Friday, July 31, 2009

Oregon's Unemployment

A reader passes on this article. Oregon has the second highest unemployment rate in the country. In the article, "Democrats are taking credit for a remarkable feat: creating 3,236 new jobs in the program's first three months. " Many of the jobs last a week and after the job, seek employment. The article points out the Democrats are justifying the stimulus package by pointing out that jobs are being created.

When a worker leaves a job, they are unemployed. If the jobs last only a week, the stimulus is actually increasing the unemployment rate. Economists look at the rate of job separation to job separation plus job finding. My humble statistics show that 545,000 workers nation wide lost jobs last month [Fox and Friends, Thursday, July 30, 2009]. This means that the total negative changes in the labor force outweigh the positive changes so the unemployment rate increased.

Democrats in Oregon might want to reconsider what they call a "job" when reporting statistics as it might come back in unemployment statistics.

Personal Savings Rate

Big Al at the Y brought up a good question a couple of days ago about savings. This blog entry is dedicated to him.

Big Al asked me what my personal savings rate was. My wife and I are lucky to be in the situation we are in and save nearly 1/3 of our disposable income. That will change when we buy a new home, but for the moment we are lucky.

Savings is important because it is channeled into investment through financial institutions. A low rate of savings means capital inflows from foreign investors and a negative net export number in the current account. As you can see from the graph, the personal savings rate is actually increasing.

One reason why the rate is increasing is consumer confidence. Consumers are fearful of the economic road ahead so they are saving. This means that consumption must be decreasing so consumers are spending less. Consumption makes up about 67% of GDP so an increase in personal savings could mean lumpy times for the economy.

Another reason why personal savings is increasing is the stock market. When the market is increasing, people feel wealthy and spend. With the market depressed, people are looking for safe ways to increase their wealth.

If you are a teacher of AP economics, here's a thought. An increase in savings would shift the supply curve to the right in the loanable funds market. This shift would lower the real interest rate and make it more profitable for business to invest. Is this what you are observing?

Tuesday, July 28, 2009

Natural Rate of Unemployment as a Moving Average

The unemployment rate varies from the natural as the economy moves from boom to bust. In this graph, I have plotted the unemployment rate as a 10-year moving average to show how the unemployment rate gravitates to a natural rate. The graph also shows that the natural rate seems to be declining. One reason for this decline is job matching. I watched my step daughter search for a job online in the comfort of her home. Job searching takes less effort.

In N. Gregory Mankiw's intermediate text, he assigns a problem where office space sits idle. It takes time for potential users of the space to find the space and adapt the space to their needs. In this problem, office space is unemployed. If the space could be posted online, searching would lower the cost and increase use.

Job matching services have lowered the cost of searching and might have lead to a lower NAIRU.

Sunday, July 26, 2009

How to Profit from the FED's Exit Strategy

Four Ways to Profit if Bernanke's 'Exit Strategy' Backfires By Jason Simpkins

Managing Editor

Money Morning

After more than a year of lax monetary policy and direct capital infusions, U.S. Federal Reserve Chairman Ben S. Bernanke has finally outlined an "exit strategy" that he says will lead to the "smooth and timely" withdrawal of monetary stimulus and keep inflation at bay.

However, analysts say that Bernanke's exit strategy is far from foolproof and could touch off an inflationary firestorm that hammers the U.S. economy, debases the dollar and sends prices soaring.

Indeed, analysts have long been concerned that Bernanke's unprecedented effort to boost market liquidity and expand the Fed's balance sheet would lead to a significant increase in inflation once credit markets return to normal.

The Fed has injected more than $2 trillion into the U.S. financial system, expanding credit through increased loans to banks to provide liquidity. It's also created the Commercial Paper Funding Facility - which holds $109.2 billion in short-term IOUs issued by corporations - and the Term Asset-Backed Securities Loan Facility (TALF) - which has lent $25 billion to investors to buy securities tied to auto and other consumer and business loans.

The Fed has also lowered its benchmark Federal Funds Rate to a record low range of 0.00%- 0.25%.

As a result, the U.S. monetary base has about doubled during the past two years.

Bernanke acknowledged in the Federal Reserve's Monetary Policy Report to Congress - as well as in an op-ed piece in Tuesday's Wall Street Journal and in comments made directly to the House Financial Services Committee - that inflation poses a significant threat. But he has also made it clear that the Federal Reserve has no interest in changing the course of its policy before it is certain that a recovery is underway.

"Economic policy conditions are likely to warrant accommodative monetary policy for an extended period," Bernanke said in the Fed's report to Congress.

Nevertheless, the central bank leader said he is confident that when the time comes he will have the "necessary tools" to rein in inflation in a "smooth and timely manner."

So what is the Bernanke's exit strategy? Will it work? And what should investors do if it backfires?

A Look Inside Bernanke's Toolkit

Bernanke has heard the concerns about inflation and this week he went a long way to address them. The Fed chairman not only addressed those concerns in his report to Congress, he penned an op-ed piece for The Journal. Bernanke pointed out in each of those statements that some of the Fed's emergency lending facilities automatically wind down as the economy recovers, because they have onerous pricing and terms.

Short-term credit extended by the Fed to financial institutions and other market participants has already fallen to less than $600 billion from about $1.5 trillion at the end of 2008, he noted.

Additionally, Bernanke named two key measures that the Fed could take to raise market interest rates as needed and drain the central bank's bloated balance sheet:

Increase the amount of interest paid on balances held at the Federal Reserve by depository institutions (banks).

Selling securities from the Federal Reserve's portfolio with the agreement to buy them back at a later date.

The Federal Reserve last fall was granted the authority to pay interest (currently 0.25%) on the balances maintained by banks at the central bank. Raising the amount of interest paid, Bernanke argues, will give the Fed substantial leverage over the Fed Funds Rate and other short-term rates, because banks don't typically supply funds to the market at an interest rate significantly lower than they can earn risk free by holding balances at the Federal Reserve.

Basically, banks will be keener to keep their money at the central bank for a substantial, risk-free premium, than they will be to lend it out at a lower rate with a higher risk. And this can be done without draining reserve balances.

Bernanke noted that it's common practice for many foreign central banks - including the European Central Bank (ECB), Bank of Japan (BOJ), and the Bank of Canada - to use their ability to pay interest on reserves to maintain a floor under market interest rates.

"Thus, the interest rate that the Fed pays should tend to put a floor under short-term market rates, including our policy target, the Federal-Funds Rate," Bernanke argued in the The Journal. "Raising the rate paid on reserve balances also discourages excessive growth in money or credit, because banks will not want to lend out their reserves at rates below what they can earn at the Fed."

The second part of Bernanke's exit strategy, which will be orchestrated in concert with the first, is to unwind the Fed's balance sheet by conducting reverse repurchase agreements and outright sales of longer-term securities.

A reverse repurchase agreement is when the Fed sells securities from its portfolio with an agreement to buy them back at a later date.

"Reverse repurchase agreements, which can be executed with primary dealers, government-sponsored enterprises, and a range of other counterparties, are a traditional and well-understood method of managing the level of bank reserves," Bernanke told the House Financial Services Committee.

Additionally, the Fed could simply sell its holdings in longer-term securities, which Bernanke says would drain reserves, raise short-term interest rates, and put upward pressure on longer-term interest rates by expanding the supply of longer-term assets.

"In sum, we are very confident that we have the tools to raise interest rates when that becomes necessary to achieve our objectives of maximum employment and price stability," Bernanke told the House panel.

Exit Strategy or Inflationary Quagmire?

At face value, Bernanke's exit strategy is entirely plausible. But that doesn't mean it's foolproof. There are a number of lingering questions and concerns still lingering in the minds of many investors and analysts. First, there is a question of timing. Bernanke may have described the Fed's tools, but he did not define the conditions that would lead to their use. That is, at what point does inflation become enough of a concern, and at what point does U.S. growth become sustainable enough, to warrant a change in Fed policy?

Bernanke sent a clear message to the market this week that he is aware of the potential risk of inflation, but he also made it clear that the economy is still in need of nursing. What Bernanke termed "accommodative monetary policy" - interest rates near zero and capital infusions through the purchase of government and mortgage debt - likely will remain the norm for the foreseeable future.

That seems fair considering that inflationary pressures have remained low, bank balance sheets are still in disrepair, consumer spending is weak, and unemployment is the highest it's been in decade. But as the economy improves, the central bank's policymaking Federal Open Market Committee (FOMC) will have to come to a consensus about when stimulus should be retracted and liquidity tightened. "Because there is no clear model or indicator on what tools to exit with, that is where the fuzziness is," Rudy Narvas, senior analyst with 4Cast Ltd. in New York, told Reuters. "If you don't time it right, either you dip the economy back into recession, or you will fuel the inflationary fires."

But timing isn't the only uncertainty regarding the Fed's plan. There are also questions about how effective the Fed's "tools" will be.

Raising interest payments on reserves could entice banks to keep more money with the Fed, but there's a limit as to how much money the central bank can pay out.

"There will eventually be a situation where the Fed is paying the banking system something like 5% on $700 billion of reserves," Bank of America-Merrill Lynch (NYSE: BAC) rates strategist Michael Cloherty wrote in a research note. "That would mean the Fed would be paying the banking system $35 billion per year of what is ultimately U.S. taxpayer money in order to push up interest rates."

Reverse purchase agreements could help trim the Fed's balance sheet, but the primary dealers - the "government-sponsored enterprises," and a range of other counterparties that Bernanke referred to - would have to have healthy balance sheets of their own. And so far there's no indication that they will.

Even selling longer-term securities outright carries an inherent risk. Merrill Lynch estimates that the Fed will hold $1.25 trillion in Treasury, agency, and private mortgage-backed debt.

The Federal Reserve "can't fob huge amounts of paper onto the market without having some seriously detrimental implications for long-term rates," Alan Ruskin, international strategist at RBS Securities (NYSE ADR: RBS), told Reuters.

The worst-case scenario, according to Ruskin, would be if foreign holders of U.S. debt - such as China, which held $768 billion of U.S. securities in reserve at the end of March - started dumping Treasuries and the dollar, causing a currency crisis.

What to Do if Bernanke's Exit Strategy Backfires

If the Fed is too slow in its withdrawal of "accommodative monetary policy," or if the central bank finds itself unable to unwind its balance sheet in as "smooth and timely manner" as Bernanke anticipates, a major surge in inflation will be likely the result. In that case, one of the clear winners would be commodities - especially gold.

"Protection from inflation is a huge benefit to commodities," said Money Morning Contributing Editor Peter Krauth. "Specific investments would include gold, silver, oil, and copper, to name a few. All of these are valuable - and possess an actual value - which means that they will not go to zero. Since they are priced in U.S. dollars, as the dollar loses value through inflation, you need more dollars to buy the same quantity (not to mention increasing demand)."

If you're interested in purchasing gold, you could do so by purchasing bars, or bullion, or though the gold-linked, exchange-traded fund (ETF) SPDR Gold Shares (NYSE: GLD).

Today, SPDR itself holds more than 1,000 ounces of gold, and has a market capitalization of $33 billion. The fund's price fluctuates in concert with the price of gold, which adds a small mount of risk. However, buying this ETF is more convenient than buying gold bars directly, because the fund dispenses with the accompanying storage problems that comes with actually owning physical gold.

Similarly, there are other commodities-based ETFs that would offer a significant return should inflation take hold.

For instance, the United States Oil Fund LP (NYSE: USO), the iPath S&P GSCI Crude Oil Total Return Fund (NYSE: OIL), or the United States Gasoline Fund LP (NYSE: UGA) all offer exposure to oil and gas prices, which have surged recently on demand but are certainly responsive to inflation as well.

Wednesday, July 22, 2009

The Unemployment Crisis

What determines equilibrium unemployment? This is the title of Chapter 3, The Unemployment Crisis, by Richard Layard, Stephen Nickell, and Richard Jackman. The answer is deviations from the natural rate of unemployment. Consider the graph. When aggregate demand increases, workers work longer and harder. In addition, they think that the demand for their production is the reason why they are working so hard. Workers don't understand that inflation, or a change in prices, is the cause. Inflation has inertia now. Workers ask for wage increases to keep up with inflation; prices rise, wages rise, and a wage-price spiral develops. This spiral would not happen and prices would remain constant if the labor market were in equilibrium. That's the conclusion of Chapter 3. (Click on image to enlarge.)

Tuesday, July 21, 2009

A Prescription for Disaster

Obama's Healthcare Plan: A Prescription for Disaster By Peter D. Schiff

Guest Columnist

Money Morning

The healthcare bill unveiled last week by the U.S. House of Representatives (with the full support of the Obama administration) is one of the worst pieces of legislation ever drafted.

If passed, President Obama's healthcare plan will reduce the quality and increase the cost of healthcare in America. But more importantly, it will severely undermine our already weak economy. To burden a country currently in the throes of a violent recession with such a bureaucratic albatross clearly illustrates the scarcity of economic intelligence in Washington.

In the first place, specifically taxing the rich to pay for healthcare for the uninsured is the wrong way to think about tax policy and is an unconstitutional redistribution of wealth. While the government has the constitutional power to tax to "promote the general welfare," it does not have the right to tax one group for the sole and specific benefit of another.

If the government wishes to finance national health insurance, the burden of paying for it should fall on every American. If that were the case, perhaps Congress would think twice before passing such a monstrosity.

In the second place, the healthcare bill is just bad economics. For an administration that supposedly wants to create jobs, this bill is one of the biggest job-killers yet devised. By increasing the marginal income tax rate on high earners (an extra 5.4% on incomes above $1 million), it reduces the incentives for small business owners to expand their companies.

When you combine this tax hike with the higher taxes that will kick in once the Bush tax-cuts expire, and add in the higher income taxes being imposed by several states, many business owners might simply choose not to put in the extra effort necessary to expand their businesses. Or, given the diminishing returns on their labor, they may choose to enjoy more leisure. More leisure for employers means fewer jobs for employees.

More directly, mandating insurance coverage for employees increases the cost of hiring workers. Under the terms of the bill, small businesses that do not provide insurance will be required to pay a tax as high as 8% of their payroll. Since most small businesses currently cannot afford to grant 8% across-the-board pay hikes, they will have to offset these costs by reducing wages. However, for employees working at the minimum wage, the only way for employers to offset the costs would be through layoffs.

The uninsured self-employed, or those working as independent contractors, will be forced to buy insurance or pay a tax equal to 2.5% of annual income. Either choice will divert resources from more productive uses into an already out-of-control healthcare bureaucracy.

Sadly, the bill does nothing to restrain or alter the dynamics that have caused healthcare costs to spiral ever higher. In fact, the bill will intensify these pressures.

The simplest explanation of why healthcare costs so much is that demand exceeds supply. Demand is a function of how much people are prepared to pay. Insuring more people will drive demand for healthcare services even higher.

As costs continue to soar, expect additional tax hikes to fund the added expense. As these additional taxes further encumber a weak economy, the diminished tax base will yield lower total tax revenues - despite higher rates. As the politicians attempt to pass higher tax increases to make up for revenue shortfalls, a vicious cycle toward insolvency will ensue.

The worst part of the whole fiasco is trying to imagine the bureaucracy necessary to administer this plan. My guess is that the government provider will mis-price its policies on the low side, pushing employers to dump private sector insurance for the taxpayer-subsidized alternative. Such a system will further distort healthcare pricing and, ultimately, make a bad situation intolerable.

The enormity, complexity, and expense of this bill could well pull the rug out from what many of my cheerleading colleagues believe to be the beginning of an economic recovery. The way I see it, the economy is walking dead anyway, and this measure is the equivalent of a stake through the heart. But even if we manage to escape the grave this time, Congress is working on a few other ideas that will surely keep us buried.

[Editor's Note: Peter D. Schiff, Euro Pacific Capital Inc.'s president and chief global strategist, is a well-known author and commentator, and is a periodic contributor to Money Morning. Schiff is the author of two New York Times best sellers: "Crash Proof: How to Profit from the Coming Economic Collapse," as well as "The Little Book of Bull Moves in Bear Markets." For a more-detailed look at the United States' ongoing financial problems - and for some strategies that will help you protect your wealth and preserve your purchasing power before it's too late - download EuroPac's brand-new free special report, "Peter Schiff's Five Favorite Investment Choices for the Next Five Years." After one of the most-torrid rebounds on record this spring, U.S. stocks have stalled - once forcing investors to make important decisions against a backdrop of intense uncertainty. However, a a new offerfrom Money Morning seeks to eradicate at least some of that uncertainty, and actually represents a two-part bargain for investors by offering a Schiff best-selling investment book and a subscription to The Money Map Report newsletter. Schiff's new book - "The Little Book of Bull Moves in Bear Markets" - shows investors how to profit no matter which way the market moves, while our monthly newsletter,The Money Map Report, provides ongoing analysis of the global financial markets and some of the best profit plays you'll find anywhere. To find out how to get both, Check out our newest offer.]

Characteristics of Minimum-Wage Workers

Economic theory predicts that an increase in the minimum wage, will result in frictional unemployment. Just who are the workers affected by the minimum wage?

There are only 2.7 million workers who earn the minimum wage or less. They represent 2.3% of the labor force. There are roughly 147 million workers in the labor force. These are the characteristics of those holding a job that pays the Federal minimum wage rate:

* They are young.
* Tend to be women
* Minimum wage workers represented all races, genders, ethic background.
* Minimum wage workers tend to work in leisure and hospitality sectors.
* Tend to be part-time workers.

These conclusions are taken from the 2007 Current Population Survey found on the BLS website.

Most economists believe that an increase in the minimum wage will increase unemployment. Usually, teens are the first to be let go. When I observe an increase in the minimum wage, I see employers cutting hours but not workforce. I think the percentage of minimum wage workers is so small that prices are not affected. These workers only marginally contribute to structural unemployment.

Monday, July 20, 2009

Unemployment Crisis

Unemployment is the pathology that upsets the performance of an economy. When employment deviates from its natural rate, then prices change. This is the conclusion of Chapter 2, The Unemployment Crisis, by Richard Layard, Stephen Nickell, and Richard Jackman. In the next paragraph, I will summarize their main points, then I will analyze their points theoretically.

The authors make the following points: [1] unemployment is cyclical and linked to prices. During booms, prices increase. During slumps, prices fall. So wages and prices are tied together. [2] Unemployment takes a long time to return to its natural level. [3] The Non Accelerating Inflation Rate of Unemployment is a long-run adjustment and a dynamic variable. [4] Market imperfections such as efficiency wages, minimum-wage, union bargaining, menu costs, and many more keep the labor market from clearing.

In the graphic, the natural rate of unemployment is 6%. [The BEA assumes 5.5%] If aggregate demand increases by 4%, unemployment falls 2% to 4% putting pressure on prices to rise 2%. This is the short-run Phillips Curve that shows the trade off between inflation and unemployment. In the long-run, workers will expect 2% price increases and build them into their wage demands. The economy will return to its 6% natural rate. The conclusion is that when unemployment is not at its natural rate, then prices are changing and the labor force is in disequilibrium. Data from the website shows that the natural rate has been falling since the mid 1980s. This author believes that changes in the composition of the labor force, structural changes in the way US produces goods, and labor for migration are the reasons for the Phillips Curve trade off.

Saturday, July 18, 2009

iPod App for AP Students

Thanks to Integrated Solutions, my iPod app is near completion. This app is meant to be an AP Microeconomics test prep. I figure demand will be elastic until two weeks before the AP exam then demand will be inelastic. More as my brilliant programmers finish.

Fisher Effect

Investors care about the real return on investment. In economics, the term "real" means how much in physical goods one can buy after inflation has been removed. Irving Fisher derived an equation to show that the nominal interest rate reflects future inflation expectations.

In this graphic, I show that nominal interest rates on three-month Treasury Bills, move in the same direction as the inflation rate. The relationship closely approximates expected changes in the interest rate. On my graph, I have left the data for the GDP price Deflator for the last four years absent so the reader could predict the direction of inflation.

A technical note. The GDP Price Deflator is calculated by dividing the current GDP by a chained index, GDP in $2000.

Thursday, July 16, 2009

Efficiency Wages and Unemployment

"Economists call the theories that link productivity or the efficiency of workers to the wage they are paid efficiency wages." That definition is from Oliver Blanchard's textbook, Macroeconomics. I use that definition as a backbone for today's thoughts on unemployment.

When a firm pays an employee above market-clearing wages, I call this an efficiency wage. The wage is higher than necessary to retain the employee so the wage gives the employee an incentive to stay and be productive since there are no alternate uses of time that pay more. Employees who are paid above market-clearing prices have a higher morale. I have always said, that "Employees who feel good about themselves are more productive." What is the link between efficiency wages and unemployment?

Efficiency wages cause structural unemployment. In other words, the market does not clear because the pricing mechanism is broken. Wages can not adjust to market conditions so some workers who would contribute to the labor force find themselves out of a job at the higher wage. This is like the unemployment that results from the minimum wage.

There is evidence that workers who operate expensive machinery are typically paid an efficiency wage. I believe that these workers are highly skilled and finding a replacement for these workers are costly. Paying a higher wage than the market, will retain these workers and prevent these workers from leaving with valuable trade information.

In my opinion, when the demand for machine operators increases, the wages in for that job increase. Employers will find it profitable to substitute machines, or capital, for workers. These workers will be unemployed and will seek jobs in unskilled labor markets. Unskilled labor markets will see an increase in the supply of workers and wages fall. Thus, income disparity deepens.

Efficiency wages are one reason for structural unemployment. When economics talk about the natural rate of unemployment, they mean some structural unemployment is always present. Do you agree that structural unemployment caused by efficiency wages is healthy for the economy? If you believe the theory, productivity would be higher.

Tuesday, July 14, 2009

The Yield Curve Blog

This blog makes me think, and I love it. I thought readers might like it to. The site is: Mr. Hamou assembles the pieces of the macro puzzle nicely.

The Unemployment Crisis

In this blog, I cover chapter 1 of "The Unemployment Crisis" by Richard Layard, Stephen Nickell, and Richard Jackman.

[1] Unemployment reduces output, income, and increases inequality as the unemployed job skills atropy.

[2] Unemployment fluctuates. My interpretation is that when the actual unemployment rate, U is not equal to the natural unemployment rate, Un, output and prices are not in equilibrium. When U deviates from the natural rate then there can be inflation or deflation.

[3] Unemployment in the European area has been associated with a massive increase in long-term unemployment. I interpret this to mean that job opportunities vanish the longer a worker is unemployed. Some blame generous unemployment benefits and high minimum wage.

[4] Unemployment varies greatly between countries. I once heard Robert Solow speak on this subject at Cornell College, Mt. Vernon, Iowa. It was a fact he was researching. He had reached no conclusion.

[5] Unemployment varies between age groups, occupations, regions, and races.

It is my analysis that the authors believe that unemployment is the core of an economy's ills. Unemployment imposes a psychic cost on those who are out of a job. Although the unemployed have more free time to seek leisure, few actually want to be out of a job. Most people want to feel needed. I believe that working presents challenges that develop character, skills, and gives meaning to life.

Sunday, July 12, 2009

The Unemployment Crisis

In the next two weeks, I will mainly be blogging about "The Unemployment Crisis" by Richard Layard, Stephen Nickell, and Richard Jackman. The book can be purchased at This is a serious book that mathematically examines the price-setting and wage-setting relations to determine unemployment rates.

This book was recommended reading by Oliver Blanchard in his MIT introductory text, Macroeconomics. I believe this rigorous approach to understanding the unemployment rate is necessary. The turbulence in today's economy has displaced workers. This author believes that permanent structural changes will occur in our social institutions as a result.

This final paragraph is random and desultory. In Jurassic Park a character exclaims, "life finds a way" when they find a raptor nest. Our economy will find a way to adjust. The adjustment process is of interest to me.

Sunday, July 05, 2009

NAIRU or Natural Rate of Unemployment

This video is intended to be used in my presentation at the Council for Economic Education Annual Conference in Washington. In my presentation, I will be showing how the FRED data base can be used to teach macroeconomic concepts and prepare students for the FED challenge.

FRED Again

I'm experimenting with video data and wanted to see if this video both fit my blog and worked.

Friday, July 03, 2009

Expected Inflation

Food and energy costs reflect inflation expectations. In this graph I have compared two CPI indexs. If the CPI including food and energy reflects inflationary expectations, then expect prices to raise--not fall as we approach the trough.

Natural Rate of Unemployment

Using Okun's law, gap version, it's easy to see that the natural rate of unemployment is about 5%. The Cleveland FED's research shows that the rate is 5.2%.

Wednesday, July 01, 2009

Race to the Bottom?

CNN has an article about a universal phone charger in Europe. A phone charger that works on all brands would be a standardized product and erode some of the pricing power that cell phone companies have.

The chargers would eliminate search time and transaction costs making the industry more efficient.