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    How the Fed Helped Harley

    Dec 8 • Demand, Supply, and Markets, Financial Markets, Money and Monetary Policy • 422 Views

    Have you ever thought about how, every month or every week, businesses have money for paychecks? One answer is commercial paper.

    It is amazing that commercial paper is central to so much economic activity and few people have even heard of it. Simply defined, commercial paper is just a short-term IOU. Any institution that needs money for a brief time period can go to its investment banker and say, “I would like to sell my commercial paper.”

    So, if the Glove Company is low on revenue during the summer, instead of using its own money that it wants to keep, it can ask XYZ Bank to sell commercial paper to the bank’s clients. Now, everyone is happy. The Glove Company is pleased because it gets its payroll at an interest rate it can afford. The XYZ Bank is happy because it gets a fee for being a financial intermediary. And The Bathing Suit Company (with extra revenue), that bought the paper, is happy because it gets interest payments for a relatively secure investment.

    All was okay until the commercial paper market froze during 2008. Realizing the magnitude of the crisis, the Federal Reserve stepped in and bought the paper that banks were no longer selling. On December 1, because Dodd-Frank legislation said they had to, the Fed released data on the loans they provided when the financial crisis was at it peak.

    Harley Davidson, McDonald’s, Verizon and Toyota were among the firms that borrowed money from the Fed because they had no commericial paper market to use. The Wall Street Journal tells all here.

    The Economic Lesson

    A market is a process that enables the interaction of buyers and sellers to determine the price and quantity of a good or a service. During 2008, many financial markets stopped functioning because sellers did not want to expose their money to any risk.  For the commercial paper market, many business firms needed the money to continue functioning. The Federal Reserve decided it had to intervene and provide those loans.

    During 2008, the Fed, traditionally only the banker’s bank, did many things it had never done before. Some say that it temporarily became a bank for the world’s financial system.  The Fed also participated in the market for commercial paper.

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    World Cup Soccer and Game Theory

    Dec 7 • Behavioral Economics, Thinking Economically • 502 Views

    Economists can explain more about soccer than we might expect. Why, for example, do players rarely kick down the middle when taking a penalty?

    This takes us to “The Prisoners’ Dilemma.” Please assume that when arrested, two bank robbers do not know whether the police were aware of additional crimes they committed. When each is individually questioned, he knows that if his partner remains silent neither will recent a longer sentence. However, if one confesses, the silent person will get extra years in prison because he did not confess. The prisoner has a dilemma. What will the other person do? 

    So too with a soccer penalty kick. Left, right or center? Both the goalie and the kicker face the prisoners’ dilemma.

    Analysts point out an anomaly, though. A center kick is rare. Why? The incentives are different. For the goalie, if he expects a center kick, he just stands still. It is much more embarrassing to stand still when you are wrong than to lunge to the right or left.  Kickers also do not want to be wrong when they kick down the center.

    Two basic economic ideas, self-interest and incentives, and an economic game theory, “The Prisoners’ Dilemma,” are central to penalty kick decisions.

    The Economic Lesson

    Economists like to tell us that businesses that are large and dominate a market with 3 or 4 other firms also have “The Prisoners’ Dilemma.” Called oligopolies, these large firms are constantly wondering what the competition will do when they make their own decisions. 

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    State Finance

    Dec 6 • Government, Households, Thinking Economically • 447 Views

    Which state postponed a pension fund payment of $3.1 billion because of big budget problems and had a 2.4% decrease in its real GDP? (Still though, this state has the second highest median income.)

    The answer? New Jersey.

    New Jersey, though, is not alone. Jon Stewart told us that Arizona had to sell its statehouse (which included the governor’s office). A potential California default was the prototype for an Economist simulation. Illinois borrowed money to fund its pension obligations and then had to borrow money to repay the original loan.

    According to a Pew study on state financial problems, “Most Americans (58%) say the states should fix their own budget problems by raising taxes or cutting services.” But, “…large majorities oppose…” cutting major spending categories which include education, pubic safety (police and fire), and health care.

    Perhaps the reason for the contradiction is opportunity cost. The individual opportunity cost of cuts is far different from the statewide cost.

    The Economic Lesson

    Looking at a BEA map of state economic growth during 2009 provides a snapshot of state health. Oklahoma is at the top (+6.6%) and Nevada, the bottom (-6.4%). For the GDP of individual states, agriculture, forestry, fishing, hunting, and mining fueled growth. On the minus side, less durable goods production (goods lasting longer than 3 years) and construction diminished economic activity.

    Composed of gross investment (primarily business purchases and residential housing), consumer spending, government spending, and exports minus imports, the GDP is a yardstick of the value of goods and services production.




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    Walking Matters

    Dec 5 • Behavioral Economics, Developing Economies, Environment, Innovation, Macroeconomic Measurement • 429 Views

    A podcast on cities from WNYC’s Radiolab cited walking speed as a part of a city’s personality.

    To walk 60 feet, people averaged 10.55 seconds in Singapore,  12.37 seconds in Paris, 21 seconds in Buchanan, Liberia, and 31.60 seconds in Blantyre, Malawi. Hearing a city’s average walking speed, which was remarkably consistent when measured during different years, researchers could estimate economic data such as average income.

    The Economic Lesson

    Economists and their physics and psychology research partners are starting to perceive cities as organisms. They have said, for example, that cities, functioning as an economy of scale, “get more economical with size.” They also have observed that individuals tend to be more productive in larger cites, to earn higher wages, and to innovate more. In fact, when a city becomes so large that it might run out of resources, its response is to innovate. However, cities experience diminishing returns– less extra benefit– from each new innovation.

    Especially because more than half of the world’s population lives in cities, economists care about how cities function.


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    Who Do We Owe?

    Dec 4 • Financial Markets, Government, Money and Monetary Policy • 446 Views

    Who do you think is the biggest holder of U.S. government debt? China? No. It is the U.S. government. Why?

    Please think about extra money the government might collect for Social Security. What does it do with those funds? Retaining cash would mean no return at all. Buying stock could be risky. What is the safest investment? Government bonds. Another major holder is the Federal Reserve. The Fed has to buy and sell bonds when it implements its monetary policy.

    According to CNBC, in descending order, the largest holders of the U.S. debt, after 1) the US government, are 2) a diverse group investors such as businesses and savings bond owners, 3) China, 4) Japan, 5) Mutual funds. To learn more about the deficit and who holds it, you might want to look at Where Does The Money Go?

    Knowing who owns the debt is one consideration when you decide how worried you are about the size of the deficit.

    The Economic Lesson

    A second consideration when deciding how worried you should be about the deficit is how the size of the deficit compares to the value of the goods and services produced by the U.S. According to Teaching Company Lecture 10 from “Modern Economic Issues,” since 1929, the deficit has averaged 2.1% of GDP. You can see on this table, though, that during 2010, the deficit will be closer to 10% of G.D.P.

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