Comment Cards 06

Okay, I'm picking and choosing a few insightful questions/comments to respond to from this semester's crop of comment cards. We had some good ones and I don't want to miss the opportunity to support a dialogue of ideas.  These will be randomly chosen.

1. So it seems obvious that government's surplus is a good thing. Why then do conservatives argue differently?

R: This is an interesting situation in which conservatives find themselves. To be a fiscal conservative is to love surpluses (or, at least, balanced budgets) and to hate deficits. But they've been forced to embrace deficits because every Republican president since Ronald Reagan has had one. Reagan did not come into office brandishing a deficit spending strategy, just the opposite. Reagan wanted to shrink government, deregulate the economy, grow the private sector and reduce everyone's taxes -- particularly that of business. When he cut taxes though he couldn't bring himself or Congress to actually cut budgets. In fact, the Reagan and Bush I budgets grew faster than any in peace time. What they found was that the pet programs of conservatives were just as costly as the pet programs of liberals. Now it was Star Wars (weapons in space), new weapons programs, multi-billion dollar contracts to favored industries and faith-based initiatives. It still winds up to be spending more than the government is receiving in tax revenues. How do they justify it? Well lately they keep harping on how their plan is to "grow the economy out of the deficits." In other words, some time in the distant future we'll have a big enough economy to bring in more tax revenues while the government budget somehow is held in check. They haven't figured how that last part is s'posed to be accomplished though.

2. If we consider investment as an increase in capital and/or an increase in inventories then it will never decrease because as investment in capital goes down we incur a build-up of inventories (unsold goods). So, how can savings affect investment.

R: You have two different questions. Yes, investment is an increase in capital goods (at least that which is in excess of depleted capital goods). And if I doesn't increase then we will have unsold goods (a build-up of inventories is counted as an increase in capital spending for national accounting purposes). What's important though is desired investment. When savings is equal to desired investment (I minus unwanted inventory build-up) then we've achieved general equilibrium. The second question (how can savings affect investment) is answered by savings' effect on the interest rate (r). As savings rise, interest rates fall and investment rises.

3. I cannot exactly understand how a rise in government spending causes a fall in interest rates.

R: It won't. If government raises spending levels (G) then it will increase demand for output, which will usually raise demand for loanable funds causing r to rise.

4. When you talked of the economists (during the 1930s depression) suggesting that all businesses should buy plant and equipment when there was no demand for their product -- because if more equipment is bought then the economy will even out again -- how long will this take?

R: As soon as orders are placed employers would have to hire workers back, pay them a wage and begin production. One would think that in six months an economy could be turned around if all businesses acted at once. But remember, what is collectively a great thing for the economy can look ludicrous to an individual firm when they have half their plant idle and no prospects for renewed demand anywhere in sight. Individualistic capitalism doesn't act collectively.

5. Aren't people who come here temporarily from other countries,  work here and then take that income back to their countries a leakage?

R: I have said in class that services are not transportable, i.e., not subject to exporting and importing. I lied. Actually, services today are highly transportable because of the computer. When we pick up the phone and are given flight information from a person in a tele-marketing operation in Pakistan, we have just paid for a service that was imported into the U.S. When a foreign national earns money in the U.S. and returns to his or her country, he or she has performed a service that has been imported and the money in their pockets as they leave the country is a leakage from the domestic income-consumption stream.

6. Please explain the dual labor market theory a little more.

R: Okay, this was a theory developed by a professor of mine (David Gordon at the New School for Social Research). The idea is that the labor market is stratified into segments that are not connected by promotion ladders. In the simplest form of this notion, there would be a primary labor market where there is job security, decent wages, pensions, medical benefits and low turnover. Then there would be a secondary labor market where there was no job security, low wages, no pensions or medical benefits and high turnover. Since they are two separate labor markets, they have different supply and demand curves. Wages and conditions in one labor market do not affect wages and conditions in the other. I think Gordon, Bowles and Weisskopf -- and Michael Piore as well -- have all been vindicated by recent history. There is no question that we have a growing underclass of workers who are blocked from entering the primary labor market. Many of these workers are recent immigrants.

7. What would be an example of a liquid asset besides cash?

R: A government bond can be readily converted into cash since the government always stands ready to buy it back. A savings or checking deposit is also very liquid.

8. We should watch Office Space.

R: It's too frightening.

9. Is GDP a good indicator of the health of the economy?

R: No. It fails to measure the effects of pollution; unpaid, non-market activity, crime and the depletion of our natural capital.

10. What is America's current savings rate?

R: About 1% of national income.

11. Why does America have the lowest saving rate yet we are one of the wealthiest countries in terms of income, opportunity and investment/consuming?

R: We are a consumer led economy. We have the biggest market in the world and everyone wants to sell their products to us. We can survive for some time without having to worry about the shortage of domestic sources of loanable funds if the rest of the world is willing to buy our bonds (corporate and government) allowing us to continue to add to the capacity to produce. So, our investment funds come from foreigners who have faith that our economy and our currency will remain strong. That cannot continue forever.

12. What if China decided to end trading with the U.S.: If China is the biggest source of our imports, how badly will it impact GDP?

R: That's the worry. In particular, China may decide to hold its bank reserves in Euros rather than dollars. If that occurred suddenly, the dollar would free-fall in value and we would be forced back onto our domestic production for consumer and capital goods. Not altogether a bad thing since it also would be a big boost to the reduction of greenhouse gases.

13. Is the exchange rate considered part of inflation?

R: The exchange rate is connected to the domestic rate of inflation. The higher the rate of inflation, the faster prices rise each year and the less our dollar will purchase in American goods. Since foreigners will not want as many dollars because they have less purchasing power, they will cut back on buying American goods (returning to their domestically produced goods) and the exchange rate of the dollar falls (demand for dollars falls).

14. Why would the labor force shrink if each generation continues to be larger than the previous generation?

R: But it's not. Many industrialized countries are right at the replacement level of their population or less. Japan's families have an average of 1.2 children. That wouldn't be so bad if it weren't for the fact that just after World War II most of the industrialized west began a spurt in birthrates. Those in the baby boom generation represent the largest percentage of the population. They will soon leave the labor force (retire). So, we're about to have the smallest share of our population actually working in our history. Others dispute this by saying that all that baby boom loss will be made up by immigration. They're probably right.

15. What is the nominal rate of interest compared to the real rate of interest?

R: The real rate of interest = nominal rate of interest - the rate of inflation. So, if the nominal rate is 8% (that's what you would pay for an average loan) and the rate of inflation is 2% then the real rate of interest is 6%. That's important because it tells the lender how much purchasing power he/she will get after price increases have been taken into account. It's also important for workers -- if their wages rise less than price increases, then the purchasing power of their wages is less (less real wages).

16. So is the New York real estate market price inelastic?

R: Certainly the supply is inelastic with respect to price. Since there is only a finite amount of land and there are height limits on the buildings any increase in real estate prices does not bring forth a comparable quantity of new building space.

17. With the increase in the price of oil would people start to use solar?

R: That's the idea of the self-regulating market place. If a commodity's price rises then substitutes with slightly lower prices would begin to look attractive. Greater resources would then be devoted to solar technology. But we have entrenched and powerful interest groups that have great influence over our energy choices. Dick Cheney's Energy Task Force which met prior to 9/11 set about the planning of how they would divide up the oil fields of Iraq (remember this was before we were attacked). The plan was to cancel the pre-existing oil contracts that Hussein had with companies from other countries and replace them with Exxon-Mobil, Chevron and Marathon. They have done that. Read the book, The Bush Agenda by Antonia Juhasz. It is eye-opening.

18. If the minimum wage was increased wouldn't that give the workers at Walmart and Home Depot the incentive to work there longer (Due to the increase in pay)? Because from my knowledge the people who work at Walmart don't tend to want to make it their career. Higher wages -- happier workers -- less turnover.

R: Who said Walmart wants to lower turnover? When they can train workers in a few hours to work at peak efficiency, why should they worry about losing workers? Moreover they want to encourage turnover to discourage unions (the longer you're there, the more you begin talking to your co-workers), reduce the obligation of paying retirement benefits, avoid giving raises and squeeze workers to work longer hours under more onerous conditions. The last thing they want is to have their managers develop a close relationship with their employees -- that could begin to engender empathy.

19. What is the impact of rising interest rates on spending?

R: Rising interest rates mean the cost to borrow funds is higher. The higher the cost of borrowed funds the fewer individuals and businesses will borrow to finance the purchases of durable goods (consumer goods and capital goods). Spending will thus fall. The higher the interest rate the more the choice is clear -- spend or save --. People and companies will likely hold off spending and take advantage of higher interest rates by putting their money in savings accounts, bonds, securities etc.

20. People might feel really happy if they knew that for every $95 they put in the bank they would get $100 in a year. But wouldn't the cost of living in the future be higher as well?

R: Yes, and that's why it's important to know what the real rate of interest is. See question #15.

21. If the substitution effect is stronger than the income effect, what do prices have to do with the amount of $$ people want to spend?

R: If the price of a particular good rises consumers will buy less of all goods (their incomes don't go as far) but on the other hand, they may shift their consumption to the relatively lower priced commodities causing them to maintain or even increase total spending. All this depends on the ease with which consumers can substitute away from the higher priced good.

22. Does inflation change the speed of spending money today?

R: Inflation is not as high as it has been in previous years (particularly the latter half of the 1970s) but what's important is anticipated price increases. When we believe the price of gasoline is going to rise soon we may be more likely to fill up today rather than wait. So, anticipated inflation will speed up spending plans.

23. Is the bank legally bound to keep the exact interest rates -- that promised to a borrower/depositer before inflation.

R: Interestingly, the opposite is true. More and more loans (particularly mortgage loans) are inflation-adjusted to protect the bank not the borrower. Moreover, few but the very wealthy can find investment instruments that guarantee them inflation-adjusted returns. When our son was just five years old we put money into a college investment plan that guaranteed (given projections of college costs when he was 18 and our willingness to routinely deposit xx amount of dollars every month) the tuition of certain-tier schools (they ranked the projections according to Ivy League, state schools etc)  would be available in 13 years. Those kinds of investment are rare however.

24. How would you draw the production possibilities curve with more than two variables (is it possible)?

R: Yes, they're called input-output tables. They take the inputs necessary to produce all major commodities and services and project their availability then project the output that's possible to produce for the whole economy. It's very much a guessing game however. If you were to illustrate the tables on graphs, there would have to be multi-dimensional characteristics to the drawing. The use of isoquants and isocost curves represent such an effort in a minor way. Examine an intermediate micro or macro text. They have such illustrations.