Professor Paul Palley's
          Economics Seminars

Here is an interesting opinion piece written by Warren Buffett about the government budget deficit: http://www.nytimes.com/2009/08/19/opinion/19buffett.html?ref=opinion

Transactions occur because; in an example we are most familiar with, businesses and consumers meet and the consumer pays for a good or service. This indicates that the factors that affect supply and demand affect the transactions that occur. This then implies that it is cost-benefit analysis, comparisons between the marginal costs and marginal benefits, that lead to the decision on the part of the consumer to buy the good or service and the business to sell the good or service.

Businesses supply goods and services only if it is profitable to do so. In other words, if the marginal benefits associated with producing and selling the product exceed the marginal costs then the business will produce and sell that product. Or, to state this another way, if the transaction yields a profit greater than what would result from an alternative use of the time and effort to produce that product then the business will be willing to produce and sell the product. This explains why businesses focus so much time and effort on marketing. Smart marketing efforts help businesses differentiate their products and elevate the prices they can charge, and as a result increase the marginal benefits associated with producing and selling their products. At the same time businesses will also focus on improving productivity to control costs, decreasing marginal costs. The greater the differential between marginal benefits and marginal costs the more likely businesses will continue to pursue further production and transaction opportunities.

On the demand side, consumers also evaluate marginal benefits and costs. The decision to spend your money on A or B will depend on your evaluation of the relative benefits and costs associated with buying A or B. If the marginal utility or benefits associated with consuming good A relative to its price exceeds the marginal utility or benefits associated with consuming good B relative to its price, then the consumer will by A. In other words, if MU_A/P_A > MU_B/P_B, then the consumer buys A. This is a formal representation of how we make decisions, but imagine that you want to buy a new car. You may have to decide between a Toyota and Ford. Why do you pick one or the other? Won’t this depend on the utility you derive from these choices and the prices you pay for them?

As a result, if both the consumer and business determine that the marginal benefits associated with a transaction exceeds with the marginal costs then the transaction will occur. What we are seeing with this process is an important factor that is not always focused on, the increasing ease associated with transactions. Technology has greatly facilitated this. It is easy to buy products online and participate in auctions like those on eBay, greatly enhancing choice. It is also easier to pay now due to the availability of credit, and the ability to use credit and debit cards has been expanding. In this case it is technology that is facilitating this. Payment systems are another important element in this in that payment card networks facilitate the exchange of information between a store’s bank and the consumer’s bank in order to facilitate a purchase made using a credit or debit card. These systems facilitate the buying and selling process in exchange for an interchange fee. The Federal Reserve has details about this that may be interesting to read (http://www.federalreserve.gov/paymentsystems/default.htm). In addition, the modern cash register where these payments occur is a computer as much as a cash register, facilitating inventory control and productivity gains.

Furthermore, additional technological improvements can be noted. Cell phones are now being used to make payments just as a debit cards have been used. This not seen as much in the U.S., but it is readily available in Asia. Cell phones are also used as a computer, and as a result shopping online is facilitated. You may access information through electronic bill boards using cell phones in Japan, and this gives the consumer access to product details. It also gives businesses access to consumers, facilitating future transactions. Here is an interesting article in the New York Times related to this and the acceptance of these cell phone products (http://www.nytimes.com/2009/07/20/technology/20cell.html).

The Federal Reserve (Fed) is a terrific source of economic data, forecasts, and perspectives on current economic conditions and policy making. The Fed has both regulatory and monetary responsibilities and its reports to Congress and cryptic public statements shape policy-making efforts and expectations related to the economy. Understanding these responsibilities and the Fed’s data sources and expectations facilitates long-term planning and decision-making. The following discusses these roles, sources of information, and perspectives on the economy.

The seven members of the Board of Governors of the Federal Reserve System (http://www.federalreserve.gov/) are appointed by the President and approved by Congress. They are responsible for formulating policy and implementing these policies through the Federal Reserve Banks. See the following link for information related to frequently asked questions about the Board of Governors (http://www.federalreserve.gov/faqs.htm). The publication, The Federal Reserve System, Purposes & Functions (http://www.federalreserve.gov/pf/pf.htm) includes an overview, and sections on monetary policy and the economy, implementation of monetary policies (open market operations, and changing the discount rate and reserve requirements), and international perspective, and regulatory responsibilities. It also includes a section on the role of the Fed and payment systems in the United States. The website for the Board of Governors is also a very good resource for economic research and data. See this link for details: http://www.federalreserve.gov/econresdata/default.htm. Another excellent source of historical economic data and perhaps the best single site to go to in order to start a research effort is the Federal Reserve Bank of St. Louis. The link is:
http://research.stlouisfed.org/fred2/.

The Fed’s monetary policies capture a lot of the attention the public has on the Federal Reserve and the economy. This Board of Governors’ website includes details related to this (http://www.federalreserve.gov/monetarypolicy/default.htm), and this is a very good resource for details related to this issue. Monetary policy decisions are made by the Federal Open Market Committee (FOMC). The FOMC (http://www.federalreserve.gov/monetarypolicy/fomc.htm) includes the members of the Board of Governors and five Reserve Bank presidents. The FOMC meets eight times during the year, and will meet at other times if necessary. The main policy goals of the Fed include balance economic growth, stable prices, and full employment.

The Fed uses contractionary monetary policy tools at a time when the economy is in a period of very strong economic growth and inflation expectations are very high. When this occurs, the Fed will sell US Treasury bonds as they raise their target for the Federal Funds rate, increase the discount rate, and on very rare circumstances raise reserve requirements. The impact of this policy is to reduce the money supply and raise short-term interest rates. Higher interest rates will, everything else being equal, lead to decreases in household and business spending and lower the rate of growth of the economy.

The Fed employs expansionary monetary policy tools at a time when the economy is in a recession and inflation expectations are very low. In order to do this, the Fed buys US Treasury bonds as they lower their target for the Federal Funds rate, lower the discount rate, and on very rare circumstances lower reserve requirements. This increases the money supply and lowers short-term interest rates. At the same time long-term interest rates may or may not be impacted as these rates will be more dependent on inflation expectations and expectations related to economic conditions. Lower interest rates will, unless the economy is overcome with uncertainty, lead to increases in household and business spending and increase the rate of growth of the economy. As we have seen, during the very sever recession of 2007 to 2009, the twin problems of a serious decline in asset values combined with a financial crisis and uncertainty, make expansionary monetary policies more difficult to implement. Extraordinary efforts will be necessary.

The Monetary Policy Report to Congress dated July 21, 2009 also details the extraordinary efforts undertaken by the Fed to stabilize the economy, and this illustrates the vast array of tools at the Fed’s disposal to deal with the economy. The Fed reported the following in this report, “The Federal Reserve and other government entities continued to respond forcefully to these adverse financial market developments. The Federal Reserve kept its target for the federal funds rate at a range between 0 and 1/4 percent and purchased additional agency mortgage-backed securities (MBS) and agency debt. Throughout the first half of the year, the Federal Reserve also continued to provide funding to financial institutions and markets through a variety of credit and liquidity facilities. In February, the Treasury, the Federal Reserve, the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision announced the Financial Stability Plan. The plan included, among other elements, a Capital Assistance Program designed to assess the capital needs of banking institutions under a range of economic scenarios (through the Supervisory Capital Assessment Program (SCAP), or stress test) and, if necessary, to assist banking institutions in strengthening the amount and quality of their capital. In early March, the Federal Reserve and the Treasury launched the Term Asset-Backed Securities Loan Facility (TALF), an initiative designed to catalyze the securitization markets by providing financing to investors to support their purchases of certain AAA-rated asset-backed securities. At the March meeting of the Federal Open Market Committee (FOMC), the Committee decided to expand its purchases of agency MBS and agency debt and to begin buying longer-term Treasury securities to help improve conditions in private credit markets. In May, the Federal Reserve announced an expansion of eligible collateral under the TALF program. In the same month, the results of the SCAP were announced and were positively received in financial markets.” (http://www.federalreserve.gov/monetarypolicy/mpr_20090721_part1.htm).

Two reports produced by the Federal Reserve receive a lot of attention. The Beige Book (http://www.federalreserve.gov/fomc/beigebook/2009/default.htm) reports details related to current economic conditions in the districts of each of the twelve Fed banks. As a result it offers information that is useful for those who want to understand current economic conditions. The Monetary Policy Report to Congress (http://www.federalreserve.gov/monetarypolicy/mpr_default.htm) is an excellent resource for those interested in a current overview of the Fed’s monetary policies and economic conditions. It is also one of two resources I suggest for economic forecasts produced by the Federal Reserve System. The second is the Livingston Survey (http://www.philadelphiafed.org/research-and-data/real-time-center/livingston-survey/). This is compiled and produced by the Federal Reserve Bank of Philadelphia and is forecast reflecting the opinions of a large group of economists.

For example, the Monetary Policy Report to Congress dated July 21, 2009 indicated the following related to the future direction of the economy The Fed marginally raised its projections for the economy. They expect the economy to demonstrate sluggish economic growth during the second half of 2009 versus the serious decline prior to this. Moderate economic growth is expected for 2010, and stronger growth is predicted for 2011. The unemployment rate is expected to exceed 9% through 2010, before declining to less than 9% in 2011. Long-run projections are that the unemployment rate will be in the range of 4.8% to 5.0%. The inflation rate is expected to remain relatively low, and this indicates continued relatively low interest rates. This will be a necessary condition for a recovery of the housing market to take place.

The following details are reported in the June 2009 Livingston Survey. The participants in the survey expect very low levels of economic growth during the second half of this year, 1.1% growth, and then a 2.6% rate of growth of real GDP in 2010. The unemployment rate is expected to remain very high (9.1% in 2009 and 9.7% in 2010). This reflects the expectation by the economists that recovery in the labor market will trail the recovery of the economy from this exceptionally bad recession. The economists expect that the inflation rate and interest rates will remain relatively low throughout 2009 and 2010. These low interest rates reflect the expectation that the economy will be relatively weak and that inflation will remain in check.

This is an interesting column that restates old concerns about using gross domestic product (GDP) as a measure of economic well-being, and contributes new ideas related to the environment. Here is the link for this column: http://www.nytimes.com/2009/08/10/opinion/10zencey.html?pagewanted=1&ref=opinion