Free trade and US sock industry

Greg Mankiw has an interesting post on how the US sock industry has been affected by free trade. Of course, the flip side of this is that socks are being produced more efficiently at a lower cost while jobs/capital has shifted towards areas where we have a comparative advantage,

Class i on Tues

I called the college and classes are our class is scheduled for tomorrow. I will return the tests on that date.

More data - initial claims

Remember in class I told you that the data is coming in all over the place? Well initial claims were just released and came in fairly positive. You can read about it here .

The number of U.S. residents filing for unemployment benefits decreased by 13,000 last week to stand at 317,000, the lowest level in a month, the Labor Department reported Thursday.'

but

The four-week average of new claims rose by 2,000 to 329,750, the highest level since the week of April 21. The four-week average is considered a better gauge of labor market health than the volatile weekly number because it smoothes out one-time events such as weather, strikes or holidays

on the other hand

Economists are puzzled that unemployment claims have remained fairly steady and low even as the nation's job growth has slowed significantly in the past few months.
One explanation could be that firms are not hiring because they're uncertain about the future. That same uncertainty keeps them from laying off workers who might be needed if the economy rebounds

But the job market hasn't slowed to a worrisome extent yet. You can read about the Oct payroll report here. On the other hand, data on the housing is extremely weak and point to continued declines. With the inventories of homes remaining high, there is a very strong case to be made that home prices have a ways to fall and this could hurt consumption, and job growth, in the future.

As you can see, the Fed's job is not as simple as black or white. There is a lot of grey.

Topic 9 (Overview and summation of Chap 10-17)

I) Neoclassical Aggegate supply and demand curve
a) Best represenation is on Page 320 in your book
b) The goal of this graph is to combine the insights of the classical and keynesian viewpoints. So we have a
1) long run aggregate supply curve
2) short run aggregate supply curve
3) aggregate demand curve

II) What should the fiscal and monetary authorities do?
a) Fiscal
1) recessionary gap (make sure you know graph)
i) cut taxes
ii) increase government spending
2) inflationary gap (make sure you know graph)
i) raise taxes
ii) decrease government spending.
3) at equilibrium - have the budget balanced
4) automatic stabilizers - unemployment benefits, progressive tax code

b) monetary policy
1) The Fed has a dual mandate: maintain price stability and full employment. Accomplishing these goals require conflicting policy actions. Here is a rough guide as to what the fed should do.

2) recessionary gap (ditto)
i) open market purchase of government bonds (cut in fed funds rate)
ii) cut discount rate
iii) cut in reserve requirement ratio

3) inflationary gap (ditto)
i) open market sale of government bonds (raise in fed funds rate)
ii) raise discount rate
iii) rase the reserve requirement ratio

III) Critiques of fiscal and monetary policy
1) Fiscal policy
a) Time lag
b) government failure (rational ignorance, biased voters)
c) ricardian equivalence (i.e. rational expectations)

2) Monetary policy
a) Monetary policy may be unable to affect interest rates (liquidity trap)
b) Long term rates may not respond to policy changes.

IV) Examples of policy action
1) 2001 recession, 2003 Fed policy to counteract possible deflation.
2) 2004-2006 rate hikes by Federal reserve in order to prevent inflation
3) 1980 disinflationary action by Volker

Quiz 7 - Due Tues Nov 6

Quiz 7 - Monetary Economics (15-17)
Professor Matthew Festa
EC207 - Intro to Macroeconomics
Due in Class Nov 6, 2007

1) (2 points) - Identify whether each of the following items is counted in M1 only, M2 only, both M1 and M2, or neither

a) A $1000 balance in a transaction deposit at a bank
b) $50,000 certificate of deposit (CD) at your bank
c) $200,000 certificate of deposit (CD) at your bank
d) $50 traveler's check
e) $500 worth of stock in Google.

2) a)(1 point) The required reserve ratio is 20%. What is the potential money multiplier?
b) (1 point) If the Fed injects $10 million dollars into the banking system, what is the maximum the economy can expand?

3) (2 points) Draw the liquidity preference graph (money demand and money supply). Name the 3 tools of the Federal reserve? Which is the one they use the most?

4) (2 points) The Fed says they plan on cutting 25bps of the tool they use the most. Show the effect on the graph. Tell me whether the equilibrium interest rate and quantity of money will be higher or lower?

5) (2 points) Explain the equation MV=PY. Assuming that Y and V are fixed, what will happen if the Fed continually increases M? Is this a classical or Keynesian argument? Show the effect on an AS/AD graph.

Jobs Report

The single biggest monthly report on the economy is the Non Farm Payrolls report, a measure of how many jobs have been created in the economy during a given month. This report is released the first Friday of every month and is usually market moving (that is, stocks and bonds react to it). You can read the WSJ report on today's figure here

The WSJ reports that NFP rose a healthy 166 thousand gain in employment for Oct, helping to ease concerns that a recession is immanent. More important than the headline figure, which can be distorted because it is always revised, is the 3m average of 117k. 117k average over 3m is a healthy figure given market conditions.

Why is this important? Think of jobs as a way to estimate whether aggregate demand is going to be strong or weak. If employers were expecting AD to be weak, then they probably would not be hiring employees in order to boost output. Further, an increase the amount of jobs boosts income and this should help to support spending. This is extra important at a time when falling home prices threaten to hurt consumer spending.

However, economists debate whether this report can be used to predict the economies future. Some economic data is considered to be a "leading indicator of the economy" while others tend to be a "lagging indicator." Click here for a detailed breakdown over which economic data is considered leading or lagging.

In general, the unemployment rate is considered to be a lagging indicator (that is, the economy will slow and then the unemployment rate will rise). The payroll report is sometimes considered a lagging indicator but other times is considered a "coincident" indicator (it falls as the economy is weakening). In this case the markets are likely to consider it a coincident indicator and this should help ease concerns over a recession.

However, all is not well since the stock market fell yesterday and data on the housing market has been extremely weak. Although the stock market could see a rally today, I doubt it will return to the highs of early Oct before the latest round of worries commenced. It is, however, safe to say the Fed will not be cutting next month with GDP and employment coming in rather strong (pointing to decent AD) and oil prices so high (pointing to possible near term inflation).

Topic 8 (Chapter 17)

I) Demand for Money
a) Money balances - people have a desire to hold money
i) transactions demand - for purchases
ii) precautionary demand - for unexpected expenses (like if your car's transmission dies)
iii) asset demand - holding money compared to holding stocks and bonds

b) asset demand - why hold money rather than assets
1) advantages - liquidity and no risk
2) disadvantages - you don't earn any interest or gains in asset prices

c) Demand for money, therefore, should be inversely related to asset prices. For simplicity, we will assume the only asset price is the nominal interest rate. The higher the interest rate, the lower the demand for money (asset demand for money).

II) Tools of Monetary Policy
a) Liquidity preference graph - top of page 426 (the book doesn't mention its name)
b) Money demand (described above) and Money supply (fixed by the fed
c) Tools of the central bank
1) Fed Funds rate - the most used. It is the rate banks charge eachother to borrow reserves. Sale of bonds by Fed (more money supply, lower interest rate). Fed buy's bonds (takes money out, money supply contracts, interest rates rise).
2) Discount rate - the rate the Fed charges to borrow reserves.
3) reserve requirement.

III) Effect of monetary policy on output - use aggregate demand and supply

IV) Monetary policy transmission mechanism
a) Page 435
b) The argument is that lower interest stimulate the economy through higher investment. But it also stimulates the economy through higher consumption
c) However, this is only a short run argument. In the long run expansionary monetary policy can only result in higher inflation.

V) Putting together fiscal and monetary policy with a realistic AD/AS curve
a) aggregate demand - still the same
b) long run aggregate supply - still the same
c) short run aggregate supply - upward sloping now (this is a partial concession to Keyne's. An upward sloping curve means prices rise, but in the short term the market does not fully adjust to the fiscal or monetary expansion.

VI) MV=PY and its relation to the long run
a) definitions
1) M = Money
2) V = Velocity
3) P = Prices
4) Y = output

The Fed cut

You can read the text of the statement accompaning the 25bps rate cut in the Fed funds rate here. Note how the bank hinted they will not be cutting rates at the next meeting.

"The Committee judges that, after this action, the upside risks to inflation roughly balance the downside risks to growth. The Committee will continue to assess the effects of financial and other developments on economic prospects and will act as needed to foster price stability and sustainable economic growth."