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Space, the Final Frontier of Economics

When I was very small, I wanted to be an astronaut – or, better yet, to be Luke Skywalker. With the recent release of “Star Wars: Rogue One” (but I haven’t gone yet, no spoilers!), I thought it would be fun to take a look at the way economists have, in ways both serious and lighthearted, thought about outer space.

Star Wars is a big business here on Earth, as anyone doing their Christmas shopping in a big-box retail store this year will have noticed. But space can also provide an outlet for economists to practice their economic intuition in a playful way.

Last year, Washington University Assistant Professor Zachary Feinstein created an Internet sensation with his short paper written “to calibrate and simulate a model of the banking and financial systems within the galaxy” and “measure the level of systemic risk that may have been generated by … the destruction of the second Death Star.” And Paul Krugman, 30 years before his Nobel Prize, wrote “The Theory of Interstellar Trade,” in which he proves two “useless but true theorems” about how interest rates should respond to interstellar travel at relativistic speeds.

These papers each represent, as Krugman himself quips, “a serious analysis of a ridiculous subject, which is of course the opposite of what is usual in economics.” It’s easy to see how much fun they were to write (and read, for the right kind of audience), but they aren’t exactly relevant.

However, there are real-world intersections of space exploration and economics. This blog post from consulting firm Edgeworth Economics gives a brief nod to positive externalities from the Space Shuttle program. Private ventures are considering the feasibility of mining on other planets or asteroids. But my favorite application of using outer space in economic research comes from what we can see when we are in space and look down.

A 2012 study proposed and estimated a method for using lights seen from space at night to adjust estimates of economic growth. The basic idea is that for many developing countries, official GDP statistics may be of low quality due to a combination of factors, including larger informal markets, less economic integration over regions, and weak government statistical infrastructure.

With this in mind, even an imprecise signal of economic activity that can be measured objectively and easily (at least, easily to those with access to satellite imagery) may help improve estimates of GDP and economic growth. The authors show that changes in lights are useful signals of short and long-run GDP growth measures. They propose that (i) a weighting of official statistics and lighting data for countries with unreliable statistics may provide better growth estimates, and (ii) the lighting data can help us estimate growth at levels of geography smaller than countries. This is especially helpful, they say, in nations where such regional data is not readily available.

Economists may not be astronauts, but we can still learn from them.

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A More Affordable Holiday Season

christmas-take-3In the new edition of AIER’s Everyday Price Index, we discuss the prices for common holiday gifts like apparel, books, and personal-care products, which are all lower.

The EPI starts with the Consumer Price Index, which tracks inflation. It then strips out the fixed expenses faced by consumers, such as home mortgages. The EPI fell 0.4 percent in November, led by lower gasoline prices. The CPI, meanwhile, fell just 0.2 percent for the month on a non-seasonally-adjusted basis. The EPI is not adjusted either.

Read more about the new edition of the EPI here.

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Keep the Fed’s Decision in Perspective

The Fed’s decision yesterday to raise the federal funds target rate by ¼ point, from a range of 0.25 – 0.50 to 0.50 – 0.75, sent shockwaves through markets. To be more precise, it wasn’t the increase itself, which was possibly one of the most widely anticipated moves in decades. Rather, it was that the Federal Open Market Committee (FOMC) raised its rate policy outlook for next year to include three ¼-point increases instead of two, raising the fed funds target for year-end 2017 to 1.4 percent.

This is being interpreted as a seismic shift in the Fed outlook. Whether one additional quarter percentage point is seismic is up for debate, but it is important information. Any change in the Fed’s assessment of the economy and outlook for future rate policy will affect the economy, but it should be kept in perspective. The forecasts (also known as dot plots) are updated quarterly, allowing participants to incorporate new economic data into their expectations. It also allows participants to reevaluate the scope and impact of potential future outcomes based on new information such as the surprise presidential election results and the potential impact on the economy from new policy.

As critics of the Fed will note, its forecasting prowess is far from perfect. Its members and staff are among the most talented economists in the profession, but they cannot accurately predict the future with any certainty. To that point: In December 2015, the FOMC projection for the fed funds rate at the end of 2017 (the period for which the FOMC just changed its latest forecast) was 2.4 percent. In the March 2016 projection, participants lowered their outlook for 2017 to 1.9 percent; in June, they cut it to 1.6 percent; in September, it was cut again to 1.1 percent; then finally in the latest projection, it was raised to 1.4 percent. So, the forecast is back to about where it was in June, and still well below prior forecasts.

Yes, it does represent an increase to the forecast following a string of cuts and that is a positive sign, but it should not change most views of the economy.  Everyone inside and outside the Fed see the same economic data and are aware of new developments such as the results of the presidential election. They are doing what every economist does: They update their assessments of the economy and its likely future path based on the latest information about where we are in the business cycle. The Fed’s updated outlook is confirmation of this process, but not a dramatic new piece of information.

What we know:

  • The 2007-2008 recession was the most severe since the Great Depression.
  • The economic recovery has been slow by historical measures, and growth has been erratic.
  • Inflation has been well below the Fed’s long-run target.
  • Much progress has been made over the past seven years, with the unemployment rate falling to 4.6 percent in November, and inflation measures moving closer to 2 percent.
  • The Fed has been exceptionally accommodative through quantitative easing programs and extremely low interest rates.
  • The Fed has said (and shown) that it will be cautious in removing monetary support for the economy.
  • The Fed has now raised rates for the second time in two years.
  • The Fed’s best ESTIMATE AT THIS POINT is that it will continue to raise rates SLOWLY.
  • The current projection calls for three ¼-point increases next year.
  • The Fed is data dependent and the path of future rate increases is not locked in.
  • Like all economists, its forecasts are subject to revision.

Tracking and understanding developments in Fed policy and FOMC participants’ projections is important. But it should be kept in perspective. It is just one piece of information that should be considered in a prudent and thoughtful analysis of the economy.

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The Receding Risk of Recession

Economic conditions have improved, as our economic index rose to 67 in November, up from 58 in October, according to the new edition of Business Conditions Monthly, out today.

This is the third month in a row that the index is above the neutral 50 level. We do not believe there is enough evidence to suggest that the economy is on anything but a slow growth path. However, a reading of 67, the highest since September, provides solid evidence that the risk of recession in the months ahead has diminished.

The improvement was due to two of the 12 indicators improving from negative to neutral. They were consumer sentiment, as measured by the University of Michigan Index of Consumer Expectations, and real new orders for core capital goods.

It is unclear whether the improvement in consumer expectations has anything to do with the presidential election’s outcome, or simply the end of the campaign. Regardless, consumers remain the engine of growth, supported by a strong jobs market and rising consumer sentiment.

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The Struggle to Save Money

In previous blog posts, I’ve discussed some reasons Americans spend more and save less than they should or even plan to. The implicit assumption in these discussions was that they had the option — in other words, that they had the resources to achieve some level of financial wellness.

But as my upcoming brief in January shows, that only includes about half the population. The other half of Americans cannot afford to set aside the money needed to be resilient to financial shocks and prepared for the future.

For the purposes of the work, I look at three major components of what are termed financial wellness: short-term liquid savings, longer-term savings and investment, and not having or paying off debt. I look at this question of who can “afford” financial wellness by simulating the budgets of young, single Americans. I estimate how much so-called discretionary income they have by subtracting out taxes and the cost of living for basic necessities (not including things like meals out, vacations, or home appliances). We’re then left with so-called discretionary income. That money can be saved or invested, or it can be spent on the type of lifestyle goods mentioned above.

I go over multiple plans in the brief, but here I’ll focus on putting 10 percent of one’s income toward the financial goals listed above. For instance, under this plan an individual could build an emergency savings fund equal to three months’ salary (a level recommended by some experts) in two-and-a-half years, before turning to longer-term investing goals such as retirement. Many experts recommend putting away more than 10 percent, but it’s a modest start.

I estimate that the median 30-year-old with annual income of $35,600 would likely do fine with this rule; put away 10 percent and he or she would still have $250 per month for meals out, vacations, or saving for a down payment on a home. However, moving not that far down the income distribution, those below the 43rd (about $32,000) percentile of income could not afford this plan while living even a modest lifestyle. And we haven’t even considered debt: Give that median earner the average American’s credit card debt, and he or she would no longer be able to afford the 10 percent rule.

It’s staggering to think that almost half of Americans (many defined as middle class) cannot afford to set aside the money required to achieve what’s being called financial wellness. But there’s a second group deemed financially well, who could afford to put the money away but do not. For instance, well over half of earners in the top quartile do not have the recommended amounts of money in short-term savings. It’s important to estimate the relative size of these two groups because they need different assistance in addressing the problem. Those who can afford financial wellness may benefit from “nudge” type rules like making investing in a 401(k) the default option. But the group that cannot afford to set the money aside likely needs investment in human capital, as well as real discussion from experts that provide help about more modest  goals that would help more people set at least some money aside.

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Economics Education: Planting the Seeds

natalia-and-michelle-3I recently came across Fred Ende’s blog on the topic of his educational professional development resolutions for 2017. I like the analogy that he uses to describe the value of a professional-development follow-up process by stating that “regular water — reflection — and sunlight — coaching/support — are needed for the best growth” of a planted seed of a teaching idea.

One of the special features of AIER’s Teach-the-Teachers Initiative (TTI) program, Economics Across the Curriculum, is the follow-up mentoring that leads to preparation and implementation of the lesson idea into the classroom. Our participants, mostly high school teachers teaching a wide array of subjects, learn how to integrate basic economic concepts into their courses.

Learning doesn’t end when the seminars are over. It is continuous, and so our program encourages participating teachers to develop their creative lesson ideas further, and put them into action.

The most challenging aspect of this implementation phase is not the development of the actual lesson plan – teachers do it easily — but rather, it is the construction of an evaluation instrument to measure students’ learning outcomes. Yes, we aspire to see if students’ knowledge improves after their teachers go through our program.

To measure students’ knowledge acquisition, we work with teachers to develop tests to administer in the classroom, before and after they have conducted the lessons created during our program. I am amazed how creative teachers are in integrating economic concepts into their non-economics fields of study, but I can see how difficult it is to come up with the evaluation instrument that would be personalized enough to capture the nuances of that creativity.

So far we have the results of 14 field tests conducted by teachers from our 2016 program. Students say that lessons are memorable because they are connected to the “real life” and are “interactive,” as well as “fun.” These comments show that our teachers are able to spark an interest in economics in their students, and make the concepts relevant to their lives.

This year we held training sessions in Boston, Philadelphia and Chicago. We will continue our westward expansion in 2017, building the TTI program to become truly national. We are planning to be in St. Louis, Miami, and Omaha next summer.

Recently, our Education Programs Coordinator, Michelle Ryan, and I were at the National Council for the Social Studies conference in Washington, D.C., where many social studies teachers and administrators stopped by our table to get more information about our program. We are confident that the seeds of economic knowledge that we plant during our workshop will grow into mature programs of interdisciplinary approaches to teaching economics with the help of our mentoring, reflection, and support along the way.

Picture: Michelle Ryan (left) and Natalia Smirnova at the National Council for the Social Studies (NCSS) conference in Washington, D.C., December 2-4, 2016.

More Positive News For the Economy

The Federal Reserve yesterday afternoon released data on household balance sheets and income for the third quarter of 2016, and the results look favorable.  Household net worth rose to a record $90.2 trillion on gains in assets, amid modest increases in liabilities.

Equity holdings rose by $494 billion over the previous quarter, while the value of real estate grew by $554 billion. Total assets rose by $1.7 trillion. On the liabilities side, total liabilities rose by $152 billion, a 4 percent growth rate. Taking on more debt may be a sign that Americans are more confident in their own economic situation.

In another positive development, household savings rates remained at a relatively healthy level. Household savings measured in the flow-of-funds accounts tend to be volatile quarter to quarter, but on a two-year moving average basis, the household savings rate is slightly above 10 percent, well above the low of a 4.4 percent rate in 2007. But that still remains below the mid-teens rates that were prevalent from the mid-1960s through the mid-1980s.

The combination of gains in jobs and incomes, along with solid household balance sheets, rising net worth, and improving consumer attitudes are all positive developments for the economic outlook.

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Budget Airlines Are Driving Competition For Everyone

United Airlines made headlines recently with its announced introduction of Basic Economy pricing – and mostly not in a good way. Most of the coverage has focused on the fact that this plan no longer includes complimentary carry-on baggage or choice of seating, with the baggage fee recently drawing the ire of Senator Chuck Schumer.  However, this new fare is just the latest example of increasing competition between name-brand airlines and budget airlines such as Spirit and Frontier airlines.

When I lived in Michigan, there were a number of cheap routes offered by Spirit Airlines, and I can personally attest to many of the inconveniences – less legroom and comfort in seats, individual fees for baggage and seat choice, lesser customer service and fewer re-routing options if flights were canceled – but I can also attest to the cheaper price. And I benefited from Spirit even when I decided on another airline.

Research has confirmed that low-cost carriers (LCCs) provide close enough competition to have an important impact on legacy carriers’ fares. That 2016 study finds “LCCs have a much larger fare impact than do legacies, but that their fare-reducing effect diminishes as they become dominant on a route. It also finds that legacy carriers primarily affect each other’s prices, whereas LCCs have a significant impact on pricing by both other LCCs and legacies.”

In other words, Spirit is having a lot more effect on United than United is having on Spirit. In fact, low-cost carriers have been effective enough that the two types of airlines are in fact becoming more similar to each other along operational dimensions like route choice as well as in pricing structures such as United’s introduction of Basic Economy. In a recent academic book chapter on the economics of airlines, the authors conclude that the “current competitive atmosphere improves efficiency as the distinctions between legacy and low-cost carriers have become less obvious.”

While we may like to complain about service, the evidence is that when making tradeoffs between price and service, U.S. air travelers largely choose price.

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Why Auto Sales Are Up

Increased sales of both cars and light trucks have been supported by improvements in both the labor market and financing conditions.

Cars and light trucks in the U.S. sold at an annual rate of 17.7 million in November, according to information released by Autodata last week. That marks a solid increase from the spring, when vehicles sold at an annual rate of 16.5-17.1 million.

The U.S. economy has added an average of 188,000 jobs each month over the past year. Even with brisk hiring, data on job openings released this morning remains elevated, suggesting continued job gains. Layoffs are subdued, with initial claims for unemployment insurance as a share of employment are at an all-time low. The unemployment rate fell to 4.6 percent in November, its lowest point since the recession. Solid employment prospects have helped some consumers qualify for auto loans.

According to the Federal Reserve’s Senior Loan Officer Survey, auto financing conditions have improved. Over the past three months, loan officers reported that credit score requirements and down payment requirements for auto loans are little changed. Loan officers also reported that maturities for auto loans were lengthened. Loan officers at small banks reported offering lower interest rates. Auto loan delinquency rates have been stable at 3.4 percent, markedly improved from the 5 percent rate in recent years.

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How Much Control Does the Fed Actually Have?

AIER Trustee Walker Todd recently took note of this provocative piece from George Selgin, which argues that the Federal Reserve Bank’s actions since the Great Recession have done little good to boost the economy.

Todd and Selgin, director of the Center for Monetary and Financial Alternatives at the Cato Institute, recently sat on a panel at Cato’s Monetary Conference in Washington, D.C.

According to Selgin, the natural movements of the economy, not the Fed’s interventions, are responsible for the low interest rates we have seen in recent years. The Fed’s expected increase in the federal funds rate later this year follows actual increases in interest rates amid improving economic data.

The Fed isn’t entirely powerless: The Bank’s raising of rates in the months before the collapse of Lehman Brothers in 2008 contributed to economic conditions that were too tight, causing real interest rates – and consumer demand — to crash, he argues.

In the years since, the Fed kept reducing the federal funds rate, which is intended to stimulate the economy by encouraging banks to lend out more money. But at the same time, actual loan rates were already well below the Fed’s targets already in place, and “by the time the Fed got around to lowering it, the federal funds target had ceased to have any meaning, save as a symbol of Fed officials’ vain hopes.”

When the Fed used unconventional policies like quantitative easing to pump money into the economy, it would have been expected to boost spending, inflation, and nominal interest rates. But those variables were only affected modestly, if at all, and the Fed’s interventions have caused uncertainty about the course of future interest rates, which dampens the appetite for investment, he argues.

You can read Selgin’s piece here. A piece about Walker Todd’s participation in the recent Cato panel can be found here.

Do you agree? Send us your comments below. We’d love to hear from you.

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