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    A One-Handed Economist?

    Mar 20 • Economic History, Financial Markets, Innovation, Regulation, Thinking Economically • 224 Views

    Let’s not look at CDOs, SIVs, ARMs, TIPs or ATMs. Nor do we need specifically to consider credit default swaps, securitization, hedge funds or venture capital. Instead, we can go to the question that Robert Litan asks at the end of his 47 page Brookings paper on financial regulation:

    “What deserves preemptive screening?”

    During the past century our government has decided which products need screening before entering the market and those that will receive regulatory oversight only after a problem is identified.  Pharmaceutical innovation is the perfect example of prior approval. By contrast, car, train, and plane makers regularly implement progress without a regulator’s restraint.  Only when they have a problem have government regulators intervened.The question we now face is how to regulate financial innovation? Before or after?

    In his paper, Litan expresses concern that prior restraint of new financial products could retard the progress that has fueled GDP growth, created convenience, and facilitated monetary distribution. With cost/benefit analysis of an array of new financial products from the past three decades, he illustrates the good, the bad, and the so/so. Disagreeing with the Volcker Rule, Litan then asks if the cost will be too great if innovation is constrained by prior approval. 

    Your opinion?

    The Economic Lesson

    For every decision, there are costs and benefits. Defining cost as sacrifice, economists encourage all of us to assess cost and benefit when making a decision–to say, “On the one hand…but then on the other….”  For that reason, Harry Truman once asked for a one-handed economist.    

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    New Financial Products

    Mar 19 • Financial Markets, Innovation, Thinking Economically • 228 Views

    Instead of a garage or a laboratory, think of an office or a conference room. And, rather than a computer or an aircast, imagine a junk bond or a bank account.  All of these products, at one time were invented.  

    In a recent Brookings article,  Robert Litan discusses the products created by financial innovation. His purpose, which we will look at tomorrow, was to reply to Paul Volcker’s negative view of recent financial innovation.  For now, let’s just identify a variety of relatively new financial products (inventions). 

    Grouping the new products into the financial function that they affected, Litan includes the following: 

    Payments:  ATMs, credit card expansion, debit cards

    Saving: money market funds, indexed mutual funds, hedge funds

    Investment: ARMs, home equity lines of credit, collateralized debt obligations

    Risk-Bearing: futures options, credit default swaps

    The Economic Lesson

    Imagine a convex line on a graph with goods as the Y-axis and services as the X-axis. Then, because someone invents something–maybe the computer–the line moves outward because that society is able to produce more. The “rounded outward” line is called a production possibilities frontier. It displays maximum productive capability.  With innovation, productive potential typically increases. 

     

     

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    Ricardo and China

    Mar 18 • Developing Economies, Economic Thinkers, International Trade and Finance, Thinking Economically • 242 Views

    What happens when you build an airport and nobody uses it?  China has an answer. Although China faces underutilization as it develops its transportation infrastructure in the air, by rail and roads,  it seems to be continuing.

    China’s policy took me to a recent Econtalk podcast from Russ Roberts.  Focusing on trade, Adam Smith, and David Ricardo, he began by saying that, “self-sufficiency is the road to poverty”. By contrast, affluence grows when people specialize and trade.  However, people can sustain specialization only when they have demand.  And when demand grows, specialization will spawn technology, knowledge, and wealth.  A transportation network is a fundamental requisite for specialization and the innovation that Roberts says market size stimulates.

    The Economic Lesson

    As the rationale behind trade, David Ricardo’s principle of comparative advantage says that overall productivity will increase when people specialize in whatever has the least opportunity cost.  Saying specialization has so many benefits that even when two nations have identical opportunity costs they should trade, Roberts takes Ricardo a step further.

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    Mandate Broccoli?

    Mar 17 • Businesses, Demand, Supply, and Markets, Government, Thinking Economically • 254 Views

    What if there was a miracle food that helped fight colds, prevent cancer, heart disease, and cataracts, and fostered healthy bones? According to several non-medical web sites, there is one. It’s broccoli.

    And what if another food promoted diabetes, obesity, osteoporosis, dental cavities, kidney stones, high blood pressure, and maybe even heartburn? Some say soda does this to us.

    In yesterday’s NY Times, an article described a recent study that indicated a tax on soda limited its intake.  Should we support “sin taxes”?  Quoted in Econ 101 1/2, Napoleon III “was once implored by a lady to forbid all smoking on the grounds that it was a great vice.  Laying aside his cigar he replied, ‘This vice brings in one hundred million francs in taxes every year.  I will certainly forbid it at once–as soon as you can name a virtue that brings in as much revenue.'” 

    The Economic Lesson

    Contemplating decisions, assessing opportunity cost through an opportunity cost chart is always a handy way to gain insight.  At the top we would have “tax soda” and the alternative, “don’t tax soda”.  Then, for each choice, we could list the benefits.  Two benefits of the tax would be healthier individuals and more state revenue.  Two benefits of no tax would be individual freedom and jobs for the soft drink industry.  Which benefits are you willing to sacrifice?

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    Legislative Jeopardy

    Mar 16 • Economic History, Regulation • 208 Views

    Between 1932 and 1934, the Senate’s Pecora Commission, named after its general counsel, amassed 12,000 pages of testimony.  Its focus was the impact of stock exchange practices on banking, securities, and commerce.  Subsequent major financial legislation was based on the work of the Pecora Commission.

    Fast forward to 2009 when the Financial Crisis Inquiry Commission (FCIC) was created by The Fraud Enforcement and Recovery Act.  Similar to Pecora, its mission is to investigate a financial crisis: the panic of 2007. With its report due during December, 2010, the commission has begun its hearings.

    A question. We heard yesterday that the Senate Banking Committee, led by Senator Dodd, has proposed 1336 pages of legislation to prevent the panic of 2007 from recurring. If the FCIC has just begun its investigation, why is there a major legislative proposal preceding its feedback? 

    Does this approach sound like the tv game show, Jeopardy?

    The Economic Lesson

    The federal government guides our economy in three basic ways: fiscal policy (spending, borrowing, taxing), monetary policy (supply of money and credit) and regulatory policy.

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