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Politics : Idea Of The Day -- Ignore unavailable to you. Want to Upgrade?

To: IQBAL LATIF who wrote (44735)	10/2/2003 3:47:13 AM
From: IQBAL LATIF	Respond to of 50167

One Hundred Interesting Mathematical Calculations, Puzzles, and Amusements: Number 20: The Federal Reserve Problem The Federal Reserve Problem A man named Alan Greenspan is Chair of the Federal Reserve Board, and Chair of the Federal Reserve System's Open Market Committee. The Federal Reserve is our country's central bank: it is responsible for setting interest rates. The interest rate is set in percent per year. Currently, the interest rate on short-term U.S. Treasury bonds is one percent per year: buy $1,000 of Treasury bonds now, and the U.S. government will pay you $1,000(1 + 1%) = $1,000(1.01) = $1,010 back in a year. Interest rates matter because the higher the interest rate the less likely companies are to spend money building new buildings and factories and buying new machines. When interest rates are high, they say, "Couldn't we make more money by lending out our cash than by using it to build new buildings and factories and buy more machines to make more stuff to sell?" When interest rates are low, they say, "Couldn't we make more money by taking some of the cash we loaned out--the people who borrowed it are hardly paying us any interest, after all--and use it instead to build new buildings and factories and buy more machines to make more stuff to sell?" When interest rates are high, spending on buildings, factories, and machines is low. People who work in construction or machine making lose their jobs. As they lose their jobs, they stop buying as much for their households, and this means that businesses that make the things they would have bought find themselves losing money and yet more people lose their jobs. The Federal Reserve staff calculate that the relationship between the country's unemployment rate and interest rates is: u = x + 0.6(r) Where u is the unemployment rate (a number like 6%, or .06), r is the interest rate (a number like 1%, .01), and x is a number that jumps around over time and represents the strength of other forms of demand--it is the result of the combination of consumers' optimism, government spending, foreign demand for U.S.-made products, and a lot of other factors that the Federal Reserve staff tracks. Just before September 11, 2001, the Federal Reserve staff believed that x was equal to 1.4% (.014), and the Federal Reserve's Open Market Committee had set the interest rate r to 6%. What does the equation above predict the value of the unemployment rate would be? In fact, the unemployment rate on the eve of September 11, 2001 was about 5%, and that made the Federal Reserve happy. The Federal Reserve is charged by law with avoiding inflation--unwarranted rises in prices--and it fears that an unemployment rate below 5% produces rising inflation. Thus the Federal Reserve wants to keep the unemployment rate from going below 5% (because it is supposed to keep inflation from rising), and the Federal Reserve wants to keep the unemployment rate from going above 5% (because unemployment is a bad thing: the more people are unemployed, the more people are poor and unhappy). Then came the terrible events of September 11, 2001. Their effects on the economy are perhaps least important, but I think about them because economics is what I do. The terror-attack made a lot of businesses worried about spending money on factories, other buildings, and machines. In the judgment of the Federal Reserve staff, the terror-attack on September 11, 2001, increased the number x in the equation above from 0.014 to 0.044. What should the Federal Reserve have done in response if it wanted to keep the unemployment rate from rising above 5%? In fact, the Federal Reserve did reduce interest rate r to 1%. But unfortunately it looks like the number x increased not to .044 but to .054, so we have a current unemployment rate of... what? Now the Federal Reserve has a problem. It doesn't want to reduce the interest rate r even more, because it fears that if the interest rate is lower than 1% that a lot of banks will find it impossible to make money, and will close down. So right now the Federal Reserve is sitting around hoping that the number x in the equation above is about to go down, so that the unemployment rate will soon fall from 6% down to 5%. Posted by DeLong at 04:38 PM \| Permanent Link

To: IQBAL LATIF who wrote (44735)	10/2/2003 3:51:39 AM
From: IQBAL LATIF	Read Replies (1) \| Respond to of 50167

What job loss?, Don't you know there's an entrepreneurial boom! It's interesting to watch the birth of a new political spin. Bush's main weakness on the economy is being in close company with Herbert Hoover when it comes to job loss. However, when the Bush people see a number that they can't deny, they simply use a different number. So instead of presiding over the loss of nearly 3 million jobs, we are beginning to be told that there is actually an entrepreneurial boom that the traditional employment numbers aren't capturing. Don't be surprised if in a few months this new party line isn't aped by various Cabinet secretaries in some encore bus tour. Here's how the story was spun by Brian Wesbury of the firm Griffin, Kubik, Stephens and Thompson writing on the op ed page of the Wall Street Journal on September 15th: There are many other unnecessary burdens on U.S. companies -- high tax rates, product liability and litigation costs, wasteful regulation, sky-high workers' compensation and unemployment insurance, Social Security and Medicare taxes, tax preparation costs, and Sarbanes-Oxley compliance. In addition, energy prices have remained stubbornly high as Congress dithers over an energy bill. It's the death of a thousand cuts, not a Chinese conspiracy. These costs have forced the owner of one very small Midwest painting company to completely revamp his business structure. He converted all his employees into partners (owners) because workers' comp and unemployment costs had completely undermined his profitability. Eliminating these costs allowed the company to survive. These creative solutions are allowing small businesses to succeed despite extraordinary obstacles. In fact, they are creating jobs while large businesses are eliminating them. We know this because there is a big divergence between the two surveys of employment run by the Bureau of Labor Statistics. According to the Establishment Survey, non- farm payroll jobs fell by 93,000 in August, creating a total job loss of 437,000 for the first eight months of 2003. The BLS collects this data from approximately 160,000 existing businesses and government agencies each month. The BLS also collects data directly from households each month -- by either visiting or calling roughly 60,000 households and asking about employment. This data is used to calculate the unemployment rate, which fell to 6.1% in August from 6.2% in July. Interestingly, the Household Survey shows that 1.186 million new jobs have been created this year. This discrepancy of more than 1.6 million jobs can be explained by the fact that sole proprietorships and other small companies are starting up at a faster rate today than they did even in the go-go '90s. They don't show up on the Establishment Surveys' radar because they're too small and too new. However, the Household Survey catches these jobs by asking workers directly. There are well known differences between the two surveys and yes part of the difference in the numbers is due to new business formation that might not be adequately captured by the establishment survey until an adjustment is done. However, Wesbury conveniently disregards all the other factors. The household survey, for example includes farm workers and self-employed which the payroll survey doesn't. Wesbury is easy to dismiss as overtly political. He has no roots in academia and is a former Chief economist of the Joint Economic Committee chaired by former Senator Connie Mack. He's one of those talking heads you'll see on Kudlow and Cramer going on about the virtues of tax cuts. It was interesting, however, to see a similar argument put forth by a more credible source in Professor Allan Meltzer of Carnegie Mellon writing, guess where, in the Wall Street Journal op ed page on Friday. His piece is written more objectively but still neglects any differences between the surveys other than the lag in capturing new business formation in the establishment survey. Here's my take on what's going on, which is equally anecdotal to what these guys are doing. I have a close family relative who worked for one of the booming telecom companies that used highly "innovative" accounting techniques. She was making a great living. When she was laid off she spent a long time looking for work. At some point she toyed with starting her own business and actually spent time trying to get customers. Eventually, nearly a year after being laid off she found work, for much less money and fewer benefits. If she had been contacted during her short-spell of self-employment she would have been counted as having a job in the household survey while her former employer would not have counted her in the establishment survey. Any honest study of this issue would look at the busines cycle patterns of self-employment and look at the durations of self-employment and the wages associated with these short-spells. My guess is that much of the apparent increase in employment in the household survey around recoveries is due to a transitory rise in self-employment. Until these kinds of issues are addressed more rigorously it is silly to dismiss the obvious decline in employment. My story says that we have a lot of people who will do what they have to in order to make a buck during a downturn...this could be thought of as a boom in entrpreneurial activity or a boom in desperation during a jobless recovery. The other argument that these folks conveniently ignore is that the unemployment rate is also produced by the household survey which is another indicator of a lackluster job market...but that would get in the way of the spin. Lerxst