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    Operation Twist Again

    Sep 23 • Businesses, Economic Debates, International Trade and Finance, Money and Monetary Policy, Thinking Economically • 468 Views

    Operation Twist is a great name but tough to understand.

    Our starting point is interest rates. When you loan someone $100, you expect to be repaid more. How much extra? It depends on many variables so let’s just look at one.


    When the federal government borrows money for 3 months, it has tended to pay less in interest than for its 10-year loan. (Not always, but that is another story.) Which graph demonstrates the long-term/short-term difference?

    The yield curve.

    The yield curve in this FDIC example shows the 10-year treasury interest rate minus the federal funds rate, a short term interest rate that banks charge each other. When the long term rate is high and short-term is low, the difference between the two is a positive number. However, what if the long term rate plunges until the short term rate exceeds it? Then, the difference is a negative number and the curve TWISTS downward.

    Hence, Operation Twist.

    Why “Operation Twist Again?” Because the same monetary maneuver was used 40 years ago during the Kennedy Administration.

    Here is Chubby Checker singing “Let’s Twist Again.” (1961)

    The Economic Lesson

    Shown through this Marketplace.org whiteboard talk, unattractive long-term yield might make banks want to loan their money to businesses instead of buying long-term securities.

    Here, USA Today talks about the potential impact of Operation Twist on each of us.

    An Economic Question: How does yield relate to incentive?

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    Benford’s Law and Greece

    Sep 22 • Behavioral Economics, Businesses, Financial Markets, Government, International Trade and Finance, Macroeconomic Measurement, Thinking Economically • 536 Views

    Does it matter that low first digits occur more frequently?

    First some history.

    During the 1920s, Frank Benford, a physicist at GE, noticed that “one” appeared more frequently as the first digit of a number. To test his thesis, he accumulated random lists. He was said to have noted all of the numbers in an issue of Reader’s Digest. He went through demographic and scientific data. Finally he calculated that #1 was the first digit in 31% of the numbers, #2 for 19%, and #9 was the first digit in only 5% of all of his numbers. This brief article about Benford’s conclusions is fascinating.

    The current relevance of Benford takes us to Greece. “Undercover Economist” Tim Harford describes it wonderfully. During 2000, just before Greece joined the euro, its deficits deviated considerably from Benford’s Law. As Harford explains, “The criteria were somewhat irksome…but nevertheless the Greeks seemed to comply…Eventually it became clear that the Greek numbers did not quite add up.”

    The Economic Lesson

    Different from debt which totals all a government owes, the deficit is the amount by which government expenditures exceed revenue during a fiscal year. For Greece, during 2009, the new prime minister said that the deficit appeared to be closer to 12.5% of GDP rather than the previously reported 3.7%.

    An Economic Question: How does this Dilbert cartoon relate to Benford’s Law?

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  • Decisions Have An Opportunity Cost That Require Tradeoffs

    A Conservation Dilemma

    Sep 21 • Businesses, Economic Debates, Environment, Regulation, Thinking Economically • 449 Views

    Should the Dunes Sagebrush Lizard (aka the Sand Dune Lizard), a 3-inch striped reptile, be listed under the Endangered Species Act?

    Here is the problem. The home of the Sand Dune Lizard is also the home of the Permian Basin which, according to Forbes, provides close to one-fifth of U.S. oil production. To survive, the lizard needs the shinnery oak. Pipelines, road building, and drilling destroy the shinnery oak. So, if this lizard is added to the endangered species list, then oil drilling will be affected, the US oil supply would be impacted, and the price of domestic oil could rise.

    How to make a decision? For cost/benefit analysis, knowing the money that is involved would help. We probably could estimate how much the oil loss would cost us. But what about a lizard?

    After the oil spill, BP faced a similar question. To assess its dollar damages, a value had to be placed on wildlife. USA Today told us that 2263 “visibly oiled dead birds” were counted. An NPR Planet Money podcast suggested that the $500 price tag for rehabilitating a pelican after the spill could indicate the price of a bird or maybe regulators could use the rate sheet for animal actors. Flying birds command $4500 a day (non-flying $1500).

    The Economic Lesson

    The lesson here is not to take prices for granted. Market prices provide crucial information. They tell us about value and efficiency and affordability. They let consumers and businesses and government decide what to do, what not to do, and what we can do better. Yes, “Absence makes the heart grow fonder.” Maybe we care more about prices when we cannot have them.

    Here is a past econlife post about pricing the “unpriceable.”

    An Economic Question: The oil or the lizard? How would you decide?

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    Environmental “Nudges”

    Sep 20 • Behavioral Economics, Environment, Government, Households, Regulation, Thinking Economically • 512 Views

    Sometimes a nudge is not enough.

    According to science writer Jonah Lehrer, society has to do more than “nudge” us when it wants to change our behavior. When Sacramento, California wanted to diminish energy usage by showing customers what their neighbors consumed, they hoped competition would spur results. Close to 1.5%, the decrease was slight.

    Suggesting more persuasive alternatives, Carnegie Mellon behavioral economist George Loewenstein and Daniel Schwartz further discuss the “shove” we need to diminish carbon emissions. They say that the problem is the short-term/long-term trade off. Whether dealing with an attractive mortgage deal, a pastry vs. cottage cheese, or saving for retirement, many of us favor the short-term benefit.

    Loewenstein and Schwartz believe that we have a “fear deficit” for climate change because our evolutionary fear system is a short-term device. We see the predator, the adrenaline surges and we run…fast. For long-term fear, we might be physiologically inadequate.

    How then to get results? Loewenstein and Schwartz suggest a “shove” rather than a nudge through taxes and regulation. And then, to make the “shove” politically palatable, society could use the revenue stream appealingly.

    The Economic Lesson

    While psychologists cite a “fear deficit” as a cause of climate change inaction, for economists, the problem is the “free rider.” Let’s assume that Sue never turns her lights or her air conditioning off. Although her energy usage is astronomical, she assumes that her decisions will have little impact. Then, if everyone else is more environmentally disciplined, she can enjoy the benefits of their behavior. An economist would call Sue a free rider.

    An Economic Question: Which “free rider” situations could you identify?

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    Oil Worries?

    Sep 19 • Businesses, Demand, Supply, and Markets, Developing Economies, Economic Debates, International Trade and Finance, Macroeconomic Measurement, Thinking Economically • 469 Views

    Have you ever heard of Hubbert’s Peak?  No, it is not a mountain. Hubbert’s Peak refers to our oil supply. In 1956, Marion King Hubbert warned us that U.S. oil production would peak within 15 years. And, the only direction after the peak is straight down.

    In a WSJ article, oil analyst and historian Daniel Yergin explains why he believes Hubbert and his contemporary followers have been wrong. As far back as the 1880s, when the experts said Pennsylvania would soon run out, the end seemed imminent. During both World Wars and the 1970s, again, oil worries resurfaced. Repeatedly though, new reserves and new technology have nudged the “peak” further into the future.

    In this 2009 NY Times article, you can read more about both sides of the debate. You also might look at this “Remember the Pistachios” blog post.

    The Economic Lesson

    Marion Hubbert’s problem was ignoring the role of price. Every time price increased, the incentive to find new reserves and develop new technology soared. The result? More oil and price again declined.

    Correspondingly, when the price of oil increases, the incentive to use alternative energy sources also rises. The result? More wind turbines, natural gas and other energy providers.

    So, whereas Hubbard envisioned catastrophe, economists saw the market saving the world.

    An Economic Question: How might you use opportunity cost to explain why the price of oil moves up and down?

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