In most all cases, benefits and costs used to evaluate the efficiency of a policy are measured in dollar terms. Dollar prices are often used in this estimation because they reveal how people value scarce resources. This is what may be referred to as ‘use value.’ Economists also recognize ‘non-use value,’ or the value or benefit that people conceive from simply knowing that resources exist. ( ex: you may get non-use value from simply knowing that bald eagles have not become extinct etc. regardless if you ever benefit from their existence in some direct financial way.) Of course, these values are much more difficult to quantify.
Without market prices, economists often rely on survey data or data provided by the physical and natural sciences. Both revealed ‘use-value’ and approximated ‘non-use’ value are converted into monetary terms to provide a common unit of measure. This is not to say that we can put a price on everything, and this does not give greater weight to ‘markets vs. nature,’ it just provides a common unit of measure. This is no different than converting from meters to feet etc.
In the end, if total benefits translated into monetary terms exceed costs, ( the policy produces positive net benefits) then the policy is said to have a favorable cost/benefit analysis, at least from a pareto-potential perspective.
This does not mean that the policy should be undertaken, just that it may be favored over an alternative with negative net benefits. There are plenty of other criteria that must be considered such as constitutionality, distribution, rent seeking, etc. ( see ‘Public Choice’ under selected topics)
Saturday, December 22, 2007
Thursday, December 20, 2007
EASY MONEY OR FINANCIAL INNOVATION?
In earlier posts ( Discretionary Monetary Policy I-III) I presented a brief overview of a hybrid monetarist/Austrian view of bubbles and business cycles. This explained the bursting of the ‘agriculture bubble’ in the 70’s, the tech bubble in the 90’s, and I related it to recent sub-prime mortgage issues.
Certainly these ideas are not my own, but just my application of certain ideas from macroeconomics, and many people may disagree, or be in denial about an infallible fed. But, there are many who offer corroborating analysis. As Gerald P. O’driscoll (former vice president of the Dallas Fed) notes in his Cato Institute article ‘Our Subprime Fed,’
“ The Fed cut the fed funds rate sharply after the bursting of the stock market bubble in March 2000…..the Fed cut rates far too long, fueling not only a vigorous economic expansion but also the housing bubble.”
Wayne Angell, a former Fed governor and personal advisor to Dick Cheney is quoted in a recent Fortune article;
"The Fed was extremely easy from 2002 to 2005. It was not desirable or necessary, and it set off this huge real estate boom.”
So, the idea that easy, discretionary monetary policy by the Federal Reserve played a role in recent sub-prime mortgage troubles certainly has merit among some prominent economists.
However, one thing cautioned as far back as my undergraduate coursework in money and banking, was the role that financial innovation and technological change may play when modeling the macro economy or predicting the effects of monetary policy. In the 90’s people were touting that information technology, debit cards, ATM’s etc were changing the way we must view money. In addition, IT made workers more productive, allowing expanded economic growth for a long period of time with very low unemployment without ‘overheating’ or triggering inflation. Of course, the tech bubble soon burst after that.
In ‘The Bear Flu and How it Spread,’ a recent Business Week article explains the role of financial innovation in the collapse of two Bear Stearns hedge funds. It describes a tweaked version of collateralized debt obligations ( CDO’s) that they tagged ‘Kilo’s. They were designed to encourage money market funds to get involved in the mortgage market by having other large banks such as Citigroup and Bank of America guarantee the investments. To the money market manager, there were decreased risks, and better returns from mortgage products vs. the traditional short term investments used historically. The big banks received fees and more fund sources for ultimately securitizing their mortgages, and Bear Stearns was profiting from selling these new innovative investment products.
Of course, with this model being repeated throughout the real estate and financial sector of the economy, a downturn could create problems, and it apparently did. One question of course, is what played a larger role in the grand scheme of things, easy money or financial innovation? It is hard to know. One thing is true, the market distortions and noise created by discretionary monetary policy make it hard to determine any thing for certain.
REFERENCES:
http://www.businessweek.com/magazine/content/07_53/b4065000402886.htm
http://money.cnn.com/2007/11/22/magazines/fortune/cheney.fortune/index.htm?postversion=2007112517
http://www.cato.org/pub_display.php?pub_id=8638
Certainly these ideas are not my own, but just my application of certain ideas from macroeconomics, and many people may disagree, or be in denial about an infallible fed. But, there are many who offer corroborating analysis. As Gerald P. O’driscoll (former vice president of the Dallas Fed) notes in his Cato Institute article ‘Our Subprime Fed,’
“ The Fed cut the fed funds rate sharply after the bursting of the stock market bubble in March 2000…..the Fed cut rates far too long, fueling not only a vigorous economic expansion but also the housing bubble.”
Wayne Angell, a former Fed governor and personal advisor to Dick Cheney is quoted in a recent Fortune article;
"The Fed was extremely easy from 2002 to 2005. It was not desirable or necessary, and it set off this huge real estate boom.”
So, the idea that easy, discretionary monetary policy by the Federal Reserve played a role in recent sub-prime mortgage troubles certainly has merit among some prominent economists.
However, one thing cautioned as far back as my undergraduate coursework in money and banking, was the role that financial innovation and technological change may play when modeling the macro economy or predicting the effects of monetary policy. In the 90’s people were touting that information technology, debit cards, ATM’s etc were changing the way we must view money. In addition, IT made workers more productive, allowing expanded economic growth for a long period of time with very low unemployment without ‘overheating’ or triggering inflation. Of course, the tech bubble soon burst after that.
In ‘The Bear Flu and How it Spread,’ a recent Business Week article explains the role of financial innovation in the collapse of two Bear Stearns hedge funds. It describes a tweaked version of collateralized debt obligations ( CDO’s) that they tagged ‘Kilo’s. They were designed to encourage money market funds to get involved in the mortgage market by having other large banks such as Citigroup and Bank of America guarantee the investments. To the money market manager, there were decreased risks, and better returns from mortgage products vs. the traditional short term investments used historically. The big banks received fees and more fund sources for ultimately securitizing their mortgages, and Bear Stearns was profiting from selling these new innovative investment products.
Of course, with this model being repeated throughout the real estate and financial sector of the economy, a downturn could create problems, and it apparently did. One question of course, is what played a larger role in the grand scheme of things, easy money or financial innovation? It is hard to know. One thing is true, the market distortions and noise created by discretionary monetary policy make it hard to determine any thing for certain.
REFERENCES:
http://www.businessweek.com/magazine/content/07_53/b4065000402886.htm
http://money.cnn.com/2007/11/22/magazines/fortune/cheney.fortune/index.htm?postversion=2007112517
http://www.cato.org/pub_display.php?pub_id=8638
Wednesday, December 19, 2007
WHY AGRICULTURAL ECONOMICS
"The combination of quantitative training and applied work makes agricultural economics graduates an extremely well-prepared source of employees for private industry. That's why American Express has hired over 80 agricultural economists since 1990."
- David Edwards, Vice President-International Risk Management, American Express
While in graduate school, and deciding upon the traditional course work in economic theory vs agricultural and applied economics, my advanced micro theory instructor ( from a course taken at the University of Kentucky) posed the following scenario. He said
‘ You can choose to be a consumer of economics, or you can be a producer of economics.’
Phrased differently, he was asking, at what level of mathematical abstraction do you want to work. Do you want to use mathematical tools to model and solve problems of economic significance,( a consumer of economics) or do you want to develop the mathematical tools to be used by other economists to build models and solve problems ( a producer of economics).
Perhaps it is also a question of basic vs. applied research. I want to see application and results. I want answers to questions now. I don’t want to wait 10+ years for my ideas to either catch on or be forgotten.
To quote, from Johns Hopkins University’s applied economics program home page:
“Economic analysis is no longer relegated to academicians and a small number of PhD-trained specialists. Instead, economics has become an increasingly ubiquitous as well as rapidly changing line of inquiry that requires people who are skilled in analyzing and interpreting economic data, and then using it to effect decisions ………Advances in computing and the greater availability of timely data through the Internet have created an arena which demands skilled statistical analysis, guided by economic reasoning and modeling.”
Ultimately I chose a graduate program in Agriculture with an emphasis in Agricultural Economics. I had some trepidation at first, thinking that it may have a limited focus. Actually, it lead to encounters with the same theoretical and quantitative tools presented in traditional graduate work in economics, and also provided additional opportunities for application (such as natural resource and energy economics or biotechnology). At my institution, I was able to take additional courses in crop science and genetics to tailor a secondary emphasis in Agronomy. I also had the opportunity to take courses in applied economics and finance from the MBA program.
To quote from the American Agricultural Economics Association:
“Nearly one in five jobs in the United States is in food and fiber production and distribution. Fewer than three percent of the people involved in the agricultural industries actually work on the farm. Graduates in agricultural and applied economics or agribusiness work in a variety of institutions applying their knowledge of economics and business skills related to food production, rural development and natural resources”
- David Edwards, Vice President-International Risk Management, American Express
While in graduate school, and deciding upon the traditional course work in economic theory vs agricultural and applied economics, my advanced micro theory instructor ( from a course taken at the University of Kentucky) posed the following scenario. He said
‘ You can choose to be a consumer of economics, or you can be a producer of economics.’
Phrased differently, he was asking, at what level of mathematical abstraction do you want to work. Do you want to use mathematical tools to model and solve problems of economic significance,( a consumer of economics) or do you want to develop the mathematical tools to be used by other economists to build models and solve problems ( a producer of economics).
Perhaps it is also a question of basic vs. applied research. I want to see application and results. I want answers to questions now. I don’t want to wait 10+ years for my ideas to either catch on or be forgotten.
To quote, from Johns Hopkins University’s applied economics program home page:
“Economic analysis is no longer relegated to academicians and a small number of PhD-trained specialists. Instead, economics has become an increasingly ubiquitous as well as rapidly changing line of inquiry that requires people who are skilled in analyzing and interpreting economic data, and then using it to effect decisions ………Advances in computing and the greater availability of timely data through the Internet have created an arena which demands skilled statistical analysis, guided by economic reasoning and modeling.”
Ultimately I chose a graduate program in Agriculture with an emphasis in Agricultural Economics. I had some trepidation at first, thinking that it may have a limited focus. Actually, it lead to encounters with the same theoretical and quantitative tools presented in traditional graduate work in economics, and also provided additional opportunities for application (such as natural resource and energy economics or biotechnology). At my institution, I was able to take additional courses in crop science and genetics to tailor a secondary emphasis in Agronomy. I also had the opportunity to take courses in applied economics and finance from the MBA program.
To quote from the American Agricultural Economics Association:
“Nearly one in five jobs in the United States is in food and fiber production and distribution. Fewer than three percent of the people involved in the agricultural industries actually work on the farm. Graduates in agricultural and applied economics or agribusiness work in a variety of institutions applying their knowledge of economics and business skills related to food production, rural development and natural resources”
Monday, December 17, 2007
A SHORT ASIDE ON COST BENEFIT ANALYSIS
The ongoing theme for some of my recent posts has been tools used by economists in studying the environment. In this post I am going to discuss the concept of efficiency and methods of cost benefit analysis.
Pareto Efficiency: A state is pareto efficient if it is impossible to make someone better off without harming another. In other words, if you can only make someone better off by making someone else worse off, you should do nothing. This state of rest is ‘pareto efficient.’
Cost Benefit Analysis: Cost benefit analysis is based largely on ‘pareto –potential' efficiency. In this case the benefits of a policy must exceed the costs imposed on society to achieve those benefits. It is pareto-potential because, if the benefits generated by a policy exceed the costs, beneficiaries could theoretically or potentially compensate others who may be harmed by the policy.
In the next post, I will discuss how costs and benefits are measured, an important exercise for public policy analysis.
Pareto Efficiency: A state is pareto efficient if it is impossible to make someone better off without harming another. In other words, if you can only make someone better off by making someone else worse off, you should do nothing. This state of rest is ‘pareto efficient.’
Cost Benefit Analysis: Cost benefit analysis is based largely on ‘pareto –potential' efficiency. In this case the benefits of a policy must exceed the costs imposed on society to achieve those benefits. It is pareto-potential because, if the benefits generated by a policy exceed the costs, beneficiaries could theoretically or potentially compensate others who may be harmed by the policy.
In the next post, I will discuss how costs and benefits are measured, an important exercise for public policy analysis.
Wednesday, December 12, 2007
POLLUTION AND ECONOMIC GROWTH
If we are concerned with economic growth, we must carefully consider how pollution may affect growth. Can we quantify a critical amount of pollution that will be detrimental if no corrective measures are taken?
In many cases, environmental problems are the unintentional consequences of buying and selling goods. This typically occurs when these consequences are not captured in the price of the goods exchanged. Whenever the full cost of one’s behavior is not captured by a price by which an environmental trade-off can be valued, a negative externality or commons problem exists. ( see my public choice article- Our commons, Our Choice).
In many cases, without private property rights or markets to establish prices, economists must rely on evidence from the sciences in order to approximate the value of an externality. They may use this evidence to model the biological consequences of different policy options and the relevant costs and benefits. They use these models to approximate the dollar amount of a negative externality and attempt to tax or structure a system of property rights in such a way that the externality may be internalized. ( see the previous Public Choice post on the ‘Coase Theorem’) When this is done, and individuals are paying the full cost of their behavior which may be causing damage to the environment, an optimal solution may be achieved.
It is in this way that we capture both the positive and negative effects of economic growth for long term sustainability.
In many cases, environmental problems are the unintentional consequences of buying and selling goods. This typically occurs when these consequences are not captured in the price of the goods exchanged. Whenever the full cost of one’s behavior is not captured by a price by which an environmental trade-off can be valued, a negative externality or commons problem exists. ( see my public choice article- Our commons, Our Choice).
In many cases, without private property rights or markets to establish prices, economists must rely on evidence from the sciences in order to approximate the value of an externality. They may use this evidence to model the biological consequences of different policy options and the relevant costs and benefits. They use these models to approximate the dollar amount of a negative externality and attempt to tax or structure a system of property rights in such a way that the externality may be internalized. ( see the previous Public Choice post on the ‘Coase Theorem’) When this is done, and individuals are paying the full cost of their behavior which may be causing damage to the environment, an optimal solution may be achieved.
It is in this way that we capture both the positive and negative effects of economic growth for long term sustainability.
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