Market Power

Two More on the Phoenix Coyotes Bankruptcy Filing

Here is Victor Matheson's TSE post and here is one I wrote today..

RIP Gerald Scully

Gerald Scully, one of the pioneers of sports economics, has died of pancreatic cancer.  Here is my piece at The Sports Economist. 

TSE Post on the Phoenix Coyotes Bankruptcy

My latest at The Sports Economist is up.  I take a brief look at the bankruptcy filing made by the Phoenix Coyotes.

Robert Barro on Lessons from the Great Depression

Here at the Browser (via David Strom). 

They Stand, We Sit

My latest at The Sports Economist is up.  I look at a WSJ article on why American sports fans sit while fans from other countries stand.  Thanks to my colleage Ishuan Li for the article.

Getting Prices Wrong

Two weeks ago, Yaron Brook spoke at my campus about the origins of the financial crisis.  One of his primary culprits was the Federal Reserve in general, and Alan Greenspan in particular.  He likened the job of Alan Greenspan to that of the bureaucrats in the former Soviet Union whose job was to set the price of bread.  The result of the bread pricing was a chronic shortage of bread.

While Alan Greenspan may deserve much of the blame for the financial crisis, Brook would have been more accurate to argue that the Federal  Reserve Open Market Committee (FROMC), of which Greenspan was the chair, was partly to blame for the financial crisis.  The job of the FROMC is to set a target rate for the federal funds rate, the rate that banks charge each other on short term loans.  The effect of setting this target rate is to alter the money to drive the federal funds rate to the level the FROMC desires, setting off what amounts to a chain reaction that drives other interest rates.

Interest rates are essentially the future price of money, so targeting the interest rate is is setting the future price of money.  Back in the early part of this decade, the FROMC essentially drove interest rates below the rate of inflation, and the effect of this was an explosion in borrowing that proved to be unstable.

To explain, suppose there is only one interest rate, an annual rate, and all loans are made for one year.  Both the principal and the interest is paid in a lump sum at the end of the term of the loan.  If the nominal interest rate is 1% and a person borrows $10,000, he'll have to pay back $10,100 in one year.  If the inflation rate is 3%, then the lender needs to get back $10,300 to have the exact same purchasing power in one year that $10,000 has right now.  Basically, by making a loan, the lender is $200 worse off and the borrower is $200 better off in terms of overall purchasing power.

Remember that banks loan out the money that they hold as deposits, so they act as intermediaries between households.  So when one person borrows from a bank, he is essentially borrowing money from another household.  So the question is, if the inflation rate is 3% and the interest rate is 1%, is it better to be a borrower or a lender?

Many people chose to be a borrower, and that was one of the reasons the economy got into the mess it's in right now.  Basically, the FROMC did not get the future price of money "right" (whatever "right" is), much like the Soviet Union's bread bureaucrats never got the price of bread right.

Michael Bardo of Rutgers and Anna Schwartz of the NBER have a similar take in this Bloomberg column by Caroline Baum (HT to Craig Newmark).

As for Posner’s contention that the Fed’s erring on the side of low interest rates constitutes a failure of capitalism, Friedman “would have said it was total nonsense,” said Michael Bordo, professor of economics at Rutgers University in New Brunswick, New Jersey, who earned his Ph.D. in economics from Chicago. “It was not a failure of capitalism; it was a failure of the central bank.”

The odds that 19 men and women (a.k.a. the Federal Open Market Committee) will be able to select the overnight interest rate that keeps the U.S. economy growing at its potential in perpetuity are next to nil.

...“He wouldn’t agree” it was a failure of capitalism, said Anna Schwartz, a research associate at the National Bureau of Economic Research and Friedman’s co-author on “A Monetary History of the United States, 1867-1960.” “It was a failure of government.”

The Fed conducted “very easy monetary policy, which permitted the asset-price boom,” she said yesterday in a telephone interview. “It had nothing to do with capitalism failing. It had to do with the policies and institutions that conducted them.”

To be fair to Greenspan and all past, present, and future FROMC chairmen, it's asking a lot for people to be, as Greg Mankiw might say all-knowing, benevolent, all-powerful central planners.  That is, it's asking a lot for people to 1. have the sufficient information to allocate resources efficiently, 2. to have the best interests of the citizenry as a whole at heart, and 3. to be able to tell resource owners what to do with their property - all three at the same time.  Products are complicated things, and so is the determination of prices.  This is why central planning fails to do many things as well as people left to their rational self-interest in markets.

New Comment Policy

I've been getting a lot of what appears to be comment spam in recent weeks, so I have arranged for Typepad to automatically authenticate each comment.  I realize that this authentication process will add to the cost of leaving comments, and I apologize to all readers who might be affected by this.  But the volume of spam has gotten annoying, and I felt this was a necessary step to take.

Krugman Needs to Read Some Bastiat

Paul Krugman apparently has either forgotten or has never bothered to read his Bastiat and, thus, falls prey to the broken windows theory.  According to this theory, if a miscreant goes around town breaking windows, this will improve the economic activity in a society as people spend money to repair their windows.  Instead, the miscreant does no such thing because he is, in fact, destroying wealth (i.e. accumulated assets) and thus forces people into doing something they otherwise would not do.

Don Boudreaux of Cafe Hayek catches Paul Krugman making the same mistake in arguing for "green" investments.

Here's a letter that I sent yesterday to the New York Times:

Paul Krugman makes the astonishing claim that "a commitment to greenhouse gas reduction would, in the short-to-medium run, have the same economic effects as a major technological innovation: It would give businesses a reason to invest in new equipment and facilities even in the face of excess capacity" ("An Affordable Salvation," May 1).

Technological innovations benefit society not by giving firms "a reason to invest in new equipment and facilities," but by reducing costs - not by making resources scarcer (by artificially increasing demands for them) but by making resources go farther in their capacity to satisfy human desires.

If "a reason to invest" were sufficient to restore economic vigor, then war and natural disasters would do the trick even better than would government restrictions on greenhouse-gas emissions.