not included in the $19,000 total but also a cost is bridge and road maintenance and construction.

    What does that extra $19,000 mean? It says that the cost of driving is both private and social.

    Citing the private and social cost of driving as one of many examples, a new paper from the Hamilton Project, “Strategy For America’s Energy Future: Illuminating Energy’s Full Costs.” suggests we need to rethink public policy in 4 areas: 1) Changing the incentives that shape consumer and business energy use; 2) Enabling innovators to capture more of the profit of new technology; 3) Using more accurate cost benefit analysis for regulatory policy; 4) Pursuing global solutions to environmental and climate concerns.

    The Economic Lesson

    Economists see positive externalities wherever a transaction between two parties affects a third individual or group in some beneficial way. They see negative externalities when the impact on a third party is harmful. Vaccines usually have positive externalities while pollution is the typical example of a negative externality.

    Taking externalities an economic step further, we can look at cost. On a demand and supply graph, the equilibrium price of a decision that has a positive externality is too high because of the benefits experienced by society. Correspondingly, the equilibrium price of a decision with negative externalities is too cheap because of the associated costs that result.

    An Economic Question: Which business or individual decisions have a social benefit that (theoretically) offsets the private cost? Which business or individual decisions have a social cost that (theoretically) adds to the private cost?

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    Will Power and Wealth

    May 22 • Behavioral Economics, Households, Labor, Regulation • 433 Views

    Observing young children, scientists believe they can predict certain adult outcomes. One classic study from the 1960s involved delayed gratification.  A child and a single marshmallow were left in a room. The child could have one marshmallow now or two later.  When interviewed 40 years later, those who resisted temptation as children had better jobs as adults. In New Zealand, a group observed 1037 children from birth to 32. Those with more self-control were more affluent. Also, they were healthier.

    The Economic Lesson

    If one segment of the population generates excess costs to society in health care, financial dependency and crime, then should schools provide early childhood self-control programs? The New Zealand team says yes if the cost/benefit ratio is good (p. 5).

    An Economic Question:  Which variables might you identify if asked to compare the cost and benefit of early childhood programs that develop self-control?

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    Trade Deals

    May 21 • Businesses, Demand, Supply, and Markets, Developing Economies, Economic Debates, International Trade and Finance, Labor, Macroeconomic Measurement, Thinking Economically • 382 Views

    What if Mr. Jones, an assembly line worker, lost his job because of low cost imports? And, what if Mrs. Smith, a travel agent, also is unemployed but the reason is online firms like Expedia? 

    Princeton economist Uwe Reinhardt asks us why Congress is likely to express more concern for Mr. Jones than Mrs. Smith. Instead, he suggests that whether the reason is global or domestic job disruption, perhaps all who gain should compensate those who have lost.

    Dr. Reinhardt’s perspective takes us to the current debate in Congress and the size of our safety net. Should a yes vote for free trade agreements with Panama, South Korea, and Colombia include more assistance to people who, as a result, lose their jobs? The NY Times tells us that a group of Democrats say, “Yes” while a group of Republicans say, “No.”

    The Economic Lesson

    The 4 basic causes of unemployment are 1) structural (technological change), 2) cyclical (recession) 3) seasonal 4) frictional (everyday reasons like quitting and moving).

    An Economic Question: If government provides a safety net of retraining and payments to the unemployed, what are the tradeoffs? ( Here and here, you can access facts about government aid to workers who lost jobs because of trade agreements.)

     

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