About Economics

Book Recommendation for Prof. Paul Krugman

2009-11-19T15:22:26Z

I agree with both Paul Krugman and Brad DeLong here:

Brad DeLong says that the loss of public trust due to the kid-gloves treatment of bankers has raised the probability of another Great Depression, because the public won't support another round of bailouts even if it becomes desperately necessary. I agree -- but I think the bigger cost is that we've greatly increased the chance of a Japanese-style lost decade, with I would now give roughly even odds of happening. Why? Because bank-friendly policies have squandered public trust in all government action: try talking to the general public about stimulus, and it's all confounded in their minds with the deeply unpopular bailouts.

It is not the general public that is confounded here, Prof. Krugman. Small concentrated interests, whether they be the farm lobby or Wall Street, will always use governments to exploit large-scale diverse interests. Particularly when the line between Wall Street and the Treasury Department are blurred.

I believe it is time for all economists to re-read The Logic of Collective Action.

Book Recommendation for Prof. Paul Krugman originally appeared on About.com Economics on Thursday, November 19th, 2009 at 15:22:26.

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Why Use CPI as Our Measure of Inflation, When Other Measures Matter More?

2009-11-19T09:55:44Z

Veronique de Rugy in Where's That Inflation?:

In an email message, Murphy adds: "I believe we are currently witnessing a bubble in Treasury debt. I consider the current yields on 10-year U.S. government bonds to be absurdly low, just like the price of housing was absurdly high in early 2006. After this bubble bursts, investors will slap themselves on the forehead and say, 'What were we thinking? Why did we rush into Treasurys even as the government told us it was planning to double the federal debt burden in a decade?' "

The St. Lawrence University economist Steven Horwitz agrees both that inflation is already happening and that it is widely misunderstood. Monetarists, he says, were "too focused on aggregates like 'the' price level, which led economists to ignore the way inflation could distort individual prices at the microeconomic level, causing resource misallocation in the process." Virtually all economists now agree, for example, that the Fed's low interest rates inflated housing prices earlier in the decade. Yet as the prices of houses went up, few economists worried about inflation because the CPI looked relatively stable, due in part to a decrease in energy prices. When housing started to crash in 2007, many economists thought the Fed should inject still more funds into the system to stave off further declines. They failed to see that the Fed had distorted relative prices in the first place.

The majority position currently seems to be that a housing bubble that burst caused our current economic woes. During the previous recession, many blamed the poor economic conditions on a stock market bubble that burst. In both instances we saw very high levels of asset price inflation.

If asset price inflation is the problem, then why are we even looking at the CPI as a measure of how overheated (or underheated) the economy is? According to the above narratives economic woes were not caused by rises in the price of orange juice or golf clubs or vacations. It seems to me that either our choice of indicator of the price level is wrong or our narratives about what caused the last two recessions are wrong.

More on this topic: Should We Adjust Prices For Inflation?

Why Use CPI as Our Measure of Inflation, When Other Measures Matter More? originally appeared on About.com Economics on Thursday, November 19th, 2009 at 09:55:44.

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Exceedingly High Tax Rates and the Poverty Trap

2009-11-13T11:50:17Z

Another topic I have discussed before - see How Good Intentions Lead to Crushing Marginal Tax Rates on the Working Poor.

FreeExchange wonders if effective marginal tax rates of above 100% really do create a poverty trap:

Here is what I'd like to see CBO, or someone, put together: a statistical investigation into whether or not the trap actually traps. It's not that I don't understand the negative incentive effects at work here, it's just that those aren't the only factors being considered by individuals deciding how much to work.

If the line shown above ended with the dip just below the $40,000 level, the effects of the change in implicit tax rate would be clear. But it doesn't. Notably, it continues to the right, on a steady upward slope. And one assumes that the only way to move from a point to the left of that dip to a point on the right of that dip, which is where you want to be, is to go through the dip. Any worker opting to return to a lower income level would essentially be cutting off the possibility of moving to the fat part of the line with the next raise.

I do not find it particularly plausible that someone earning $10,000 a year would accept above-100% marginal tax rates because it is the only way they will be able to earn $40,000+ levels of income in the future. I suspect that an income level that high would be seen as too far off.

That being said, I think there are reasons to wonder how much the poverty trap actually traps. Because the tax and transfer system is so unbelievably complicated, I suspect that ex-ante people do not realize exactly how high marginal tax rates are. They only discover, ex-post that their 'take' would have been higher had that not attempted to increase their market income.

Exceedingly High Tax Rates and the Poverty Trap originally appeared on About.com Economics on Friday, November 13th, 2009 at 11:50:17.

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More Government Policies Promoting The Consumption of Junk Food

2009-11-12T14:42:54Z

From CBC News:

Fast food, coffee and newspapers are some of the items the Ontario government says will be exempt from a controversial blended sales tax the province will implement next year.

"It's important for Ontarians to know that today's announcement is about far more than not raising coffee prices," Ontario Finance Minister Dwight Duncan said in front of the backdrop of a Tim Hortons franchise in Toronto's west end.

Taxing everything else but excluding fast food is a de facto subsidy on fast food, which contributes to a rise in chronic diseases such as Type II diabetes. A Starbucks tall cafe mocha, with 25 grams of sugar, will be exempt from taxation. Is this really the kind of thing governments anywhere should be promoting?

I have said it three times this week (see here, here and here) - if we want the government to be improving the health of the population, and obvious first step would be for the government to get rid of the laws that contribute to poor health!

More Government Policies Promoting The Consumption of Junk Food originally appeared on About.com Economics on Thursday, November 12th, 2009 at 14:42:54.

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Inflation as an Arbitrary Concept - Part II

2009-11-12T09:58:02Z

A continuation of Inflation as an Arbitrary Concept.

Peter G. Klein left a comment that indicates that Scott Sumner and I are not the only economists leery of the concept of inflation:

Mike, you and Scott have some distinguished predecessors. Gottfried Haberler made
the same argument in his 1927 book _The Mean of Index Numbers: An Inquiry in the
Concept of the Price Level and the Methods of Its Measurement_. E.g.: "The relative
position and change of different groups of prices are not revealed, but are hidden
and submerged in a general index. Not the movement of the general price level, but
the chronological succession of special price and price combinations ... are regarded
as significant for the waves of business life.... Such a general index rather conceals
and submerges than reveals and explains those price movements that characterize and
signify the movement of the cycle."

I have to admit, my knowledge of the history of thought in economics is quite limited, so I quite enjoyed learning this (it was new to me). I decided to do some additional research (a.k.a. a Google search), and found Gottfried Haberler: A Centenary Appreciation, a summary of the man's work. I found it quite enlightening.

I figure there have to be more economists to take this view - any other names to add to the list? I still suspect, though, that we are in the minority. Too many textbooks treat the concept of inflation as an objective concept that we try our best to estimate. It is not, because our basket of goods changes over time and any attempts to account for this are based on subjective 'judgment calls'.

Inflation as an Arbitrary Concept - Part II originally appeared on About.com Economics on Thursday, November 12th, 2009 at 09:58:02.

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How to Control Health Care Costs

2009-11-12T09:41:48Z

A continuation of How the U.S. Government Can Increase Health Without Spending More Than a Cent and The Ongoing Ridiculousness of the Health Care Debate.

I tend to look at the problem differently than 'controlling cost' - to me, the problem is more 'How do we get the healthiest population possible at the lowest cost?' (which is related, but different). The New York Times brought out 9 experts to give their ideas. Of those, I believe two of the nine recommendations would work as intended. First, Arnold Kling:

The key to containing health care costs is to reduce spending on medical procedures that have high costs and low benefits. In order to do that, you have to increase the share of spending that is paid for by patients and reduce the share that is paid for by third parties, so that consumers will think twice about high-cost, low-value procedures.

Prof. Kling recognizes that the problem is a demand-side one as much as a supply-side one. My recommendations have been to reduce demand by promoting healthy living and lowering pollution. This is another way of reducing demand.

Secondly, Prof. Herzlinger:

There is a way to raise revenues and also control costs: Congress could simply extend the present tax exclusion of employer-sponsored health insurance to a cash-out of those costs as additional salary that employees could use to buy their own health insurance. This approach would motivate insured employees to treat their health insurance as if they paid for it directly and appeal to taxpayers.

I have always found the tax treatment of health care plans odd. As an employer in Canada, if I give a worker an extra $200 a month in salary, the employee is forced to pay income and payroll taxes on that amount. However, if I give an employee $200 worth of health care insurance, no taxes are paid on that by the employees (provided that certain conditions are met). As an employer, either form of remuneration counts as an expense, so the tax implications for the firm are the same. Thus the tax system is biased in favour of giving employees expensive health care plans.

Overall, though, I find it frustrating that so many of the proposed policies are expensive 'supply side' solutions to what is, at least in part, a demand side problem.

How to Control Health Care Costs originally appeared on About.com Economics on Thursday, November 12th, 2009 at 09:41:48.

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How the U.S. Government Can Increase Health Without Spending More Than a Cent

2009-11-10T17:44:02Z

a.k.a. Mike Moffatt's one cent health care plan - a continuation of an earlier post - The Health Risks of Obesity.

A RAND study suggests that obesity causes an increase in chronic medical conditions of 67 percent. Similarly living in poverty increases the rate of chronic medical conditions of 58 percent. These naturally lead to an increase in costs to health care:

Obese individuals spend more on both services and medication than daily smokers and heavy drinkers. For example, obese individuals spend approximately 36 percent more than the general baseline population on health services, compared with a 21 percent increase for daily smokers and a 14 percent increase for heavy drinkers. Obese individuals spend 77 percent more on medications. Only aging has a greater effect -- and only on expenditures for medications.

Want to improve the health of the U.S. population? You can do so in three steps:

Remove highly distortionary farm policies, which largely subsidize the production of 'junk food'.
Place a tax on junk food - such as the proposed cola tax:
"In what is certain to become a world-wide debate on the use of economic sanctions to tackle obesity, a group led by academics from Yale and Harvard universities proposed a "cola war", with a 1 cent tax per fluid ounce on sweetened beverages, raising the price of the average can of cola by 15 to 20 per cent.

They say this would cut calorie consumption from drinks by a minimum of 10 per cent (enough to prompt weight loss) and contribute almost $15bn towards the health costs of obesity."
Transfer the tax revenue collected to low-income households, or implement some kind of negative income tax, in order to help raise families out of poverty.

These three steps would greatly improve health outcomes in the United States and not cost the U.S. government a thing. Lives would improve as chronic disease would be reduced - the benefits go beyond financial costs. Furthermore, health care resources would be freed up to be used elsewhere.

This is a far, far more sensible plan than increasing government spending and only treating people after they get sick.

How the U.S. Government Can Increase Health Without Spending More Than a Cent originally appeared on About.com Economics on Tuesday, November 10th, 2009 at 17:44:02.

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Inflation as an Arbitrary Concept

2009-11-10T17:25:02Z

In Should We Adjust Prices For Inflation? I discuss my concerns with the concept of inflation. The short story is, because our 'representative basket of goods' changes over time due to technological and social changes, there is simply no objective way to measure changes in the 'price level' (that is, there is no such thing as a 'changing price level' in an objective sense. I was delighted to see that Scott Sumner agrees with me:

Inflation is an arbitrary concept that has never been clearly defined, or at least defined in a way that relates to how it is actually measured.

He then links to an earlier blog post - Six reasons to abolish inflation, which ends with:

What's the use of inflation? It's worthless. Let's get rid of it. Take it out of our models. Take it out of our policy rules. If indexing is required then use wage inflation. If you can't afford to do that for Social Security, tell old folks they'll get wage inflation minus 1%. Remind them that although at age 70 they'll be playing golf and taking cruises, by 90 they'll mostly be sitting around watching TV. And by that time even 60 inch 1080P Pioneer Kuros will be considered so crappy that Walmart will be almost giving them away.

I know that Sumner is being 'provocative' (his words), but he is right on the money. I am actually rather shocked to find another economist who agrees with my views on inflation.

Inflation as an Arbitrary Concept originally appeared on About.com Economics on Tuesday, November 10th, 2009 at 17:25:02.

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The Ongoing Ridiculousness of the Health Care Debate

2009-11-05T08:20:24Z

One thing I find frustrating about the whole health care debate, on both sides, is the presumption that more doctors and hospitals and technologies (either paid by the private or public sector) is the lowest cost way of improving the health of the population. But given how many illnesses are caused by lifestyle (overeating, excessive drinking, smoking) or environmental (pollution) factors, we need to be considering other solutions to improve health. A Pigovian tax on sources of air pollution offset by lower income taxes would improve the health of the population, be a net benefit to the economy (by replacing an economically damaging tax with a less damaging one) and come at zero financial cost. Why do I feel like I am the only economist, on either the left or the right, talking about these things?

More here: One Economist's Thoughts On the Health Care Debate.

The Ongoing Ridiculousness of the Health Care Debate originally appeared on About.com Economics on Thursday, November 5th, 2009 at 08:20:24.

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Understanding Cross-Price and Own-Price Elasticity of Demand

2009-10-31T17:15:41Z

It is a common topic in first year microeconomics courses that often confuses students. I hope this walkthrough helps - Price Elasticity - How to Use Cross Price and Own Price Elasticity.

Understanding Cross-Price and Own-Price Elasticity of Demand originally appeared on About.com Economics on Saturday, October 31st, 2009 at 17:15:41.

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